Unless you’re struggling for money, your life may not be any better if you fritter away your pay rises.

And that’s provided you’re at a company where you get a pay rise – many people don’t.

If you invest any additional money from pay rises, you might watch yourself getting richer over time.

How it works

How does this work? I hear you say that you need pay rises to cope with the increasing cost of inflation. Maybe not…

Kiwibank’s Product Manager Transactional Overdrafts, Mark Lonergan, explains there’s a law of nature that says the more you earn, the more you tend to spend.

“Your lifestyle simply expands or contracts, based on what you’re earning,” he says.

“If you try to put away a little of that extra, you’ll almost never notice the difference.”

And if you invest those savings instead, you’ll benefit from ‘compound’ interest, where you earn interest on your savings, plus interest. That accumulating wealth can make a huge difference over time.

Says Lonergan: “Regardless of whether you’re on NZ$50,000 or NZ$70,000, your lifestyle is probably not going to be significantly different, but if you save part of that difference, you’ll be a lot better off down the track,” he says.

What’s your spending level?

Take someone earning NZ$50,000:

· They might buy nice clothes from a cheaper chain store.

· They might eat out at a cheaper restaurant and choose cheaper meals from the menu.

Take the typical $70,000 earner:

· They might buy nice new clothes, but from an average high-street store.

· They might go to an average restaurant once a month with friends and select average meals from the menu.

Take the typical NZ$90,000 earner:

· They might buy nice clothes from a boutique.

· They might go to a nice restaurant and select nicer meals from the menu.

Says Lonergan: “When you get more money, instead of buying nice clothes, you buy nicer clothes. Or you buy a nicer dinner at a nicer restaurant,” says Lonergan. “That’s how you spend that extra money.”

“It isn’t that you can’t still eat out on a lesser pay, it’s just the ‘where’ that will change.”

Lonergan suggests that if you get a pay rise, yes, you should use a proportion of it for spending, as a reward and to offset inflation.

But he says you should also save a proportion. That way, you’ll certainly be better off in the long term, he says.

Save some, spend some

As a rule of thumb, many financial advisers around the world suggest a 20:80 split of any windfall, giving yourself 20 per cent for spending, and putting 80 per cent into savings. Others suggest a more generous half-and-half split: half for you, half for your savings.

It’s up to you how much you save, or spend, but here’s an example.

Spend half, save half

Let’s say you get NZ$100 a month more as a pay rise – and save half of that NZ$100 each month, NZ$50. Invest that at 4 per cent and in a year you might have saved NZ$611.

Let’s assume you did that each year of salary increases (assuming an average of NZ$100 per month each year and 50 per cent saved).

Here’s where compound interest comes in.

After 10 years of investing NZ$50 each month at 4 per cent interest from each yearly increase, with compound interest you could have a whopping NZ$37,993.

Imagine if you invested the whole pay rise!

So, if you’re fortunate enough to experience a pay rise, have a think about what you could do with it. If you invest it, you might be surprised at the growth you could experience.

Check your own pay-rise results using the savings calculator on Sorted.org.nz.

First published 13 February 2019

Story by Brenda Ward

This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.