Friday, January 10, 2014

Rule #33 Don't spend all of that salary increase

One thing that people entering the workforce often do is adjust their lifestyle upward to match their paycheque.  They live at a level they can sustain with their income and as they receive pay raises they typically adjust their lifestyle incrementally further upward.  This presents itself, often unnoticeably, in the form of bigger houses, newer/fancier cars, eating/drinking out more, gym memberships, more vacation trips South, more electronic doo-dads, more/bigger gift giving etc.  It is also commonly associated with higher personal debt levels as banks will loan more to people as they make more.  This gradual incremental edging up of lifestyle expenses is often referred to as Lifestyle Creep.   There is typically an increase in the cost of living due to inflation, but usually "lifestyle creep" is a result of voluntary spending more than the inflation amount.  People then become trapped in a higher cost lifestyle that is difficult to pull back from once they get to that spending level.  It is very difficult to save and invest for the future if all of your pay increase is going towards Lifestyle Creep.  The other concern is what happens in the case of someone losing their job, getting a demotion, or changing to a lower paying job?  How about if you allocate some of that salary increases to saving/investing/debt reduction each year?  If you never let your lifestyle creep up with your salary, it will be easier to put that money to good use now.

Early in my career, the on-the-job learning curve was fairly steep, and so were the salary increases.   My base salary increased about 30% within the first 3-4 years as my value to the company went up.  Because I had gone from student living to full-time professional employment, the initial bump from TA wage to Professional salary was huge.  We began living on my salary alone and investing Kim's.  Our lifestyle had already skyrocketed from starving (but happy) students to full-on mature adults and we were living a very comfortable lifestyle.  We decided that any salary increases that were over and above the general cost-of-living would further go towards savings, investing and paying down any bad debt (debt that doesn't result in fiscal betterment).   So when I began receiving pay raises in the 5-8% per year the first few years that I was working, we were able to max out RRSPs, pay down debt, and save enough money to buy a used car with cash.  Once we were saving the amount we wanted to, we then started living on some of the salary increase but we have always used some of the pay increase to increase savings.  We have rejected lifestyle creep as best as we can.  We've done our best to reject spending money just because we have more of it.  If we had spent more of the money each year as we made it, it would leave very little wiggle room if, for some reason, our pay had decreased.

The way we ensured that the incremental raise on my paycheque went towards savings was to have automatic withdrawals set up on our account that would come out the exact same day as my paycheque would get deposited into it.  That way the additional money was not just sitting there waiting to be spent.  The money had already been allocated to our goal of saving, investing or debt reduction.  As pay raises came over the first 5-6 years of my professional career, so did our contributions to our investments.  At present, we've hit a happy medium where we're very happy with the amount we're contributing to our savings and investing accounts, so now when we get a raise, we are a bit more free to spend the money since our financial goals are being met, but we've been able to live well below our means for some time now and this financial manoeuvre has helped us set up a base that will help us reach Financial Independence without "doing without" in our later years.

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