One of the most important facets of career progression through your life is getting regular pay rises. These are not just a signal that your company is increasing the remuneration of employees to match, or chase, the rate of inflation, but also that they are rewarding you for your progress up the career ladder. Often, these match or dictate major life milestones: you might wait until you’ve made progress in your career before deciding to have a baby, get married or buy a new house.
Hopefully as these come along, they are also matched with an improvement in both quality of life and disposable income. These increases should be more than linear, and as such, should in theory rise faster than your cost of living increases. This difference, when saved or invested, can go towards things like a retirement fund, pension, your children or spouse’s backup pot, or even to fun things like holidays or a new car.
The danger is in knowing how much to save, at what point - especially because there isn’t a hard and fast rule. How much you spend in any given year, and how much you hold back for retirement, rainy days or other things is a decision that only you can make. Of course, you’re making it with a number of set parameters, that hopefully we can help set for you. For example, you can easily back-calculate approximately how much you’ll need to live on in your retirement years, and then work out how much you’ll need to have invested or saved by then to make that a reality.
As long as these are conscious decision that you’re making, they’re perfectly acceptable whatever they are. The danger is when you allow pay rises and the increase in available cash each month to let you subconsciously spend more. It’s a common pattern to spend more money as you earn more, and this often happens without even noticing. You might suddenly stop thinking about how many times you eat out per month, or whether you fly economy or business class - and why not, right? You’ve earned it. Well, yes, but the result is often a lack of saving for emergency or retirement funds. This phenomenon is known as lifestyle creep.
How to Avoid Lifestyle Creep?
A regular (ideally monthly) review where you analyse and reassess your budget is a great way of keeping track. Because if you can’t see it, how do you know what’s going on? It’s the small expenses that accumulate over time that often cause the most damage, and need to be avoided. Using a digital bank like Monzo for this, where you can separate spending into pots and allocate budgets for each pot, is a great way to do this.
The second is more existential. Setting hard and fast rules on how much you want to spend and allocate before you get the pay rise is a great way of checking up on how well you’ve stuck to your own rules. Of course, you need to agree to this with your spouse too. Family financial planning is a group task, and the implications of your increased income will reverberate throughout your family. So what should the rules be?
The 50 30 20 Rule
Before we jump into this, it’s important to note that this is just an indicative example. Everyone’s situation is different, and things like the cost of housing for many people have little to no flexibility. It’s just an example of a common rule that people use to gauge how well they’re allocating an increase in income.
The 50-30-20 rule recommends putting 50% of your money towards need, 30% toward wants, and 20% towards savings. Read that again. This is of course allocated to the net, rather than gross amount.
These are things like utility bills, rent or mortgage payments, healthcare and groceries. If you can truly and honestly say “I can’t live without it,” you have identified a need. Minimum required payments on a credit card, loan or any other debt service belong here too.
These are things that you enjoy, and spend money on by choice, like subscriptions, supplies for hobbies, meals out and holidays. Perfectly fine to have.
The remaining 20% of your budget should go towards the future. You should first put this into a rainy day savings account, and then into your pension, tax advantaged savings accounts, before finally a general investment or brokerage account. Note that this also includes paying down debt beyond the minimum payment amount.
So where does that leave us? Well, the most important two things to remember are to set the goals you want before the pay rise arrives, and then to track these monthly as part of your budgeting process to see how well you stuck to them. Whether the 50-30-20 rule, or any other, applies to you is a personal one, but you can track the implications of this increase in saving and spending using the Strabo Net Worth Forecast. Find out exactly how much you’ll be likely to have in retirement based on your existing portfolio of investments (if you have one), and know what to tweak and what to keep the same. Good luck!