At the start of 2007, many Americans received a welcome addition to their paycheck: a cost of living raise. This raise is a small percentage (between 3 and 4%) of salary added to keep pace with the increase in the cost of everyday life in the United States. Yet, on a year-over-year basis, many of us do not feel a heavy pinch from inflation: our mortgage bills stay the same, our car payments stay the same, and most of our utilities stay roughly the same. Sure, food items are becoming more expensive over time, but not enough to make even a slight dent in our cost of living raise.
The fact of the matter is that cost of living raises are more than adequate – and by not investing that money, you’re squandering it. Let’s take a look at Joe. He’s 30 years old and made $50,000 in 2006, and then received a 4% cost of living raise at the end of the year. This bumps his salary up to $52,000 and, after taxes, increases his monthly take-home by about $100.
Many Americans like Joe simply take that cost of living raise and use it to buy more day-to-day luxuries. Maybe Joe can now afford to buy a KitchenAid stand mixer or is saving up to get an iPhone. Or maybe he’s going to start that wine cellar he’s always talked about.
What would happen to Joe if he invested that money instead? Let’s say that Joe can get an 8% annual return on his investment. At age 65, by just investing the cost of living raise from one year, Joe would have $268,429.22 saved up. At that stage, this is a healthy sliver of Joe’s retirement plans, just because he didn’t burn a cost of living raise on an iPhone.
Instead of just blowing through the cost of living raise you get this year, invest it instead. If nothing else, put it into a high-yield savings account for a rainy day emergency fund (Joe would have about $1,400 in an ING savings account emergency fund at the end of the year – more than enough to cover a car accident or some other big unexpected bill). Or, pay that much extra on your home mortgage each month and trim years off of the mortgage. You have the money and the opportunity – here’s a chance to step things up and make a difference in your financial life.