Getting A Raise
When you get a raise at work, you are faced with a number of decisions which will either increase or decrease your financial independence. If you increase the percentage you are saving when you get a raise, it will increase your financial independence. If you continue to save the same percentage, which also means your spending is increasing substantially, you will actually decrease your financial independence.
Increasing Financial Independence by Increasing Savings
Every time you get a raise, you should save a portion of it for your retirement before allowing yourself to spend more money. 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 you are spending $48,000 per year, you have a temporary financial independence of a little more than two years ($100,000 savings / $48,000 cost of living = 2 years and 1 month of independence). If you are saving $12,000 per year, 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 on shiny toys and fancy dinners than before! Your temporary financial independence is now under two years ($100,000 Savings / $53,000 cost of living = 1 year and 10 months). Raising your cost of living costs you 3 months of temporary financial independence. However, you are now saving $17,000 per year, so 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
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.
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 ($100,000 / $56,000 = 1.78, which is a little over a year and nine months). Raising your cost of living costs you 4 months of temporary financial independence. Your $14,000 savings each year is increasing your temporary financial independence by 3 months for every year of savings, same as before. However, 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 the raise.
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.
In the first scenario, you are saving a higher percentage of your income than before. In the second, that percentage remains unchanged. The first scenario lessens the hit to your financial independence and turns a raise into an opportunity to build independence faster; the second is taking a full hit to financial independence and turning the raise into an opportunity to increase splurges.
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 to your financial independence.