When you get a raise, it’s natural to start daydreaming about all the things you’ll be able to do with the money. And there’s nothing wrong with a little daydreaming, so long as that daydreaming doesn’t lead to premature action.
But the very last thing you should do is increase your spending without giving it serious thought. If you do this at all, be sure that you’re not increasing your spending to a level that is higher than your new after-tax income.
So what should you do when you get a raise?
When you get a raise…
Have a little celebratory dinner out if you want to, but hold off on any other spending plans. It usually takes a few weeks before you see exactly how much the raise is really going to increase your paycheck. If you go on a spending spree before you’ve got the money, that raise could cost you.
Next, take a look at your current goals. If you’ve got SMART goals, chances are you already know exactly what you need to do next. Raises are an wonderful opportunity to meet your long-term goals painlessly. After all, you won’t miss the money you weren’t used to getting in the first place. So use the money to help you take that step. Otherwise, decide which of your goals is your biggest priority, and then use the money to help you achieve that.
Unsure of what to use the money for? Instead of succumbing to lifestyle inflation and watching the money get sucked away on things you can’t even name, remember that a raise brings two easy ways to improve your financial life.
Get rid of your debt
If you’re working on getting out of debt, you can add the increased amount to your debt snowball to knock it out even faster. (My debt reduction app can show you exactly what kind of impact throwing a little bit of extra money toward your debt can have.) And when you’re out of debt, you’ll have a whole lot more money available.
Get set for the future
If you’ve already got your debt whipped, this is a great opportunity to make your future self happy by pumping up your retirement savings. You could start by using it to max out a Roth IRA each year. If you’re already maxing out an IRA and your company offers a 401(k) account, consider starting or increasing a contribution there.
To decide how much your raise allows you to contribute, sit down and figure up what percentage a raise you’ve received. To do this, take the dollar amount of your raise and divide it by your current salary. For example, if the dollar amount of your raise is $3200 per year, and your current salary is $32,000, $3200 divided by $32,000 equals .10 or 10 percent.
Next, fill out the form and increase your 401(k)/company sponsored retirement plan contribution by at least an amount that falls within the percentage you calculated. Use each raise as an opportunity to increase your contribution until you reach the maximum allowed. Monthly or bi-weekly contributions are excellent, because they allow you to take advantage of dollar cost averaging.
Your mileage may vary
Keep in mind that while everyone’s situation will vary, it’s usually better to do just about anything with a raise except spend it. (Especially because people tend to over-estimate the difference the raise will make, and end up overspending.) The important thing is to actively think about what you want to do with your raise — and then go make it happen.Posted in Money Management on 12.19.12 with 2 comments.