It’s getting close to that time of year where annual budgeting occurs and raises and bonuses are given out, assuming the state of your organization supports such things. I know, I’m doing our group’s annual financial plan and just got notified what my raise will be after the 1st of the year. Some incentivizing by upper management methinks, but it’s nice to have that number for my personal financial planning.
So as you start to get your hands around what your income may be in 2016, I highly recommend you start having those discussions with your spouse about how to earmark that money before it just vaporizes into the ethos like so many people have happen. What typically occurs is raises and bonuses just go into the direct deposit coffers and just magically vanishes into consumption and lifestyle “improvements.” I use improvements in quotes because I ask: Is what you procured with that money really an improvement in your life, or just mindless use of the dollars?
I like the blog Afford Anything because it basically (and correctly) states that “you can afford anything, but you can’t afford everything!” That means if you prioritize a high performance sports car as a big life improvement, then you can make that happen, but you have to give up other areas. Don’t ever apologize for spending money on what you want. A friend of mine goes on a big hunting trip for elk every year, others go to Vegas a few times a year. It just means that they maybe don’t have a new car, or work longer, but they go after what they want and sacrifice somewhere else. That’s what prioritizing means: pursuing something of higher importance or rank.
Like most of you, we wish we had more money. For us, a large goal is financial freedom and I suppose retirement – though not in the traditional sense of just not working and lazing around. We’d do more volunteering, travel, and pursue side businesses with more passion, but I digress. Holly and I have had corporate jobs for most of our careers, and have contributed a minimum of 10% to a 401k (with additional employer match added on top) since our early 20’s. Over the years, depending on our situation, we’ve been adding percentages to that to an eventual end game of full 401k max limit ($18,000 in 2016 if under age 50). I had my contributions up to 20% last year, after inching up little by little over a five or seven year period.
Additionally, if you have a side hustle, you can contribute more on top of this max for your own benefit – deferring your own income in tax advantaged accounts for a later day thereby reducing tax burden today. Having a side business isn’t for everyone, but it does allow you to write off legitimate expenses (including a nice deduction for home office space if applicable) keeping more money in your own pocket and out of Uncle Sam’s. I never saw myself as an entrepreneur or business owner when I started my word diarrhea that graces these posts, but as the years pile up and more thought is given to this endeavor, it is becoming apparent that there is some seed of a business here, but again, I digress. For those who do have some side income, and want to set up additional retirement saving program, I really recommend Mike Piper’s short book Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less. I purchased a kindle copy and laid out my strategy for allocating future coaching income toward our big goal of financial freedom/retirement. This short book won’t get you 100% there, but with a little more elbow grease, I expect you can figure it out, just like me. And I’m not tax adviser, so talk to a CPA. Kay?
So earmarking raises or bonuses and having those discussions early help to set yourself up for success. My wife and I have a standing “state of the family” meeting over Thanksgiving break to discuss big picture things, go over finances, goals, where we are and where we want to be. I’ve talked before how to calculate personal savings rate, and each year we try to improve that. We are rapidly paying off a new minivan, but besides that low interest car loan and a mortgage we are debt free. If you aren’t, that should be part of your strategy for allocation of raises. Then we try to plug as much as we can into savings – either retirement accounts, cash savings, investment savings, or the kids’ college accounts (which are woefully behind right now, but we prioritize retirement over that, and you should too). You sacrifice a little bit today for the betterment tomorrow. Hard to do in today’s society.
Not that you’re asking, but here’s what I recommend you do with raises (and bonuses). Please take a patient long-term route and you’ll set yourself up for success, and be as aggressive as you can as early as you can – time and compounding are super powerful tools for those that are young enough.
- Save 10% of your income, if you have a 401k, have it automatically thrown into that account. Use any raises to increase this amount to 10%. If not, set up an automatic withdrawal program for a Roth IRA. I won’t get into it here, but I am a fan of Vanguard and they can walk you through that process. This should be automatically distributed (or manually on a regular basis- though you’ll likely incur more fees) to investments. Again, beyond the scope here. Roth limits in 2016 are $5,500. If you are above that then the next best bet is a brokerage account, but retirement (or FI savings) is very important. And while the math may not be ideal, I think you should start saving even before paying off debt to start the ball rolling, and is what we did.
- If #1 has been accomplished, and you have credit card debt, use that strategy to pay down that debt faster. Again, I’d have that increase automatically withdrawn into a separate account, and transfer that money back into your checking to make a higher payment. So it may be something like this: you get a $1 an hour raise, after taxes that may end up being (let’s say) $30 a week more. Have an account set up that every paycheck day you pull $60 into it (assumes a bi-weekly paycheck). When you are doing bills, transfer back $120 (4 weeks worth of “new” salary compared to last year) and write your CC check for $120 more than you normally do. Be aggressive in paying this down, it’s a huge life and money suck.
- As a quick aside here, The Simple Dollar has a little calculator widget they call Debt Payoff Calculator that shows how extra payments impact your time to remove debt. You take your debt, interest rate, and monthly payment and it gives you payoff date. Then, you can play with how much extra payments decrease that payoff date. Kind of cool.
- If #1 and 2 are accomplished, this is where it starts to get fun. I’d recommend taking half or all your raise percent and keep bumping up your 401k withdrawals to either 15% or the maximum allowed – more is generally better. It increases your chances of success in getting out of the work game at a reasonable time and having a retirement nut of suitable size. If you intend to retire earlier, there are many other things to consider that I won’t get into here, but this strategy fits for most people.
- After that, it’s up to you and your priorities. If you get a bonus, please try and save some of it into a place that protects it from you. We spread our extra income around. Some goes to child college accounts. Some gets put into higher car payment. Some gets put into extra mortgage payment. And yet more goes into future savings accounts for bigger items like vacations, vehicles, and home improvement projects.
- Anything left after all of that get’s put into non-tax advantaged (401k, Roths) accounts at a regular brokerage, or we earmark for other investment purchases in the future (like maybe Real Estate? – we’re not there yet). I’ve also set up an Acorns account in the last year for micro-investing “spare change” so to speak. Basically any transaction you make at any store rounds up to the nearest dollar, and the difference between the purchase price and that rounded dollar amounts gets invested. For example, if you buy $21.50 worth of gas, the extra $0.50 gets dropped into your Acorns account and gets invested. It’s not perfect (fees are higher at $12/year on lower balances, not super great selection of auto-investing, though the funds chosen have low fees themselves). I am not an affiliate, but just like the idea of sneaking even more into savings, and this is better than a change jar. I seeded our account with $300 in May and have added about $200 in small increments since then, with $5 in fees against that. The market hasn’t been great (my net loss thus far is 2.4%), but I haven’t missed the $5 here and there that get dropped into the account.
And while I didn’t talk about socking away to start a business, or investing in yourself through training or education, or having an emergency fund, those may be perfectly legitimate things to do with your raise or bonus. Captain Capitalism doesn’t have faith in the standard model I laid out here, and instead likes the idea of investing in yourself, much like James Altucher, so don’t think this is one-size-fits-all advice
So to summarize:
- Know your goals and priorities
- Save early, save often
- Get out of debt
- When you spend, spend on net happiness accumulators for you, and save money by spending less in areas you don’t really care about
- Work the system as much as you can with tax advantages
- Use money as a tool to reach YOUR goals.