So, you’ve earned yourself a raise, and maybe even a promotion. Congratulations!
But, what now?
While you may want to celebrate and treat yourself by heading on a shopping spree and out to a celebratory dinner, you don’t want your spending to get out of hand. You should think about making that extra income work for you, and not just fritter it away.
When a raise isn’t really a raise
When you get a raise, it’s imperative that you try and put it in context as to how much purchasing power you’re gaining. In some cases (such as a cost-of-living raise or adjustment, meant to offset inflation), a pay bump does little to increase your financial standing.
For example, the average pay raise in 2018 is expected to be around 3%, according to industry data. But when you factor in taxes and inflation, which is our money’s tendency to lose value over time, you may not actually see much of a pay boost at all.
Inflation rates, as of August 2018, are 2.2%—so, if you receive a 3% raise this year, it means you’re effectively earning less than 1% than the year before. Your pay raise is being eaten up by economic forces beyond your control.
Similarly, your income is taxed based on the total amount of your pay. So, when your salary goes up, likely so will your tax bill. And if your raise pushes you into a higher tax bracket, then the amount taken out of your raise will be even higher.
That’s why the single most important thing you can do when receiving a raise is probably to keep your lifestyle in check.
You may have heard or read about “lifestyle inflation,” which refers to a person’s tendency to spend more money as they make more money.
Think of it this way: When you’re making more money, you may be tempted to eat out more often, or maybe go out to dinner at better restaurants. This is an example of lifestyle inflation or lifestyle creep. Before you know it, you might also spend more money on all sorts of things—a nicer apartment, perhaps, or a new car.
While you can probably get away with some small upgrades following a significant pay raise—more than just a cost-of-living adjustment—the best thing you can do is to try and maintain your current lifestyle and stick to your current budget.
And as for that extra money you have coming in? Here are a few ideas.
Bump up your savings
Hopefully, you’ve already started saving, stashing money away for retirement, and investing. If not, start now.
If you already have an emergency fund, retirement account (either a 401(k) or an IRA), and an investment account, you can increase the amount you’re putting away every month. For example, if you’re currently contributing 4% to your 401(k), consider increasing your contribution to 6%, or another percentage that you’re comfortable with.
Pad your savings
You should have an emergency or rainy-day fund. If you don’t, start one now.
If you do, see what you can do to pad your savings. If you have three months’ worth of expenses saved up, consider increasing it to six months. You can never have too much money squirreled —though you probably don’t want to have too much sitting in savings, as it can be vulnerable to inflation and won’t earn much interest sitting in a savings account.
Broaden your investments
Finally, look at ways to expand and diversify your investment portfolio. You can probably always broaden your holdings, and even consider new types of investments.