Making your raise work for you

It’s raise and bonus time guys! At least it is for some industries including my own. It’s that fun part of the year when your bosses tell you exactly how you did as an employee and then get down to the parts that matter more; your raise and annual bonus.

Raises and bonuses are important because they can make a big impact on what you can purchase but also what you can save. This is important because your savings rate as I’ve mentioned before is one of the only things you can control when it comes to your retirement strategy and a raise is one of the only things that may allow some people to have a direct impact on their savings rate.

After all – what does a raise or bonus allow you to do? It can certainly allow you to spend a bit more or take a vacation but it also allows you to do something else if expenses are kept fixed(or slightly bumped for inflation) – raise your savings rate. For a lot of people, there’s only so much you can cut on the expense side of things and ultra frugality is not for everyone so raise and bonus time may be the best time for substantial changes in your savings plan.

Let’s take a look at an imaginary person that’s currently spending $40000/yr, an amount that’s relatively healthy and allows for some fun alongside covering the basics in most areas of the United States. Let’s give that person a net income of $70000/yr, healthy earnings that when set against their expenses yield a savings rate of 42%. At a simple 5% ROI with a 4% withdrawal rate, that person can retire in 20.6 years – pretty good, right?

Now let’s give that person a 3% raise bumping up their salary to 72100. That’s a nice 2100 bump in potential spending that can be used for a variety of things. It’s pretty easy to just take that money and spend it on something or take a short vacation with your loved one but it’s also pretty simple to see what that money could do for you if you didn’t spend it but invested it instead. It’s a simple calculation that can be done using this calculator and I feel like it’s always good to do some simple math to fully understand the impact of your savings before just spending it on something that may not provide a ton of value.

In our scenario, taking that 2100 and investing it every year instead of spending it and keeping your expenses static at 40k/yr would mean you have to work 1.1 years less to reach your savings goal and be financial independent. Not bad right?

That’s not to say that 40000/yr is all you should ever live on and that any additional money you earn in your life should be invested with the goal of retiring earlier and earlier. There will be certain years when my raise and my bonus go towards something I enjoy doing – a vacation or a wedding or something I’ll remember forever. I’ll still spend money on fancy restaurants and concerts and things I enjoy. As I’ve said before, I’m not overly frugal and do spend quite a bit on frivolous things but I still enjoy looking at the math behind “what if” type situations. What if I were to live on 30k/yr and save everything else? That’s not happening right now and in most years I’ll end up spending most of my bonus on something frivolous. But there will be also be years when the raise and the bonus go entirely towards my savings because that 1.1 years of working means a lot more to me than the newest piece of electronics or whatever may be out that year.

Remember, that 1.1 years of work relief from the 3% raise? This is just one year of raises! The raises and savings rate increases will compound upon themselves. Let’s say this person is comfortable with 40k/yr in expenses for the rest of his or her life and imagine that the person also get a 3% raise each year. Using a conservative 5% ROI to account for inflation, the next 3% raise can shave another 10 months off their working career if they save it all with more and more months being shaved with each further raise. Pretty soon our imaginary person is 13.5 years into their working career with the freedom to do whatever they want as long as they maintain their relatively frugal spending habits. Naturally, this is all imaginary and this spending level won’t work for everyone. Not everyone is lucky to net 70k after taxes per year either or have the ability to keep their expenses the same year over year due to inflation and increasing costs. However, the concept, the idea behind this, is one that applies to all of us. Any additional funds that come in through a raise or bonus that don’t immediately go out as an expenses may mean a shorter work career for you.

So the next time you get that raise – however small it may be – remember what the power of compounding can do and the kind of life changes that can come from a small bump in savings combined with a little bit of lifestyle frugality. In this scenario, the person is making the choice to keep their expenses the same and saving an extra 2100 per year – not a fortune by any means – but that small amount can mean an extra year of freedom. That’s not bad and if I had the choice to spend a little bit more this year or save it all and not give in to lifestyle inflation, I think I’d make the second choice.

And luckily, I have the option to do just that this year. I was fortunate enough to get an 8% raise due to a promotion this year and a decent bonus(less than 10k still – I’m not rich!) and my goal this year is to send most of that money into my savings. This is the first year I’m doing this sort of tracking and it’s important to me that this first year sets a good tone for the rest of this journey.

Hopefully this 8% raise will mean I can shave a year or two off my working career and I value that a lot more than anything I could buy with the few thousand I’ll net after taxes this year. I think starting next month – I’ll start tracking my savings rate alongside everything else I track to get a better idea of where I’m actually falling in that regard month to month. Hopefully the raise and small bonus and the fact that my girlfriend is now living with me and contributing rent will mean my savings rate is north of 50% these days.

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