Friday, July 4, 2008

Got a raise? Don't go shopping now!

It's the first week of July and a number of you must already be armed with your increment letters. While some of you must be delighted, some disappointed and the others neutral, the fact is you've come to posses some extra cash and if you don't act fast this extra money is going to seep into your daily expenses and lose its way. If you want to get the best out of your pay raise, you need to plan and plan right away.

The first thing NOT to do is splurge that extra amount. Even before that amount reaches your salary account by the end of this month, plan in advance what you want to do with the money. Stop thinking of your pay increase as a way to up your lifestyle. Instead of increasing your spending habits, increase your saving habits. This means no new gadgets, new clothes, branded stuff, or visits to an expensive restaurant, etc. with the money. The trick is to continue living like you never got the raise.

When you keep seeing people around you indulging in luxuries and when your credit card bill is bursting at the seams, it may seem easier said than done to pretend like you never got the raise. If it does get difficult, allocate a much smaller percentage (say 10% of the increment) for your expenses, earmark the rest for savings. This way you can pretend like you got a much smaller increment than it actually is.

Decide on where you want to utilize this extra money. There are a number of options depending on your requirements.

1. If you have an outstanding loan (educational loan, car loan, home loan, money borrowed from parents, friends, etc), you could use this extra amount to increase your EMI on the loan. Ensure that this amount is allocated for paying off your debt right at the beginning of the month before you get tempted to start spending it either by setting up an automatic transfer or manually setting aside those funds in a different account.

2. Use this money to set up an emergency fund (if you don't have one already). A salaried person must have an emergency fund equal to at least four months of the individual's monthly compensation. Now that your monthly compensation has increased, so should your emergency fund. Remember that an emergency fund is for a raining day and not to pay your irresponsible over the limit credit card bill. Stash away a portion of your income every month to set up this emergency fund. The best place to store your emergency fund is a savings account. But make sure that this is not the same account as your primary account.

3. Year after year we keep seeing people who declare that they will save the maximum tax exempted amount to their finance departments. Come March and when this hasn't happened they end up paying a lump sum in taxes. Set aside your increment for this very saving.
  • Set up a SIP for an tax saving ELSS fund
  • Use the amount to pay up for your insurance premium
  • Use the amount to buy tax saving deposits
This way you've saved and you don't have to scramble during the last minute to save your hard-earned money from being eaten up by income tax.

4. Set up a Systematic Investment Plan to invest in a mutual fund or index fund. If you already have SIPs running, use the money to top up your investments or delve into a new fund. Remember to do your research before investing.

And about me... I plan to set aside a part of my raise for an emergency fund and a part of it for an ELSS fund

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