Updated on 01.12.07

It’s Not Just Another Raise: Turning That Cost Of Living Increase Into Your Dreams

Trent Hamm

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.

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  1. Martin says:

    This is a great article, and I always tell myself I am going to take the difference in my raise and try to do something with it (I never do). This year I did not get a raise, but I should be getting a nice raise around March as I will be hired on full-time. My goal is to take about 1/2 the difference to pay off student loans and the other 1/2 to start an emergency fund.

  2. Daniel says:

    Lol, but the iPhone looks SO COOL!

  3. James says:

    Where do you get the $268k figure by just investing the cost of living raise from one year until age 65 at 8%?

    I’m showing $1,200 turns into $17,742 after 35 years at 8%.

    To get $268,429.22 after 35 years at 8% Joe would need to start with a much more substantial $18,155.09

  4. Marc says:

    I like that the KitchenAid stand mixer always makes a regular appearances in your posts.

  5. Chris says:

    I have recently done this on a grand scale. I graduated college, and while in school I was making X dollars/year. After graduating and getting a full time job, with a significant pay bump, I’m making 3X dollars per year. I’m putting a full 1X towards debt payments and savings. I will be free of interest bearing debt in only a few months, and totally debt free a few months after that.

    Investing and saving a windfall is almost always the right choice. Since I am so young, I will be ready for retirement at 55 (or maybe a bit younger) since I’m planning ahead for it. Nothing like taking YEARS off my forced working life, not that I’ll stop, just not be so tied down to it.

  6. Trent Hamm Trent says:

    If you’re thirty, and you invest the amount of your cost of living raise this year and repeat that investment every year (you’re investing the raise itself, not just one year’s worth), you’ll end up with that amount.

  7. 'Neeks says:

    While you do make some good points, I’m just not sure how valid your basic premise is, regarding expenses not going up as much as our raises.

    I don’t know where you live, but in most places, homeowners’ property taxes have skyrocketed in recent years, My own have quadrupled in the past 6 years, while the actual assessed value has only increased by about 30%. In many parts of the country, homeowner’s insurance has jumped dramatically too. Since most people pay these bills from an escrow account via their monthly mortgage, it has made what most consider to be their house payments swell tremendously.

    Other examples: My trash collection bill has tripled in the past 5 years. Electricity has doubled, as has gasoline. Medical Insurance premiums have soared to 4 times what I paid just 5 years ago, and the co-pays have at least tripled!!

    All of these combined make it very hard to put away even raises of up to say, 10% a year!

  8. Connie says:

    I do not know who that nit-nut is who thinks the COLA is excess, but he/she/it must not have a family or pay the bills very often. I am retired, ex-postal(SSA, not civil), and a widow. I do not have that kind of money to play with. I know our servicemen and women do not get that much to play with,either. The Congressmen all do, though. Interesting?

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