How to Think About a Pay Increase

A pay increase is often one of the clearest signs that you’re contributing value to your employer. It is also an event that can materially change your current financial situation, and if dealt with sensibly, your future financial prospects.

From our years working with clients, we’ve seen how different ways of responding to this event can shape a family’s financial future.

We share these ideas in the hope that it will get you thinking about how best to deal with this event when you next face it.

Why the Increase Disappears

We’ve seen families use a run of pay increases to move onto a financial path they would have struggled to imagine a decade ago.

We’ve also seen families who earn a great deal more than they did ten years ago and are no further ahead. There was no single decision along the way that looked like a big mistake, but somehow their career progressed without their financial future changing.

The difference is all down to how they deployed the increase in income.

The tempting option is to use a pay increase to address your family’s short-term needs and improve your current situation, even though it raises your cost of living. By our very nature, we place more value on the present than on the future, so this decision is entirely understandable.

We’ve seen these increases go towards a bigger house in a better area, a car that fits the family, and holidays taken while the children still want to come along. Each of these is reasonable, and on the day the money arrives, each one is easy to say yes to.

Within a few months, the higher spending level and the changes it brought start to feel normal. Going back to your previous situation feels incredibly difficult because reversing an upgrade feels like a loss, even though you are only returning to a life you were content with a few years ago.

The Cost Is Paid Twice

Importantly, a permanent increase in your standard of living is a cost you have to pay twice. The first cost is the obvious one. Money spent is money not invested, so what you accumulate is smaller.

The second cost is less spoken about. The amount you need to accumulate in financial assets to stop working depends on what you spend rather than what you earn. If your spending rises permanently, the number you need to aim for also rises. You’re now aiming for a bigger target.

Ultimately, every ongoing monthly commitment carries a capital cost because your portfolio will need to fund it when you stop w

orking. While you have a salary coming in, the commitment feels small. But once that same amount has to be funded by hard-earned money you worked for in the past, the commitment takes on another feeling.

Conversely, a family that invests a portion of each increase sees their target rise more slowly, even as more money goes into their portfolio. A small behavioural change can put two different families on significantly different paths.

Decide the Split Before the Money Arrives

One practical solution is to decide in advance what percentage of any future pay increase goes straight to your future self.

Deciding in advance, while the increase is still hypothetical, means you don’t give up anything you already have. Once the money is in your account, this same decision becomes much harder.

We are not arguing against improving your life. Your income rose so that your life could get better, and it should. By encouraging you to think about this decision differently, we are advocating for your future self, and we think it’s a decision worth taking seriously.

If you don’t have a number, it is worth setting one before your next pay increase. If you would like to discuss how this affects your specific situation, please let us know.

Compliance disclaimers:

“The value of investments and any income from them can fall as well as rise. You may not get back the full amount invested. Past performance should be used as a guide only and is not a guarantee of future performance.”

“Different investors will view these trade-offs differently depending on their objectives, time horizon, and attitude to risk. If you would like to discuss how this relates to your own circumstances, please speak to us".”