Economists keep a close eye on inflation as measured by the consumer price index (CPI). It tells us how much more the stuff we regularly buy costs us over time.
We tend to get pretty worked up about the ever-increasing cost to fill up at the pump – enough so, that most people think about various ways to save on gas. What we don't have a good grip on is lifestyle inflation: the increase in the amount or type of stuff we want to buy over time.
Inflation in prices is something we have no control over as individual consumers. Just ask anyone close to retirement what they paid for their first house compared with what they paid for their latest car. My parents' first house in Ottawa was $26,000 in the seventies and their most recent vehicle purchase was about $40,000.
Extrapolate that to when I would hit retirement age and a mid-sized sedan might cost $250,000. That's CPI inflation. Lifestyle inflation means that, by then, I'll want a sporty little convertible that could run to $500,000.
Truth serum: I want one of those right now. Really badly. I'm a "car guy" of the first order, so frivolous spending on all things automotive is high on my want list. I believe that one or two spending vices are okay. It might be travel, sports, home, fashion or fancy coffee beans. As long as you're not spending beyond your means over all, you can indulge. The problem is that we want to indulge in everything.
As our incomes grow, so do our expenses. You make $30,000 a year, you'll spend $30,000 a year. Fast-forward 10 years and you might be earning $60,000, but spending $60,000. On the lower side of the income spectrum, it's harder to put money aside for savings, because there is a floor of spending required to maintain a basic lifestyle.
But everyone has the thought of taking their next raise and using it to accelerate debt payments or increase savings, while maintaining their current level of spending. Unfortunately, all too often the debt payments and savings are the items that are not increased as the spending rises.
When a big raise is in the cards, or perhaps a big payment is eliminated, you might ask if now is the time to upgrade your home or cars. "We've got an extra $500 in cash flow. What can we afford to upgrade to now?"
The absolute maximum lifestyle inflation you might be able to afford would be to fill that $500 momentary surplus with a new continuing $500 monthly commitment. That would be perennially living at your means, not within them.
Some of that extra $500 is going to be consumed by CPI inflation. What you are already buying is going to be 2 to 3 per cent more expensive than last year. The difference between what CPI inflation claims and what your additional wants claim of that $500 plays a large part in determining how successful you are going to be with your finances. If you don't think seriously about it you'll discover that it all finds a way of getting spent. You'll never get ahead.
Too much inflation of either kind is not a good thing. While we have one of the most respected central bankers in the world in Mark Carney looking over CPI inflation, only you can control your lifestyle inflation.
Preet Banerjee, B.Sc, FMA, DMS, FCSI, is a W Network Money Expert, and blogs at wheredoesallmymoneygo.com. You can also follow him on twitter at @PreetBanerjee
Preet Banerjee