The recent economic downturn triggered a series of salary freezes throughout the work world–including among senior executives in many industries. As the economy recovers, the salary freeze is finally thawing. If you weathered the winter of recession with a frozen salary, you may now be seeing your work bear fruit in the form of raises or bonuses missed in previous years. You’ve worked hard for what you’ve earned. Here are three ways to ensure your recent raise or bonus works as hard for you as you do for it.
1. Avoid increasing your standard of living to match your new income.
A raise offers you a range of opportunities–but not if you spend it on an increased standard of living. Instead of adding a new consumer expense to your life, resolve to continue living as you have been. This frees up your raise to do some long-term “heavy lifting” that will improve your life more in the long term than in the short term.
Although you should avoid channeling your raise into an increased standard of living, you may find yourself in a situation where receiving a raise actually means you have less disposable income. When handled correctly, however, this situation can pay off significantly in the long run. Here is an example:
Suppose that, after taxes and other withholdings, you find you have a net raise of $600 per month. You also have a car payment of $350 per month. By adding $100 from your disposable income to your raise and applying the entire thing to your car payment, you can double the payments every month–paying off your car in half the time and saving the interest you would otherwise have paid the auto company. Although your disposable income goes down in the short term, your raise works harder for you–and offers you more disposable income–in the long term.
2. Pay yourself first.
Commit to putting at least half your raise in savings–whether that means an ordinary savings or money market account or other savings and investment tools. Consult a financial advisor, if necessary, to help you choose savings tools that accumulate interest that outpaces the rate of inflation, so that your money is earning real value for you. Which savings or investment tools you choose will depend on your current position in life, your expectations regarding your career continuation or advancement, and your needs. Two options for putting your raise to work ’round the clock include:
- 401(k) contributions. If your employer matches your 401(k) contribution, focus on contributing the maximum amount your employer will match. If you contribute less, you leave free money on the table–money that could contribute to the freedom and security you’re seeking in retirement.
- Roth IRAs. A Roth IRA offers an alternative retirement savings plan that also decreases your income tax burden in the years you contribute to the plan. For 2013, the maximum you can contribute to all of your traditional and Roth IRAs is the smaller of: $5,500 ($6,500 if you’re age 50 or older), or your taxable compensation for the year. (Source: irs.gov). Choose a Roth IRA with an interest rate that exceeds the rate of inflation to not only save your money, but grow it.
3. “Snowball” your debt.
Most professionals understand the importance of paying off high-interest debt first. As you pay off debts, however, you can build momentum and increase the rate of debt payment by “snowballing” your debt payments. “Snowballing” is the practice of applying payments for previous debts to current debts. For example, suppose that you have a credit card you are paying off at $100 per month and a vehicle loan you are paying off at $400 per month. After six months, the credit card is paid off, but you have 24 months to go on the vehicle loan. By taking the $100 per month you had previously budgeted for the credit card payment and applying it to the vehicle loan, you maintain the same standard of living you had while paying off the credit card–but you are suddenly paying off your vehicle loan over 25 percent faster, saving interest and freeing up additional income in the long term.
You work hard for your money. Use these ideas to help your money work just as hard for you.