Regular readers will know how important it is to have your finger on the pulse of your finances. That doesn’t mean tracking every expense for the rest of your life, but it does mean knowing your budgets, and understanding where your spending generates the most value.
If you’re not in control of your finances, they will control you. One such example is what happens when you receive a pay rise.
A pay rise should be a big win. But perversely, there are two common problems which result:
1) The Problem of Not Adjusting
2) The Problem of Over-adjusting
The Problem of Not Adjusting
This first problem refers to people who earn more, but don’t spend any of their raise. What’s the point of having money if you don’t spend it?! These people fall into the miser’s trap – they accumulate money but keep forgetting to spend it.
They’re the people who will sit in the dark to save electricity or leave the bar when it’s their turn to buy a drink. Nobody wants to hang around with people like that. So don’t let that be you!
Sure – it makes sense to save and invest. But up to a point. If you keep saving for the future you’ll be the richest person in the cemetery. Not a good look. It’s all about balance between today and tomorrow.
Why do some of us self-sabotage in this way and become misers? Because, as with all types of habits, we get used to our standard of living. We identify ourselves with the lifestyle we have, and can’t imagine stepping up a level, even if we have the means to do so.
This type of person also sees a world of constraint rather than a world of abundance. It’s easy for them to see how to spend less, but it’s hard for them to see how to earn more. So they spend all their time cutting expenses, becoming miserable in the process, when all the while along it would have been easier to earn more money…
The role of money is not simply to have more of it, but to use it to do the things we want to do. So when you get a raise, make sure you spend some of it!
The Problem of Over-adjusting
The second problem is more common, and more severe. The damage of the first problem is that you save too much for the future, at the expense of the present.
But with the second problem – the problem of over-adjusting – you increase your spending by more than your pay rise. The pay rise causes the opposite change in mentality – a feeling that the shackles are off – and you end up spending unsustainably.
It sounds like a stupid mistake – why would anyone increase their spending by more than the increase in their salary? But it’s surprisingly common, and there are psychological reasons why this happens.
The mental process is described well by the Diderot effect. This is a phenomenon where making one new purchases leads to a spiral of other new purchases to keep up with the new lifestyle expectations you have created.
For example, when you buy a new couch, the lamps, tables and chairs in your living room suddenly seem dated. Once you replace them, you realise the carpet isn’t up to the same standard. And once you replace the carpet, the windows seem out of place…. We are creatures of habit, and when your new habits become expensive, it’s easy to get carried away.
And so a pay rise leads to one purchase, which leads to many, many more purchases, thereby changing your expectations about what makes you happy. This is clearly unsustainable - it often leads to financial ruin.
The Wealth Equation
So, with all this in mind, how should we think about a pay rise? It’s not rocket science.
The simple answer is to save half and spend half. So if your salary increases by £200/month, save and invest £100, spend £100. But when you spend the extra £100, spend with intention on what’s actually going to move the needle for your happiness. Don’t just waste it on what other people say you should want. It’s your life; live it on your terms.
Remember the wealth equation, which looks like this:
Work + Saving + Investing + Spending in ways that make you happy = Wealth
There’s no point doing the first three parts, then spending on things that don’t add value to your life.
The bottom line? Be conscious of what happens to your mind when you get a pay rise. Do you hoard it away like a medieval pirate? Or do you spend it all (and more)? Success with money means having your finger on the pulse and asking yourself the question ‘what lifestyle uplift can I have with the extra money I earn?’
Once you have that answer, go and spend – quite literally, you’ve earned it.