You likely can’t save your raise
Unless you plan to live with an ever-diminishing standard of living, you probably can’t do what all the personal finance blogs and books tell you to do - save your raise and live on your previous salary.
It’s another one of those personal finance ‘rules’ that is great in theory, but unrealistic in practice. We’re told by many sources to save any salary increase we earn and live on what we were making. This advice is usually accompanied by a statement like, “and in 30 years, if invested in an stock index mutual fund, it will be worth 5 zillion dollars!”
You see, the reason this is stupid advice is that if you’re like the vast majority of taxpayers in the US, your real salary has likely gone down over the past 10-15 years. (The term ‘real salary’ refers to your inflation-adjusted salary. If you get a 4% raise and inflation is running at 5.6%, you’re making less money every month in real terms.)
The plain fact is, if you get a raise, you’re going to have to spend it just to try to keep up with the rising cost of food, fuel, and just about everything else.
Saving your raise. Nice idea. But you probably can’t do it.
September 8th, 2008 at 12:53 pm
While overall real wages are steady or declining, for a given individual real wages tend to increase over a lifetime as they gain seniority and experience. Your spending on durable goods also drops, since you start out needing to buy everything but eventually you mostly own what you need.
The point of saving your raise is to avoid increasing your standard of living when your income increases or your expenses drop.
September 8th, 2008 at 1:31 pm
You know, I had never really thought through that suggestion. It always seemed like good advice, but it falls apart when you really look at it. When I got out of college, I believe I was making about $25,000. I make considerably more than that now. I can promise you there is no way I could be living off of my original $25,000 a year and banking the rest of my salary.
If I could - I would be close to that zillion dollars…
September 8th, 2008 at 1:34 pm
There are plenty of ways to cut back on spending, most people just don’t want to. Stay at home on the weekend, plan your errands, cook more from scratch, eat less, go to library to get books, use towels a few extra times to cut down on laundry, cut the cable to basic, go to dial up on internet or give up the cell phone. Many things we think are necessary, really aren’t if you are truely struggling for money.
September 8th, 2008 at 4:09 pm
The problem is that most people have a standard of living that is already higher than they can afford
Also, let’s not forget that our standard of living has increased significantly in the last 10-15 years in terms of what we get for our dollars in a lot of other areas (electronics being a big one there).
September 8th, 2008 at 5:52 pm
Do you consider my advice stupid: Save Some of Each Raise? You point about inflation is definitely right. But I think we also have to acknowledge most people are saving far too little.
They need to fix that problem. Hopefully they can do so by increasing their earnings and avoid reducing their current standard of living (though frankly I think many people in the USA spend lots of money on stuff they don’t need to at all and they could reduce spending without any real loss - how many pairs of shoes do you need, how frequently do you need a new car…). But if that is not a realistic situation for them over the long term, what is the solution? I would say they just have to reduce their current standard of living. It is not ok to live beyond you means just because you got used to doing so earlier in life.
September 8th, 2008 at 7:14 pm
I think saving your raises is difficult but definitely still possible. To some degree it’s mental accounting I suppose. If you pay off your debt that was costing you 3% of your total gross income per year and you get a 3% raise, you will have effectively be able to save your raise.
I consider items like this “budget productivity”. Everyone has some fluff in their budget. It doesn’t necessarily reduce your standard of living to pay of debt or more your switch to a checking account that actually pays interest. Buying a used BMW will save you big bucks compared to leasing or buying new. Grocery shopping at multiple stores or planning your meals will save you money as well.
You can’t make each of these specific changes over and over every year, but there are ways to cut items from the budget or reallocate how you spend your income to get the same quality of life (potentially in different areas though) without spending more total dollars. It just takes some creativity.
September 10th, 2008 at 6:52 am
To address the general concept of ‘frugality’ expressed by Todd, Jeff B, and John, my point is wholly different. Cutting costs where possible is wise and a step in the right direction. But lots of people have already done those things, and as Todd points out, you can’t make these changes year after year.
I’m talking about inflation versus wage growth. When the price of many staples is rising faster than wages, you aren’t going to be saving your raise.
Jesse, I have to strongly disagree with you on your point about standard of living. People confuse standard of living with neat stuff your parents or grandparents didn’t have. I would argue middle America’s standard of living has, in fact, gone down. Simply look to the fact that many, if not most, people had one working parent but still owned a home, car(s), sent kids to college, etc. Try doing that on one income today.
September 12th, 2008 at 5:33 am
The plain fact has been that the inflation has risen like anything in most of the countries. This has compelled many to save as much as they can because you never know what will happen next?
November 6th, 2008 at 3:41 am
I don’t recall ever having increased spending due to getting a raise. I worked freelance for a couple of years and got behind on paying taxes. That resulted in living a couple of years on a budget and I got used to only buying what I needed plus minimal extras. These days, the only optional extra I buy is the occasional DVD which is cheaper than going to the cinema or getting a movie package on cable.
I don’t believe that most people have had their spending power eroded over the last 5 or 10 years. Some people lost their jobs and had to take something less and there has been an increase in McJobs but anyone who has stayed in the same line of work has most likely increased their spending power and could save some of that increase.
The problem is definitely with people living beyond their means as evidenced by the number of people who refinanced to use the equity to finance spending sprees. This practice has caused an enormous number of people to lose their homes. It is time to buy less stuff, sell the stuff you won’t be using, stop using credit cards, and get out of debt.
December 2nd, 2008 at 3:59 pm
“Jesse, I have to strongly disagree with you on your point about standard of living. People confuse standard of living with neat stuff your parents or grandparents didn’t have. I would argue middle America’s standard of living has, in fact, gone down. Simply look to the fact that many, if not most, people had one working parent but still owned a home, car(s), sent kids to college, etc. Try doing that on one income today.”
There’s truth to this, but let’s keep some details in mind: owning a home used to mean owning a small, 1000+ sq foot home. Now it is 2000+. Owning a car used to mean owning 1 car and a relatively affordable domestic. Now it is 2+ and one of them is an overpriced SUV, volvo or beamer. Vacation used to be a camping trip to a state park. Now it’s a family cruise.
I’m not suggesting you don’t have a point, but you do need to factor in how much people’s conception of what is the American standard of living has inflated.
December 22nd, 2008 at 10:21 pm
I agree but disagree at the same time. if your pay raise is less than inflation or equal to inflation, i agree with you. however, and i presume this is what all the advisers say, if your pay increase is substantially more than or simply more than inflation, then you can, and probably should, save your raise or at least a significant portion of it.
December 25th, 2008 at 12:45 pm
Watch out for those who leach in your life as well. Do the math, and keep doing it. I have paid for two and half college educations and I have yet to step foot in a class. I have always had not conventioonal type work , therfore those around me see me as an at home mom yet I make more than my friends who go to real work. Everyone else dips their hands into my earnings therfore I have nothing left to save for myself or even spend on what I would like to. When they “borrow” from me they never pay back. Everytime they get money they buy what they want they see no need to ever pay me back. I have zeroed out my retirement accounts twice in my lifetime for others. In 2009 new policy I am not spending one penny of my money on anyone else but me. Take a hint from those around you and learn from your mistakes. If you do not history will repeat itself.