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- When you get a salary raise or bonus, it’s tempting to spend the extra money.
- Try not to succumb to lifestyle inflation, which is when you spend more as you earn more.
- Use the extra income to bulk up your emergency fund and increase your retirement account contributions instead.
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Scoring a pay raise or a bonus feels really good.
It’s validating and can often boost motivation, but it’s not easy to come by.
Fortunately, hourly wages for US workers have risen 3.4% in the last year, according to the Economic Policy Institute. But despite the average American believing they deserve a raise, more than 70% aren’t asking for one.
This could be a huge mistake, especially for younger employees. Securing big salary gains in your 20s and 30s – before income levels off in your 40s – can make all the difference when it comes time to retire.
So if you’ve worked hard for a pay raise, don’t take it for granted. Here are the first three things you should do with your money, no matter how big or small the bump in your paycheck.
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1. Bulk up your emergency fund
Everyone needs an emergency fund, because it’s really not a matter of if you’ll need to fork over cash for a car or home repair, child expense, or medical emergency, but a matter of when.
Experts recommend putting away three to six months worth of expenses in a money market account or high-yield savings account. It will keep your money safe and liquid and you could earn an interest rate of more than 2%, compared with the much lower 0.01% on a traditional savings account.
Once you get a raise, transfer money from each paycheck into an emergency fund until you reach your goal. And don’t forget – automation is your friend when it comes to saving.
2. Increase your automatic contributions
After getting your emergency fund into shape, turn to your retirement accounts.
We know it’s not easy to forgo money in your pocket to bulk up a savings account you won’t see for decades, but it’s the smartest thing you can do with any extra income.
The Money Wizard is a 28-year-old blogger who has banked more than $281,000 as part of a plan to retire by 37. Each time he got a pay raise, he increased his 401(k) contribution by the same amount to reach the maximum allowed investment of $18,000 a year. He calls it “the smartest investment I ever made” in part because he saves more than $5,000 a year in taxes.
“By saving off the top, an amazing thing will happen,” he told Business Insider. “You won’t even notice all the missed money, and you won’t even have to adjust your lifestyle to meet your savings goals. Your spending will instead mold around what’s left, leaving you feeling like you’re living just as great of a lifestyle, all while saving a fortune.”
Keep in mind, it’s not ‘either or’ when it comes to 401(k)s and IRAs. It’s ‘both and’. You can set aside $19,000 in your 401(k) this year and another $6,000 in an IRA. That’s a grand total of $25,000 that you can invest for the future while saving on taxes at the same time.
3. Keep your spending the same
Lifestyle creep is the enemy of building wealth, according to Tom C. Corley, the author of “Rich Habits: The Daily Success Habits of Wealthy Individuals” who studied millionaires for five years.
It’s tempting to increase your standard of living when you start to earn more money, says Corley, but it’s a bad habit.
“The good habit – I call it the ‘Rich Habit’ – is to forgo the desire to spend your money today and, instead, sock it away into savings and investments that grow in value and provide financial resources that can be used in the future to maintain your standard of living,” he wrote in a post on Business Insider.