Attention Investors - Half of Your Salary Raise Should Go Towards the Future

Getting a raise in salary is one of the best things for an employee. Professionals from all walks of life set targets and make wish lists in anticipation of a salary raise. A salary raise is usually an occasion for a celebration. To the more savings-minded, it is an opportunity to top-up on their investments. But before you decide to splurge the money, let’s have a look at why a fifty percent of the raise should be invested for your future.

The prevalent thought – Percentage Savings

Retirement planners bank upon the classic “save a percentage” model. It usually means taking a slice out of the income pie every year. There’s no universal consensus on what’s a reasonable amount. A 10% savings on the pre-tax salary seems reasonable to most. The general idea is that, as your salary increases, so does your savings. But there are pitfalls that we turn a blind eye to.

Drawbacks

• Increasing standard of living – When you save 10% of your income, you save only 10% of your raise. This puts you in a position of spending 90% of your salary, no matter what the increase. This significantly increases the standard of living and requires much greater savings for an equivalent retirement corpus.

• Post-retirement difficulty - With the standard of living peaking just before retirement, it becomes difficult to sustain the lifestyle. Troubles multiply after hanging up your boots and a reduced corpus doesn’t help at all.

The alternative – Save your raise

Alternatively, you spend only 50% of each raise, implicitly saving the raise. Instead of dedicating the same percentage of your income to savings, you save the same percentage of our salary hikes.

Benefits

• The controlled standard of living – Saving half of your salary raise helps you to control the rise in your living standard. Expenditure is capped and savings grow in parallel to your paychecks.

• Early retirement opportunity – With your standard of living in check, and your salaries burgeoning, you can easily move for an early retirement.

A Case Study

Figures rarely lie. Logic and reasoning need to be backed up by some solid figures to support claims.

Let’s take two examples to illustrate the point.

Case A: Traditional Savings

Mohan starts off with a Rs 4,00,000 per annum salary in the mid-twenties. He follows a 3% savings growth plan. With a reasonable increment of Rs 20,000 per annum, his savings build up somewhat like this:

Now in a period of 3 years, Mohan will have an annual contribution of Rs 13,800 per annum.

Though Mohan possibly becomes a millionaire, he’s forgotten to take the bigger picture into account. He is raising the lifestyle costs by 90% each year.

Thus, an initial living cost of Rs 3,88,000 per annum (Rs 40K minus the 3% saved) can exponentially increase.

With a 4% withdrawal rate, Mohan is going to need a lot more to make it through.

Case B: Saving half your raise

Mohan’s friend Rohan started off on the same Rs 4,00,000 per annum as Mohan. However, he doesn’t plan to save exactly 3% every year. He plans to save half his salary raise every annum.

He puts aside 3% for the first year and then spends only 50% of each salary raise, saving the rest.

In a period of 3 years, Rohan has saved much more than Mohan. His annual savings contribution is now Rs 42,000. His savings graph now looks something like this.

Since he has significantly reduced his lifestyle growth, he’s more likely to make do with a much smaller corpus than Mohan’s on retirement. He had a lifestyle growth which was slower, but it definitely means that he won’t have to do with less once he hangs up his boots

Saving more and spending less is a double blessing. It grants more flexibility during your working career and significantly increases the chance that you will enjoy a comfortable retirement.

It’s worth your while to save that next pay raise—and you deserve it!