Getting a Raise

When you get a raise at work, as you likely will every year or every other year, you are faced with two financial strategies that will determine whether you increase or decrease your financial independence. If you increase the percentage you are saving when you get a raise, then you will set back your temporary financial independence but your independence will be growing faster, paying off greater in the long run. If you keep the percentage you are saving the same, then you will set back your temporary financial independence by a larger amount without increasing the rate at which it is growing, setting yourself back permanently.

Increasing Financial Independence by Increasing Savings

Every time you get a raise, you should save a greater portion of it for your retirement before allowing yourself to spend more money. This is controlling your lifestyle creep in a responsible manner - treating yourself while building independence. A common rule-of-thumb is to put 50% of any raise towards your savings, so that the percentage you are saving ultimately keeps increasing. If you are earning $60,000 before your raise and $70,000 after, that means you will go from saving, say, $12,000 per year (20% of $60,000, a common amount to save for retirement) to $17,000 per year (20% of $60,000 and 50% of the $10,000 raise). The closer you are to retirement, the greater percentage of your raise you should put into savings.

If you have $100,000 saved and are saving 20%, then you are spending $48,000 per year. This means that you have a temporary financial independence of a little more than two years, since you will spend $96,000 in that time. ($100,000 savings / $48,000 cost of living = 2 years and 1 month of independence) You are saving an additional $12,000 per year, which means that your temporary financial independence increases by 3 months for every year you save at this rates.

After your raise, you still have the same $100,000 saved. You are now spending $53,000 per year - that’s $5,000 more shiny toys and fancy dinners than before! Your temporary financial independence is now under two years, since you would need $106,000 savings to support your $53,000 cost of living for two years. ($100,000 Savings / $53,000 cost of living = 1 year and 10 months) Raising your cost of living cost you 3 months of temporary financial independence. However, you are now saving $17,000 per year, which means that each year of saving increases your temporary financial independence by nearly 4 months, 1 month more per year than it was growing before.

Decreasing Financial Independence by Increasing Spending

This is known as “keeping up with the Joneses” and is unfortunately what nearly everybody does. As your salary increases from $60,000 to $70,000 (whether all at once or over several years, the effect is the same; the larger the increase, the more pronounced the effect), you can continue to save the same percentage. If you saved 20% before, you might think you should save 20% now. But that actually dilutes the savings you already have and decreases your financial independence.

Same as above, if you have $100,000 saved before your raise and save 20%, then you are spending $48,000 per year. Your temporary financial independence is a little more than two years, since you will spend $96,000 in that time, as above. ($100,000 savings / $48,000 cost of living = 2 years and 1 month of independence) You are saving an additional $12,000 per year, which means that your temporary financial independence increases by 3 months for every year you save at this rate.

After your raise, you still have the same $100,000 saved, but you are now spending $56,000 and saving $14,000 per year. This means that you have temporary financial independence of less than two years now, since you would need $112,000 to support your $56,000 cost of living for two years. ($100,000 / $56,000 = 1.78, which is a little over a year and nine months) Raising your cost of living cost you 4 months of temporary financial independence. Your $14,000 savings each year are increasing your temporary financial independence by 3 months for every year of savings, same as before; it will take you an additional 1 year and 4 months of working to get back to the level of financial independence you had before.

By allowing your spending to grow proportional to your raise, you decreased your financial independence by nearly four months without increasing the rate at which you are building that financial independence. Your raise just hid the setback of your retirement in slightly shinier toys.

The Critical Difference

In both scenarios, you got the same raise. In both scenarios, you allowed yourself to spend more money. Because of this, both scenarios decrease your financial independence.

But in the first scenario, you are saving a higher percentage of your income than before while in the second, that percentage remains unchanged. The first scenario is mitigating the hit to the financial independence while turning a raise into an opportunity to build independence faster; the second is taking a full hit to the financial independence while turning it into an opportunity to increase indulgences.

As you approach retirement, the first strategy becomes more and more important. It is difficult to decrease cost-of-living once it has increased, so it is more effective to prevent it from increasing too much in the first place. The higher the percentage of the raise that is saved, the less of a setback your financial independence experiences - and that setback directly relates to when you can retire. In the first example, saving 50% of the raise set back their retirement by 3 months but increased their rate of independence growth by a month per year, meaning that after three years they would have been in the same place of independence they would have been in without the raise and with the shinier toys. If they had been planning to retire the next year, however (though probably not off $100,000), they could have saved the entire amount of their raise; by saving the full $10,000 raise instead of just $5,000, they could have pushed their retirement forward by 2 months instead of back by 3.