Everybody knows the excitement you get when you receive a raise. No matter if it is a $100 month raise or a $2,000 month raise it still feels good. Our minds usually go to imaging what it will be like to sit on beach or go to the mountains for vacation, or making that big purchase you have been waiting to make for months. The problem is often we can end up spending more than our raise if we are not careful. If for example you get a $300 raise and go sign up for a brand new car payment of $385, you really did not receive a raise; you took in essence a pay cut! To avoid that situation below are three tips for budgeting a raise.
Avoid Lifestyle inflation
It is easy to spend your raise right away. This goes in with the mindset of our culture today that preaches if you got money, you got to spend it right away. Do not get me wrong, spending more on lifestyle is OK, depending on where you are at in your finances. But putting 100% of a raise into increased lifestyle pushes your budget and finances to the maximum and leaves no margin for life.
The recommendation we make is to put away 15% of your income into retirement. However most people are not there yet. A good way to increase the amount you are saving for retirement is to up your percentage a few points with a raise. If you are making $5,000 a month and are contributing 6% ($300/mo) of your pay into retirement and you get a raise to $5,500 a month, why not up your contribution to 8%. That way you will be putting $440/mo into retirement with the $140/mo increase coming entirely from you raise. You will not miss it a bit and the power of compound interest will start to work in your favor even more!
Pay down debt
This is not the most exciting thing to do with a raise obviously. But if you are using the debt snowball approach to paying off your debt, putting the raise completely on your debt will increase the speed of your snowball and ultimately leave you with more money to spend! If you are already out of debt except your mortgage, you could even start to pay extra monthly on your mortgage and retire that debt early. If you put an extra $200 a month on an $180,000 mortgage financed over 15 years at 5%, you will pay off the mortgage two and a half years earlier and save over $10,000 in interest!
Ultimately you have got to resist the urge to spend your entire raise. Increasing the lifestyle is ok, but instead of committing 100% to lifestyle, why not commit to put a third on lifestyle, a third in increased investments, and another third onto debt elimination? By becoming debt free and investing long-term you will be able make up in lifestyle inflation by becoming wealthy.
So how do you budget a raise? I would love to hear how you go about budgeting a raise.