So, you just got a salary increase. With a promotion, you have more disposable income to do as you please. You know what you want to do, but what is the financially prudent course of action?
A salary increase is definitely a cause for celebration. But once that celebration is over, it’s time to consider what the increase means for your financial future. In many cases, it means surprisingly little.
Many mistakes can be made, leading to issues such as forgoing responsibilities or suffering from “lifestyle inflation”.
In this article, we will investigate how to reevaluate your budget after a salary increase.
The easiest budgetary mistake to make after receiving a salary increase is to thoughtlessly spend more. $60,000 per year isn’t that different from $70,000 per year when it comes to long-term finances. At least it isn’t if you don’t use the extra $10,000 properly…
If, however, you use that same $10,000 prudently, your future finances can be very different than if you never got the raise.
Of course, it’s natural to want to enjoy life more after a hard-earned promotion. In fact, increasing your quality of life is a very good decision, as long as it’s accounted for in your budget.
The ideal situation would be for you to continue living a comfortable life and setting aside the extra money for savings and investing. Long-term thinking is extremely well-rewarded in finance.
But increasing daily expenses for comfort is also fine if it’s done in a measured way. It’s when you forgo re-budgeting that problems can arise.
The most prudent action you can take with a sudden increase in your cash flow is to eliminate debts. Specifically, eliminating high-interest debts frees your finances for more investment, or at least to have more money available for other purposes.
Either before or after budgeting, using extra disposable income for debt reduction can never be the wrong choice. Once you’ve eliminated future interest you would have to pay, you can focus on other investments.
Lower-interest, long-term debts like student loan debts can be put off or even ignored for now. The key is to reduce the money you sacrifice to interest. Even a small increase in your monthly repayments will have a significant impact on your financial health going forward.
Read this next: How to Build a Debt Reduction Plan, Step by Step
Your new income can help you work towards a basic financial goal that about 40% of people fail to or cannot afford to address: emergency savings.
Emergency savings accounts are meant to help you when you go through an emergency and/or cannot continue working. You just got a raise, so you’re not likely thinking about a lack of income being your problem.
But emergencies eventually happen to everyone, and it’s best to be financially prepared.
In general, emergency funds should cover your regular expenses for at least 3 months. Then, they should cover any foreseeable expenses that aren’t covered by some kind of insurance.
Emergencies typically include a variety of indirect additional expenses, which is why they’re so important.
Now that we’ve gotten the basics out of the way, let’s talk about budgeting. If you expect your salary increase to become your new normal, it’s time to revisit your budget and long-term financial goals.
We’ve gone over budgeting a lot here, and in this case, must revisit the same topic.
Even though you’ve received a salary increase, the basics of budgeting are the same. Following a revised 40/40/20 budget, or any similar budgeting guidelines that fit your personal needs should be continued.
If you have the money for it, it makes sense to spend less on needs and wants, and even more on savings and investments.
Of course, it’s also important to reward yourself! As a part of your budget, it makes sense to increase spending on “wants” in a way that aligns with your new income. Resisting “lifestyle inflation” or “lifestyle creep” is very easy when you consciously re-evaluate your budget.
Receiving a salary increase is a cause for celebration. You have more money to do what you want with. But it’s easy to celebrate too much and lose out on the real financial benefits of having a greater income.
The only way to avoid letting your salary increase go to waste is to re-evaluate your budget. If you don’t have a budget yet, that’s fine! A salary increase is an even better reason to start making a budget that enables you to:
June 30, 2022