Fewer than half of Americans got a raise or a higher-paying job in the year leading up to November 2017, according to a survey by Bankrate. And if you’ve received a raise recently, you might be wondering what to do with the extra cash flow.
Making a large one-time purchase may be out of the question, especially if you’re getting an extra $100 to $200 a month or less. To help you decide, we’ve put together a list of smart money moves you can make with your raise every month going forward.
5 smart ways to use your raise
As you read these tips for using your raise to boost your financial health, keep in mind that you can focus on more than one of them at a time. You can even contribute to all five, but be sure to prioritize what matters most to you.
1. Set aside extra money in your emergency fund
Life doesn’t always go according to plan, and a major unexpected expense could cripple you financially if you’re not prepared.
There’s no hard-and-fast rule for how much to put in your emergency fund. But many financial experts recommend saving three to six months’ worth of your basic monthly expenses in case you lose your job or become disabled. Any amount is better than nothing, though.
“I would focus more on the emergency fund if your income is very sporadic or if you’re expecting a life transition coming up,” said Eric Maldonado, a certified financial planner and owner of Aquila Wealth. For example, if you’re expecting a baby, starting a business, or planning to move, it’s a good idea to have a robust safety net.
2. Save for retirement
While retirement may be decades away for you, the best time to start saving is now. The sooner you start saving, the more time you have to benefit from compounding interest. To give you an idea of how powerful it is, this graph shows how much you’ll earn over time if you start investing $100 a month at ages 25, 30, and 35.
If you have an employer-sponsored retirement plan, such as a 401(k), that offers a contribution match, plan to save at least enough to get the full match. Then, Maldonado recommended saving money in a Roth IRA.
“You put the money in after tax, so it goes straight from your bank account to the Roth IRA,” he said. “It’s an individual retirement account, so you own it and control it.”
Whatever you choose to do with your raise, Maldonado recommended putting at least a little into your retirement account to take advantage of compounding interest.
3. Pay off toxic debt
“If you have debt that has an interest rate of 10.00% or higher, you want to get that out of your life,” said Maldonado. He specifically called out credit cards and other consumer debt.
If you have more than one loan or credit card with a high interest rate, target the account with the highest interest rate first, and then use the debt avalanche method to eliminate your debt more quickly. Also consider using a debt consolidation loan to speed up the process.
If you have debt with a lower interest rate, such as a mortgage or car loan, paying it off might not be urgent, especially if you can earn a higher rate by investing your money instead.
4. Invest in yourself
Many employers offer raises only once a year after performance reviews or when you get a promotion. So, it’s important that you do whatever you can to improve your chances of getting another one.
“Put money aside to invest in yourself, whether that’s an online education program, sales training, hiring a mentor, or getting coffee with a business owner in your town that you admire,” said Maldonado.
Investing in yourself can be difficult because there’s no guarantee you’ll get a return. But if you’re passionate about taking your career in a new direction or you want to move up at your current company, developing new skills can make a big difference.
5. Upgrade your lifestyle
Spending the money from your new raise instead of saving it or using it to pay off debt sounds like a bad money move. But allowing yourself to enjoy the present is a key element of your happiness, productivity, and future financial success.
For example, a report by the U.S. Travel Association found that employees who use more of their vacation time reported being happier on the job and at home. What’s more, they’re more likely to get a raise than employees who use little or none of their vacation time.
I’ve experienced this shift. When I earned little during college and shortly afterward, I rarely spent money on entertainment, travel, or other fun experiences. But as my income has increased and I’ve tried to focus more on self-care, I’ve noticed that I’m happier and less likely to burn out with work because my life is richer overall.
It’s important to find balance, though. Maldonado suggested starting out with 90% of your raise money going toward financial goals and 10% going toward lifestyle improvements. But as your overall financial situation improves, he recommended working toward a 50-50 approach. “Save half and spend half,” he said.
Focus on your priorities
Depending on your financial situation and goals, it’s possible that some of these recommendations won’t work for you. If you’re drowning in debt, for instance, you may not feel like you have room to invest in yourself or your retirement. And if you’re a business owner, you may be investing in yourself more than in other areas.
Take the time to set financial goals but understand that they might change over time. Once you pay off your high-interest debt or max out your emergency fund, for instance, you’ll have more money to put toward your other priorities.
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