If you just got offered a new job or negotiated your way to a higher salary then congratulations, but be careful how you handle (or spend) this increase in pay.
Flash forward to two paychecks from now when you’re going to be wondering how you ever lived on less, rather than rejoicing in how much you’re socking away. You might be surprised on how much you actually lived off of, rather than be thankful for the extra “cushion” you’re dealt now.
“Most people expand their spending according to their new salary,” says Kit Yarrow, author of Decoding the New Consumer Mind. “Every category seems to get a boost, and all of a sudden, that increase in salary hasn’t stretched across all those categories.”
Take a look at how you can best use this opportunity to improve your future:
Get the most emotional bang for your buck
If you don’t want to saddle yourself with a house or car payment (and you’re at a stage in life where you don’t have to), then don’t, says Yarrow. Purposely save for your goal, whether it’s to visit Thailand or pay down debt.
When people are budgeting for things that don’t match their goals or bring them joy, “they cheat, and when they cheat, they feel bad about themselves, and when they feel bad about themselves, their budgets tend to get wacky,” says Yarrow. Be true to yourself and what drives you as a person.
Spend your values
Now that we’ve established that you should save for your goals… how do you figure out what they are? You can use your new job as a jumping-off point to ask yourself what you care about and what you want your money to do to line up with your values, says Jesse Mecham, founder of You Need A Budget.
How do you start? By not thinking about money at all. Sit down and make a list of your aspirations and what drives you. Examples could be kids, travel and health. Then, dive deeper — what is it about health? Good food and exercise? And deeper — what kind of food? Soon, you’ll have specific items to budget for and a better idea of the jobs you want each dollar to do for you. You can weave these goals into a budget with your fixed expenses and use it as a guide for achieving your goals, both personal and financial.
Know your vice
“The Achilles heel of young people in particular is breaking their budget on going out,” says Yarrow. So whether your number one spots are the bars, concerts or hot new restaurants, there are a couple of things you can do to make sure your entertainment spending doesn’t rise along with your new salary.
You could diversify your friend group and hang out more with the frugal folks, find different ways to entertain yourself, or be honest about how much you spent before the raise and build that amount into your budget.
Make it a realistic one that matches your life and what you really want. So if eating out is your number-one cash flow issue, have your friends over for a potluck or DIY cooking night. If it’s concerts and festivals? Organize a bike ride. “You’ve got to be the maverick and be really clear on what your spending goals are. Try to encourage your friends to accommodate you,” says Yarrow.
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Hike up your retirement plan contributions
Then of course, there’s the opportunity to save more for retirement — which should be one of (if not the) first things you focus on when getting a salary bump or starting a new job, says Kelly Graves, certified financial planner.
Some employers allow employees to enroll in the company 401(k) on day one, and some have a one-year rule before they’re eligible. If it’s the former, make that your first priority. If it’s the latter, make a note in your calendar. But for now (or if you work for a place without a retirement plan) start or ratchet up your contributions to an IRA or Roth IRA.
Eventually, you want to be saving 15 percent of what you earn (including matching contributions) for retirement. But if you’re not there yet, don’t panic — increase your savings by as much as your new salary allows. The key is to automate, so you don’t have to make the decision every time.
Use your extra money to pay down debt
There’s no better return on your money (except, perhaps, for 401(k) matching dollars) than the one you get paying down high interest rate credit card debt. The return you get is equal to your interest rate — and it’s guaranteed. So if you’re carrying credit card debt, that bump in your salary is money you can use to finally get it off your plate. Start with your highest interest rate card and pay as much as you can toward that one while making minimum payments on the rest; when it’s retired, move on to the one with the next highest interest rate.
Build up an emergency fund
Finally, use some of that additional income to build up an emergency fund of at least $2,000. No, it’s not the full six-to-nine month cushion you should aspire to over time, but a couple thousand can help you avoid a laundry list of smaller financial disasters. “You’re going to have a health emergency, the car’s going to break down… you lose jobs, and you’re going to need something to bridge that gap,” says Graves.
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