Posted by Ryan on September 17th, 2007 in Money Management

Did you recently receive or are you expecting a raise and dreaming about how much extra cash you will have to burn? Pay increases have a strange way of not really changing people’s financial situation at all. If you are a saver, you will save a little more with your raise. If you allow your income to determine your budget, you will likely continue to waste money without tracking where it really all goes. The money management habits, or lack of, will generally remain the same regardless of income.

Let’s look at a hypothetical situation. John is an employee that currently makes $50,000 and counts on his annual 5 percent raise. Rather than planning what to do with his increase, John spends until his check is gone. He doesn’t really know where the money goes and doesn’t really feel like his raises help him become wealthier.

If, however, John continued to live as if he were still making $50,000 things would be different. By consciously planning to invest his entire 5 percent annual raise in a fund that returns 10 percent, here is what his money would earn for him:

Year 1: $2,750
Year 2: $8,663
Year 3: $18,198
Year 4: $31,870
Year 5: $50,252

In just five years, John is actually able to accumulate $50,000. Obviously this does not take taxes or fees into consideration, but this can actually be achieved if you deposit funds into a retirement account, such as a 401(k), which is a pre-tax investment.

Don’t let your hard-earned raise not really feel like a raise because of poor money habits. Instead, put it towards some good use, such as an earlier retirement. Here are some recommendations:

• Treat yourself. You’ve earned it, so use some of the extra cash from the first pay period or two to reward yourself.
• Adjust your 401(k) to put that money in your retirement account. Its pre-tax dollars, you’ll reduce your realized income for your taxes and you can take advantage of any company matching incentive.
• Use your raise to pay off mortgage faster, credit cards or other bad debt.
• Allocate a portion to deposit in your “fun budget”, and invest the rest to ensure you have a healthy fun budget later in life.

If you could live comfortably off your income before your pay increase, most likely you can continue to live that way. Use this extra cash in a way that will help you accumulate more wealth and reach your financial goals more quickly. If your expenses already exceed your income, use your raise to get on your feet and gain control of your personal finances. Whatever you do, don’t disregard creating a plan for your raise or you will end up spending it without even noticing where it goes.

You May Also Like:

• 10 Steps to Better Money Habits
• 15 Money Pitfalls to Avoid
• Spend Your Budget
• Take Control of Your Financial Situation – Part I