What to do when you get a raise
Ever wonder how some people work a modest job their whole life and never worry about money? Yet some people make six-figure salaries and are always worried about money. While there’s a broad range of income across the world it’s undoubtedly feasible to live on a $63,000 salary (U.S. national average household income) and many people do this with no issues retiring. Yet others make double this and can’t afford to retire come the appropriate age. The difference — financial education. No matter how much you make or how little you make what you do with every dollar matters. This is why getting a raise is such a pivotal moment in people’s financial trajectory.
Getting a raise, no matter how much or how little, is a great feeling. It opens the door to new opportunities, increases motivation, and let’s face it — it feels good to see your hard work pay off. After a raise, most people’s minds will immediately jump to how they can finally afford the new iPhone or a new TV. But, that’s the opposite of how you should think.
The most common mistake people make when they get a raise is inflating their lifestyle to match their new income level.
Lifestyle inflation is when you raise your ‘cost’ of living to match your increase in income. By inflating your lifestyle you limit your ability to ever truly attain financial security — something most people claim they aspire to have.
An example of this is if you make $3,000 a month, spend $1000 in rent, $300 on a car, $200 on groceries, $300 on student loans, $200 on entertainment, and save the rest; but then you get a raise and now make $4000 a month. With this extra income, you move into an apartment that now costs $1500 a month, buy a second car that costs an additional $400 a month, and spend $100 more each month on entertainment. In this case, you have increased your spending to match your income, thus, inflated your lifestyle. You may feel like you’re more financially secure because you’re making more, but the fact is you’re not. By inflating your lifestyle you’ve actually become less financially secure. If your job were to stop paying you, you now have more expenses at a higher cost than before to cover.
Lifestyle inflation may not seem dangerous because you make more to account for the increase in expenses, but as you continue to spend more with every raise you are technically saving less and less based on percent of income. Generally, you should save at least 20% of your income. Though in many cases this can easily — and should be — be made much higher if you create a strict budget, and stick to it. True financial minimalism would be taking the additional income from a raise and saving all of it, never advancing your lifestyle. This is because in many cases when someone gets a raise nothing in their lives has changed that requires them to spend more. However, people’s emotions often get in the way of this. The lure of bigger and better materialistic goods is more attainable so they think why not splurge.
What they fail to consider when spending more on material goods is where that additional money they spend could be going to. For example, by adding an extra $500 in rent you spend an additional $6,000 annually or $210,000 over the course of 35 years. If you were to instead invest that $500 a month into VTSAX or a similar index fund it would accrue on average 7% interest annually. With all compounding interest accounted for that would grow to be more than $900,000 over the course of 35 years. That means at $500 a month, you could either have $900,000 or have spent $210,000 over the course of 35 years. That’s a spend difference of over $1.1 million dollars. It’s easy to justify spending an extra $500 because you can afford it with an increase in income, but if you were to instead use that money to invest you can create a much more financially stable position for yourself. Consider if a slightly nicer apartment is really worth $1.1 million dollars over 35 years, or if you can live with the one that costs $500 a month less.
By breaking the association of a raise with spending you avoid a life of chasing a ‘better paying’ job or a promotion. You avoid lifestyle inflation and put yourself in a better position to attain financial independence, allowing you to retire on your terms even if you never made a six-figure salary. There will be opportunities to make slight improvements to the quality of life — moving into a bigger house, taking an extra vacation and more. But, it’s important these be done systematically and are accounted for with an increase in savings as well. Whenever possible, look at a raise, not as the opportunity to spend more, but to save more to avoid inflating your lifestyle to a point that surpasses your income.
