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.
You have three basic choices on how you can use any extra money in your paycheck: invest it, save it, or spend it.
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. 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.
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. Thanks to the explosive growth in online, high-yield savings accounts, you can likely find plenty of suitable options for your money.
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.
In conclusion, whether you choose to invest, save, or spend your salary increase, it’s important to make a conscious decision that aligns with your long-term financial goals. Each option has its pros and cons, so consider your priorities and make a choice that will set you up for financial success in the future.
