This article originally appeared on Money254. Money254 helps consumers and business owners to search, compare and apply for financial products in Kenya.
An increase in your salary is a cause for celebration, whether you took a higher-paying job or received a raise. It makes you feel like an important member of your company and helps to justify the work you do.
What should you do with the additional money, though? The majority of people can't stop thinking about all the new things they want to buy when they get a raise. However, before you go on a shopping spree, you should carefully analyse your personal finances.
You'll know exactly how much your income raise is worth, what your financial objectives are, and how to use your extra money to make wiser investments and purchases.
Here are five tips for you.
1. Take some time to plan
A raise in pay can encourage you to spend it on things that were previously out of your financial reach. However, exercising restraint allows you to consider the shift in your paycheck and what it means for your financial goals.
At this point, you may have to reflect on your current financial situation and lifestyle. Think of how you can maintain the same without going overboard with unhealthy spending habits.
More importantly, calculate your take-home pay carefully to establish how much you earn each month. Remember that just because you got a Ksh 20k raise doesn't mean the complete amount will appear on your paycheck at the end of the month.
Like the rest of your income, this increment is subject to tax. With most automatic tax deductions, you can determine the exact take-home for your next pay, keeping in mind other deductions like health insurance and retirement benefits.
Subtract your old salary from your new one to get the exact pay rise amount. That is your take-home salary.
2. Create a new budget that factors in the salary increase
With the calculations out of the way, you now have to figure out how to meet your financial goals based on the new net pay. A new budget will help you to track your expenses and make better financial decisions factoring in your new income.
The new financial projections can help manage your spending habits and increase your savings and investments. With it, you can make visible progress in achieving your short-term, medium-range, and long-term financial goals.
While you may still be excited about the raise, a budget is an important deterrent to spending money you don't have. It prevents you from developing harmful spending habits or succumbing to lifestyle creep. Instead, the new budget will:
- help you pay bills and necessities on time and be more flexible
- enable you to prepare for unexpected costs better
- help you work towards eliminating existing debt faster.
You can now step up your efforts to become debt-free and enjoy a higher net worth. So don't put off paying off that car, phone, or bank loan. To be free of those high-interest loans can be a huge gain and a weight off your shoulders.
3. Boost your savings
A pay increase provides a chance to boost your savings. You cannot, however, do so haphazardly. It is best if you have a plan in place to devote all of your efforts to attain your short-term and long-term goals.
Indicate what goes under short-term goals, and what can be set aside as savings for a car down payment or a vacation. You can create a high-yielding savings account to cater to your short-term goals.
Medium-range savings plans can cater to purchases like housing or college, while long-term goals include things like a retirement fund.
Retirement savings are an important priority that should never be overlooked. When you are unable to work, the fund will look after you. Even a small proportion of your raise might have a significant impact when you reach retirement age. The secret is to set up automatic deductions for the amount you want to save so you don't have access to it in your regular savings account.
An increase in your savings should also factor in a safety net fund, as it prepares and shields you in case of unexpected costs or a financial crisis. With a healthy emergency savings account, you can comfortably take care of that tire burst, childcare costs, or any other expense.
Increasing your investing savings is another excellent strategy to appreciate your current increment. Purchasing valuable assets could be one way to grow your money. Does real estate, equities, or mutual fund shares? It's a personal choice, but whatever you do, focus on a high return on investment.
Finally, if you have been thinking of a big purchase, this is the time to start saving. It could be a house, a developmental plot of land, or even a car. Monthly savings with a target within a timeframe can help you achieve that goal.
Since the above goals meet different purposes, you will have to create separate accounts for your short-term, medium-range, and long-term goals so that none interferes with the other.
4. Reward yourself
The truth is, you worked extremely hard to earn that pay increment.
How about you do something for yourself? You can hive off some money to reward yourself – maybe take a trip, buy yourself a gift, anything that pleases you. Have you had your eye on that glossy pair of shoes or the latest office wear for some time now?
Go for it! You deserve it.
5. Resist lifestyle inflation
Things might change when you get that new paycheck. Because for many people, and sometimes unknowingly, more money may begin to lead to more expenses. Previous luxuries become necessities, and you might start to spend more and save less, or nothing at all.
Here is how it might go. You might want to live in a better neighbourhood, bigger house, and dress differently. You have to take extra care to avoid lifestyle inflation, which could threaten your financial goals.
If you are smart enough and financially savvy, you will not want to jump on this bandwagon. For you, more money means more savings and more asset acquisition. Here's how to avoid lifestyle inflation:
- Calculate your actual net worth. Due to the attached deductions, you will discover less than the stated pay raise.
- Avoid abrupt changes in your lifestyle as you might not manage to maintain it in the long run. You could run into debt instead, making the pay increase less worthwhile.
- Celebrate modestly, save every single coin of this additional income, and maintain your exact current lifestyle.
- Treat yourself. You deserve to reward yourself once in a while. But be careful not to go overboard.
- Set up automation for your savings. It enables automatic deductions into your specific savings account before the rest of the money hits your everyday bank account.
- Avoid new debts. A change in your lifestyle could be taking you straight into debt. To avoid such a situation, do not borrow. Instead, use any extra income to pay off existing debt.
- Finally, monitor your spending with a budget, which helps you track your spending and expenditures. You will know if you go off-grid.
A salary raise should be a cause for a well-calculated and prudent plan rather than just a celebration. How do you do it? First, you ponder and identify new opportunities that match your latest paycheck. Decisions at this time might also include:
- total review and update of your budget
- saving for the item you always wanted
- wiping off your existing debts.
Still, don't go into savings and investment mode without shelving a small percentage for personal fun.