If you’ve recently received a salary bump, congratulations! An increasing salary is one of the keys to long-term financial success. But what you do with that extra income plays an important role as well.
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You have three basic choices on how you can use any extra money in your paycheck: invest it, save it, or spend it.
Here’s a breakdown of the pros and cons of investing, saving or spending your salary increase.
Invest
Investing means using money to buy an asset in the anticipation that it will generate income and/or an increase in value over time. If you’re looking to build wealth, investing is your best option.
The S&P 500 stock market index, for example, has a long-term average return of about 10% per year. Thanks to the power of compound interest, that’s enough to double your money every seven years or so.
One trick many financial advisors recommend for building long-term wealth is to invest any “found” money. This includes any type of money that’s not part of your monthly budget. Typical examples include tax refunds and bonus checks, but salary increases qualify as well. Since you were already (hopefully) spending less than you earn, it means that you should be able to get by without spending the salary increase.
If you’re looking to boost your long-term nest egg, investing is the best choice. Savings accounts can’t keep up with the return of the stock market, and spending subtracts from wealth, rather than building it.
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Pros
- Boosts long-term wealth without having to go “out of pocket”
- Multiplies the value of the salary increase thanks to compound interest
- Prevents cash from being spent
Cons
- Can diminish the feeling of accomplishment since the money “goes away”
- Requires patience to ultimately receive the reward of a higher net worth
Save
While long-term investing can net the highest returns, sometimes the best place to put a salary increase is in a savings account.
When your money is in a savings account, it’s instantly accessible via a debit and/or ATM card, giving peace of mind in case you have any financial emergencies. It’s also federally insured by the FDIC for up to $250,000.
Thanks to the explosive growth in online, high-yield savings accounts, you can likely find plenty of suitable options for your money. Most competitors in the space offer insured accounts with no fees or minimums that pay 10x or more in interest as traditional brick-and-mortar bank accounts.
Pros
- Protects against falling into debt
- Can be used as a foundation for short- or mid-term goals, such as a home down payment
- Provides Liquid access to cash, if needed
- Can earn decent rates of return for an insured account
Cons
- Can’t compete with the returns of riskier assets like stocks and bonds
- Interest is fully taxable
- Rates are variable
Spend
The final option is to spend the extra money that you’re earning. While this isn’t a good choice if you’re looking to build long-term wealth or preserve your capital, there are some scenarios in which it can make sense.
If you’re “spending” the money to pay down high-rate credit card debt, for example, that can be a smart move. There’s also a case to be made for catching up on important expenses you have been delaying, such as driving a safe vehicle or maintaining your home properly.
But if you’re just planning to blow the money on discretionary items, you’re giving in to what experts call “lifestyle creep,” in which you continue to spend your money as fast as you earn it, even when your income increases. Over the long run, that’s the path to the poorhouse.
Pros
- Gives a feeling of satisfaction/reward for earning the money
- Can be used to buy items that are really needed, such as home repairs
Cons
- Makes it hard to get ahead in the long run
- Gets you in the habit of not saving or investing
- Traps you in the cycle of always spending more
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What To Do with a Salary Bump: Invest, Save, or Spend?
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