Avoid These Pitfalls Like The Plague When You Get A Pay Raise was written by Amaka Chukwuma and originally appeared on Wealth of Geeks. Amaka Chukwuma is a freelance content writer with a BA in linguistics. As a result of her insatiable curiosity, she writes in various B2C and B2B niches. Her favorite subject matter, however, is in the financial, health, and technological niches. She has contributed to publications like ButtonwoodTree and FinanceBuzz in the past and currently writes for WealthofGeeks. You can connect with her on Linkedin and Twitter. It has been republished with permission. Please note that contributing opinions are that of the author. They are not always in strict alignment with my own opinions. –Joe.
The annual pay raise for workers in the U.S. continues to climb. According to Salary.com, one-quarter of employers plan to give increases of five to seven percent in 2023. The four percent upward trend that began in 2022 continues into 2023.
Undoubtedly, an increase in pay is music to many employees' ears, but when it comes down to it, managing one can be very difficult. Just because you see a little more in your weekly paycheck doesn't mean you've reached affluence yet. Here are pitfalls to avoid if you get a raise.
According to Robert R. Johnson, Professor of Finance, Heider College of Business, Creighton University, People make the mistake of moving into a bigger apartment or buying a more expensive car or home to reward themselves for receiving the raise.
But if they just increase spending to align with the additional money, they will not improve their financial condition overall. They'll just have more stuff. According to Johnson, the best approach is to continue living the same lifestyle you led before receiving a raise.
It's important to evaluate the cost-effectiveness of whatever you are spending on your income and lifestyle. You should aim to always spend less than you earn.
Johnson points out, “People would be well advised to heed Warren Buffett's sage words: “Do not save what is left after spending; instead spend what is left after saving.” Living below your means early in life allows you to live a more prosperous retirement.”
It's not easy, but developing the self-discipline necessary to save and invest a portion of each paycheck is possible. A person can increase their wealth through investment and receive actual returns regardless of the inflation rate.
Johnson advises investing any money from a raise. He illustrates that investing a $5,000 annual raise early in one's career into an investment account growing at a 10% yearly rate will have accumulated over $822,000 in 30 years.
Investing a total of $150,000 from your salary over 30 years adds up to an additional $672,000, thanks to compound interest. A 10% average annual return is not unrealistic. Johnson notes that Ibbotson Associates says, since 1926, the average annual return on a large capitalization stock index, like S&P 500, is 10.3%.
Meanwhile, investments in long-term government and long-term corporate bonds have, on average, grown annually by 5.7% and 6.2%, respectively.
Neglecting to Budget
Budgeting is the only way to know if you're making the most of your new income. Your pay raise should help you make smart financial decisions, and budgeting can help. It enables you to prioritize what is most important to you and your family. To enjoy life and save money, Johnson recommends stepping back and deciding what purchases provide you the most pleasure and prioritizing them.
“For some, the daily latte is very important. For others, attending concerts or dining out is most important.” He says, “I am not a car person. I see a car as simply transportation, so I budgeted for and drove a very modest automobile in my life. But I am a cyclist. The quality of my bicycle matters to me.
“For years, I actually rode a bicycle that was more valuable than my car. Others would find that incomprehensible. We are all different and should spend money on goods and services that provide us the most utility.”
A budget is vital for prudent spending and becomes even more important as your income rises. As your wage rises, you must also update your budget.
Dennis Shirshikov, Head of Growth for Awning and a finance professor at the City University of New York, advises that until the pay hits your bank account, don't go racking up credit card debt because ‘you'll have more money soon;' that can be a recipe for disaster.
Set a goal for yourself and use that extra money to make it happen. This is especially good because you don't need to cut back on your current lifestyle. The pay raise takes care of the difference. A pay raise is not just extra money in your pocket but an opportunity to improve your financial situation.
Not Paying Off Debts
While you deserve some reward for your hard work, paying down your debt should be one of your top priorities. Avoiding accelerated repayment can lead to a buildup of debt and a drain on resources. Your standard of living will decline because your future income will be reduced due to debt.
Not Upgrading Your Emergency Savings
Debt Consolidation Care Spokesperson Loretta Kilday explains why ignoring your emergency savings is a bad idea. “When you get a raise, there is a possibility that your expenses will eventually increase. So, it becomes even more important to consider updating your emergency savings to accommodate your new spending habits.”
Ideally, your emergency savings should cover your expenses for at least three to six months. So, if your salary increases from $30,000 to $40,000 yearly, your six months' expenses increase, and your emergency fund should follow suit. Reviewing your emergency savings will prepare you for unexpected bills.
Forgetting About Retirement
People often tend to overlook their retirement contributions as their salary increases. But practically, as your income increases, the amount you need to stock for retirement must increase too.
Kilday notes that it is even more critical if you need to catch up on your retirement contributions or feel your retirement savings will not be enough. Investments in a retirement account like a 401(k) or an individual retirement account (IRA) are intended to increase steadily over time, thanks to the power of compound interest.
If you start saving early enough, your money has more time to grow and build a bigger emergency fund.
Not Adjusting Your Withholding
If your raise moves you into a new tax rate, you must withhold extra to avoid owing the government money at tax time. You can modify your tax withholding by filing a new W-4 with your employer.
Not Negotiating Benefits
Whether or not you get a raise, negotiating for additional perks to increase your total compensation package and improve your financial security is in your best interest. A few arguments favor bargaining for better benefits: You may save more for your retirement and secure your financial security if you negotiate for a higher company match or additional contributions.
Attempts to negotiate for better health options, life insurance, or a donation towards the coverage cost can help lessen medical care's financial burden. And that may be the essential raise you really need if unexpected medical expenses crop up.