Steadfast FinancesShould I Ignore my Raise and Save the Difference in Income?

Should I Ignore My Raise and Save the Difference in Income?

Filed in Career , Personal Finance , Saving Money 13 comments

This personal finance question comes from reader Gary, who recently got a surprise promotion and a 20% raise after his boss left the company. He’s married, has a 2 year old daughter that his wife is caring for full time, has a monthly mortgage payment, two monthly car payments and no consumer debt. He’s curious if he should use the salary increase to boost his standard of living or if he should pretend his income has not changed.

Congratulations! After 5 years of diligence and hard work, your company surprises you with a big promotion. Obviously, with the big increase in responsibility and the additional headaches, management also thinks you deserve a fat 20% raise! (You lucky devil!)

Compared to what you’ve been making over the last few years since joining the company, you’re going to see a fairly generous boost to your (disposable?) income. But does this mean you should buy a bigger house or buy a shiny new car?


*assumes a 4% annual raise every year.

Opinions and pre-existing debt levels will vary from person to person, but the safe play is to live as you have prior to getting a raise, act as if it never happened, and stash this money in a rewarding stocks and shares ISA.

Allow me to explain…

Continuing to Live on Your Pre-Raise Salary

While you definitely deserve to spoil yourself over the short term (weekend golf trip, an out of the norm shopping trip, etc.), life altering events like these offer a great opportunity to raise your standard of living, or take the opportunity to strengthen your financial foundation for you and your family.

Here’s some supporting evidence for ignoring your raise:

  1. Were you living comfortably prior to raise? If you were living fairly comfortably prior to your raise, why should a 20% bump in salary change your spending habits? Over the last 2 years (after his daughter was born and his wife stopped working), you’ve managed to pay your mortgage, support your family, and by all appearances, had the foresight to avoid any serious financial shortcomings and keep yourself out of debt. In other words, since you’ve obviously had a reasonably good standard of living prior at $60k per year, why should $73k be all that different?
  2. Your living expenses are fixed and/or predictable. Since the majority of your monthly expenses are fixed (mortgage and car payments), you probably don’t have any major expenses that would validate tapping this increased income. Sure, things like food and utilities will vary from month to month, and perhaps even your real estate taxes might go up a little each year, but you can be relatively certain that you’re not going to have any major expenses come up in the short to medium term. (Of course, this could change if you decide to have more children, but that only strengthens the case to save the extra income.)
  3. Resisting the cash flow leeches. Now that you have more disposable income, the temptation to spoil yourself will increase. A little spoiling is good, but keep it all in moderation. Even though you can afford to be frugal in better stores, it doesn’t mean you should add additional cash flow leeches to your how things own you calendar.

If you don’t buy this argument of ignoring your raise, you’re probably thinking… sure, this all sounds great, but is it really possible or just fantasy land gibberish?

I would argue that it’s definitely realistic because I did it. I implemented this technique after job hopping four years in a row and each time I’d get a bump in salary by switching jobs, I’d funnel the additional income into a savings account or somehow put that money to work. So even though I was making far more than when I first entered the job market, I took pride in knowing that I was still living on a first year, fresh out of grad school salary.

In the end, the trick is to know the difference between buying the things you want vs. buying things you need. Anyone can justify and self-validate the need to buy stuff, but once you realize that you can modify your spending behaviors and that you might not need every little thing you want to buy, you’ll probably find yourself right path to saving a substantial portion of your disposable income.

Alternatively, if you find yourself in a similar position with your career, but you haven’t been as steadfast in your fiscal responsibilities, then you should consider using these funds to right the ship. If you’re over-leveraged and barely keeping your head above water, then by all means, use this extra income as a means of stabilizing your monthly budget. If you have a significant amount of consumer debt, then use these funds to aggressively pay down your debts using the debt avalanche method starting with your highest interest rate debt first.

Got any additional advice for Gary?

Overall, I think Gary is in pretty good shape since he’s thinking so far ahead and has the foresight to ask questions what to do about his additional income.

My advice would be to create an emergency fund totaling 6 months living expenses (better safe than sorry), then begin to aggressively pay down your auto loans. Also, if you haven’t done so, you should consider maxing out your 401k contributions to get 100% of your employer’s retirement fund match, max out your Roth IRA (for you and your wife), and create a 529 fund for your baby girl. After all, she’s one of the big reasons you’re busting your hump everyday!

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Posted by CJ   @   20 January 2010 13 comments
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13 Comments

Comments
Jan 20, 2010
4:16 pm
#1 Kyle :

I recently had this same dilemma, well I don’t know if I would call it an actual dilemma having to deal with “extra” money. In the end I didn’t see any reason to increase my take home pay at all so I actually pushed my entire raise into my 401k. I didn’t need the raise to survive and this way it is stashed away for retirement pre-tax, making my raise that much more effective.

Jan 20, 2010
4:23 pm

Gary is in a great position and I think you hit the nail on the head, create an emergency fund then max out the 401K and contribute to a 529 for the daughter. I wish I had a way-back machine so I could do that for myself.

Jan 20, 2010
4:59 pm
#3 Carrie :

i think that if you’re already in a good position financially, give yourself a bit extra each month to spend on some treats and save most of it

Jan 20, 2010
7:49 pm
#4 Bytta @151 Days Off :

I agree with Carrie. My pay fluctuates each month due to commission and bonus payments, so I set savings target for each month.
For those good months with extra cash, I would put 90% to savings and 10% to splurge. After all I want to live today AND save for tomorrow.

Jan 20, 2010
8:09 pm

I would definitely say, increase giving, build an emergency fund, repay debt, fund retirement and then college savings.

Jan 20, 2010
9:26 pm

I’d look at what’s been going towards retirement. If it’s less than 15%, bump it up. If it’s 15% or higher, make sure you have a decent emergency fund, and then use 3/4 of it for medium term savings, and 1/4 (i.e. 5% of the 20%) for increased fun.

Jan 21, 2010
3:19 am
#7 moink :

I’ve taken a moderate tack in my own life.

We’re living a pretty bare-bones existence right now – no car, I own two pairs of work pants and one pair of jeans, rarely eat out, etc. I can’t live like this forever, and I want to be motivated to earn more money. So I allow some lifestyle inflation.

Here’s my rule: I increase my spending at half the rate my salary increases. For example, when I first started this job (my first real, post-PhD job) I was bringing 1950 gbp home and spending 1700, putting the rest into a tiny emergency fund and then paying off debt. Then I got a 5% raise. So I am now bringing home about 2050, and spending 1750. I increased the amount I’m putting towards debt from 250 to 300. I get a better lifestyle, *and* I get to pay off debt significantly faster. My debt will be paid off next month and then I will save a bigger emergency fund.

When this strategy gets me to saving 20% of my paycheque I will re-evaluate.

Jan 21, 2010
11:17 am
#8 Matt SF :

Good move, that’s probably one of the more effective ways of “saving” money. Hard to spend what you can’t get your hands on.

Jan 21, 2010
11:18 am
#9 Matt SF :

I call shotgun on the way-back machine if you find one!

Jan 21, 2010
11:19 am
#10 Matt SF :

Good advice Carrie. All work (or saving) and no play makes for a dull life.

Jan 21, 2010
11:20 am
#11 Matt SF :

Excellent work, a 90/10 savings to splurge ratio is hard to do considering it takes so much discipline. Bravo!

Jan 21, 2010
11:22 am
#12 Matt SF :

Good points all around Joe. Gary didn’t include how much he’s saving in his 401k, but considering he seemed like a pretty savvy guy, I’d bet he’s getting all of his employer’s match.

Jan 21, 2010
11:24 am
#13 Matt SF :

Good plan Moink. Aggressively paying off debt is always a solid plan, just make sure you’re not paying so much that you don’t have adequate reserves should an emergency arise.

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