Getting a raise? Don’t let increased spending blow away any extra cash you earn. While a little treat to celebrate won’t hurt, reconsider whether you really need a new car or house — or anything else that will grow your debt.
Even eating out more can nibble at that raise. Rather than focusing entirely on your wants, prioritize your needs first and then find room in your budget for pleasure. That way, you can avoid living paycheck to paycheck but also reap the benefits of your hard work.
With that in mind, here’s where you should put your added earnings.
1. Pay Off Your Debt
A raise is the perfect opportunity to start tackling your debts. You can choose one of two strategies: pay off your highest-interest debts or lowest-balance debts first. The former strategy curbs the amount you spend on interest over the course of repayment. The latter helps free up money in your budget so you can put more toward other debts.
If you’re the kind of person who needs instant gratification, pay off your low balance debts first. Of course, if you have credit card debt, prioritizing it can save you a lot of money. Credit cards have notoriously high interest rates, and the savings you’ll earn can be more than worth the trouble.
For example, if you have $5,000 in debt on a credit card with a 20% APR, and you’re making monthly payments of $100, it will take you 109 months to repay your debt, costing you over $5,800 in interest. But if you put $300 toward your balance each month, you’ll pay off your debt in 20 months and only pay $907 in interest.
2. Build an Emergency Fund
If you don’t carry credit card debt, or you’ve already paid it off, the next place to park your salary raise is in your emergency savings fund.
Sock away between three and six months’ worth of living expenses, depending on how the rest of your financial situation stacks up. If you’re saddled with a lot of debt, save up for a few months’ worth of expenses before paying it off. Once your debt is under control, you can go back to building your emergency fund.
Having a cash cushion is about more than just having the funds to fix the roof if it starts to leak. It can help fund a career switch or move to another state or country.
3. Pad Your 401k
Once you’ve put away enough money into your emergency fund, it’s time to target retirement savings. If you don’t have a 401k, the first place to look is work. An employer-sponsored retirement fund with a match is like a free raise.
Your contributions each month might not feel like much, but your savings will grow with compound interest over the next few decades. If you’re 30 years old and making $40,000 per year, saving just 10 percent each month will net you about $574,000 by 65. That assumes you’ll never make more than $40,000, too.
Earn an employer match of 50 percent on up to 3 percent of your salary, and your savings balloon to just under $660,000 by the same age.
4. Tackle the Mortgage
For the fortunate few who are already maxing out retirement plans, the next place for your salary bump is right at home. Paying down your mortgage builds equity in a home. In short, it’s an investment in your future.
If you’re thinking of wiping out student loans first, reconsider that thought. While it’s nice to pay off that balance, you can borrow against home equity you build, helping you cushion your lifestyle.
5. Have a Little Fun
Of course, don’t forget to have fun, too. Once you’ve accounted for your emergency fund, debts and retirement savings, stow away a little each month for a vacation or something else you want. If your budget allows for it, you can even work in a little money for a night out each week or every other week.
As long as you keep spending on material goods on a short leash, you can enjoy your raise without the guilt that comes with spending more.
But I’m Not Getting a Raise This Year
While many people will see a salary bump this year, not all industries — or workers — are treated the same. If you’re not slated for a raise, you should be prepared to ask for one. Here are some steps to follow:
Come to the table prepared to talk about contributions you bring to the team. Have you saved the company money? Received glowing comments from customers? These are things your boss will want to know when she decides who is getting a raise — and who is not.
Bide Your Time
Knowing when to ask is just as important as knowing that you have to ask in the first place. Contrary to popular opinion, during the annual review is the worst time to ask. Your manager is likely overwhelmed with the competing needs of her entire team and won’t have the adequate time to review your request. Instead, initiate the conversation right before you take on new responsibilities or just after successfully completing a high-visibility task.
Remember that the conversation is about you and the value you bring to the team. It’s not about what your colleague is doing or your outside financial obligations. Stick to these three strategies and next year, when you receive your pay raise, you’ll know exactly what to do with it.
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Michael Galvis contributed to the reporting for this article.