Lots of people wait for an opportunity to finally save money. But when that opportunity arrives, it all of a sudden doesn't feel like an opportunity, thus they wait for the next opportunity. And before they know it, it's too late.
"I'll save money when I have more money to save" isn't exactly an original excuse. I hear it all the time. Yes, you're likely to make more money than you do now, sometime in the future. The problem is while you're waiting to earn more dollars to save, time is ticking by. You're stuck thinking dollars matter, when in reality, time, which you're wasting hand over fist, matters as much as dollars.
Your opportunity to save more, like many opportunities in life, arrives to the party in a disguise. It actually can appear to be an insult.
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Imagine this scenario: Your boss calls you into her office and lets you know about your modest pay increase. You quickly do the math and realize your pay increase may buy you one additional meal per week. So much for working hard, you think to yourself.
For instance, if you have a $60,000 salary and receive a 3% raise, you'll net about $24 more per week after taxes. Doesn't exactly look like the more money you were waiting for, does it?
From what I've seen, most people would take a $24-per-week raise and use it for pizza money. It's hard to believe that if done properly, a $24-per-week raise could be over $51,000 in 15 years, and that's if you just save your first raise every year going forward. It doesn't even account for future raises.
The trick is to not only save the first raise, but to keep saving every time you learn of a pay increase.
How 3% can grow to $104,000
When you receive a raise, you've got three options.
You can do nothing, which still isn't exactly nothing, if you're deferring a fixed percentage of your income into a company-sponsored retirement plan each year. Because if you're saving 5% of your $60,000 salary to equal a $3,000 contribution, and you get a 3% raise, your contribution rises to $3,090.
As long as you're saving a fixed percentage of your income, a raise will cause you to save more. In fact, after 15 years of a 3% raise and your hypothetical $60,000 salary and 5% contribution, you will have accumulated just north of $104,000 if you can average an 8% return. That's not terrible. Ending up with over a hundred grand when you thought you were just getting a few pizzas, is actually quite impressive.
But the alternative save-your-raise strategies are much better.
How 3% can grow to $253,000
Your second option when receiving a raise is to increase your retirement plan contribution by 1 percentage point per year. In year one you're saving 5% of your income, in year two 6%, in year three 7%, and so on.
This strategy allows you to still keep pace with cost-of-living increases, as well as dedicate increasingly more money toward your financial future.
Using this strategy, based on your starting salary of $60,000 and your beginning contribution of 5%, after 15 years of 3% raises, you will have accumulated around $253,000. That's more than double your balance had you done nothing, as in our first example.
How 3% can grow to $479,000
The third option is amazing, but it's very difficult.
If you were able to save every penny of every raise for 15 years, using the same numbers above, you'd end your 15 years with over $479,000 in your retirement plan.
In order to realistically pull this off, you'd have to somehow become immune to cost-of-living increases. Which means you somehow are able to keep your health care premiums stagnant, energy prices stagnant and consumer goods prices stagnant. It's a very difficult task, but not impossible.
You may not be able to save every additional penny you earn beyond your current annual salary, but that doesn't mean you shouldn't have a strategy to harness both dollars and time.
Small raises add up, and if you don't see it that way, that means your lifestyle is constantly expanding, making it much more difficult to become financially independent. If your lifestyle constantly expands, time is your enemy.
When you employ time to magnify the impact of small raises, true financial independence gets closer and closer.