Tips to Make the Most of Your Pay Raise

Getting a pay raise can be exciting and even life-changing. And while there’s nothing wrong with the occasional splurge (if you can afford it), consider dedicating part of your new pay hike to a long-term wealth-building strategy.

If you want to maximize the impact of your raise, here are some ways you might use the extra cash.

Take Care of Financial Essentials

Could you come up with a large sum of money in an emergency? Many Americans couldn’t. Experts suggest having a "rainy day" fund to cover three months' worth of living expenses, but any amount you can set aside for the future is helpful.

If you've been procrastinating on establishing an emergency fund, your pay raise could be a good opportunity to get serious about saving for the unexpected. If you get paid via direct deposit, ask whether you can send part of each paycheck to a separate savings account. Or you can set up transfers on your own schedule. Your bank might make it easy to automatically transfer set amounts between accounts for purposes like this.

Another way to boost your financial well-being is to pay down existing debt balances. Consumer debt—particularly credit cards—often carries a very high interest rate. A pay raise can provide a great opportunity to pay off some or all of your debt before high interest rates add substantially to your debt load.

Increase Your Retirement Contributions

If your emergency fund and debt are in good shape, consider bumping up your retirement contributions right away. Not only will this move benefit you down the road, but doing it immediately means you won’t get used to the extra cash in your paycheck and so won’t feel like you’re giving something up.

This can be a particularly good move if your employer offers matching 401(k) contributions and you haven't yet taken advantage of the full match. When it comes to matches, it's rarely a good idea to leave free money on the table as long as you can meet your living expenses without the extra funds.

Even if you’re already taking full advantage of any matching contribution, this could be a good time to increase your contribution if you’re still under the federal maximum 401(k) contribution limit. You might also want to consider contributing to other retirement accounts, such as traditional or Roth IRAs.

Reevaluate Your Savings Goals

Once you’ve satisfied the above obligations, you might decide to dedicate some of your pay bump to other financial goals. Would you like to buy a house, put money aside for a child’s education or save for a vacation?

It's a good idea to assign each of your financial goals a price tag and a time frame, and then identify the kinds of savings and investing strategies that might be appropriate for meeting your goals. That could mean setting up separate savings or investment accounts for each major goal and choosing investments based on your time frame and risk tolerance.

If you want to invest but aren’t sure where to start, consider consulting an investment professional to help you figure out the best way to achieve your financial goals.

Learn more about investing basics.