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Saving Strategy: Bank your Raises/Extra Income

This is a saving strategy that I’ve mentioned before but I thought it deserved more attention as I believe this is one of the larger factors as to why we are able to save a significant portion of our income.

That is, when you obtain extra income, instead of spending it or increasing your lifestyle, bank or save it instead.  The extra income can be in the form of tax refunds, GST cheques, salary increases, business/investment income etc.

As I have explained in our financial story before, we graduated university with a boat load of debt.  However, we kept our expenses low by living frugally, renting out a portion of our home (paid for most of the mortgage), and constantly looking for opportunities to increase our income.  As we are professionals by trade, even though we didn’t start with huge salaries, our incomes have increased every year.

Instead of using the pay increases to fund a more expensive lifestyle immediately, we continued to keep our expenses low while saving and investing the increased income.  We did this for about four years and as a result, eliminated $65,000 worth of student/car debt, purchased another rental property (now sold), and had a good start on an investment portfolio.  If you’re interested, you can follow my net worth progress since late 2006.

Today, even though our expenses have increased with the baby and the new house (no apartment), we still live fairly frugally and bank extra income.  For us, most of the extra income comes from dividends and the online business.

Coincidentally, this same strategy helped QCash build his million dollar net worth and fund his early retirement.

What do you do with extra income?  Do you splurge it on yourself?  Or do you save/invest it?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 27 comments… add one }
  • Frugal by Nature April 8, 2009, 10:08 am

    We have always banked the extra income/tax refunds/unexpected cash, but then decide jointly what to do with it. It’s our way of rewarding ourselves for “good behaviour”. By doing so, we are avoiding those impulse buys (like the home gym and the slot machine) but we still have the 52″ LCD, take an annual vacation somewhere warm, we were mortgage and debt free after only 15 years, always contribute annually to RRSP’s, and still managed to have decent vehicles and other assorted toys. (We have never purchased a new vehicle, only slightly used, until last year where my job now requires me to take clients about town, so it is a tax write-off anyway.) I think what worked for us was looking at the financial benefit of each decision – ie: paying down our mortgage by $500 equated to $2300 worth of savings off the mortgage! – why pay it to a bank?! Or $7000 in RRSP’s gave us a refund of $3000 – better us than the gov’t, right? There are so many calculators on the ‘net now that anyone can find the financial benefits of any decision, if they truly want to.

    Frugal by Nature

  • Dividend Growth Investor April 8, 2009, 11:42 am

    I use any extra income I get to buy income producing assets that generate even more income. Dividends get reinvested, interest checks get reinvested and I add more to my accounts as I earn more..

  • Baker @ ManVsDebt April 8, 2009, 11:51 am

    Great advice. We try to pile up whatever unexpected income we have to help pay off our smallest debt. It helps keep us on track and motivated to already have a plan for where that money is going to go!

  • Scrotzy April 8, 2009, 11:52 am

    I work a sales job that is 100% commission based. I’m going to try this year to change my ways and once I make 50,000 for the year I’m going to try and bank the rest. I live pretty frugal and $50,000 should float me for the year.

    Anyone in commission sales knows finding motovation every day is the most difficult part and I hoping this will spur me on.

  • srichardhfx April 8, 2009, 11:56 am

    After watching many episodes of Til Debt Do Us Part, we have decided to use Gail`s magic jar system. So far so good… Eating out was killing our budget and for a few weeks now we’ve been planning meals and taking lunches to work. What a difference at the end of the month when you look at the disposible income you have left for savings. I must admit it was hard not to go to Tim Horton’s a couple of times every day at the beginning but it’s a matter of breaking an old habit and starting a new routine. Another thing we did was to eliminate all the little fees that we normally don’t pay attention to (DVR rental box, cell phone features, extra costs to get more air miles on credit card, extra insurance on items already covered, etc..).

  • Ben April 8, 2009, 12:03 pm

    We’ve actually got very similar stories and philosophies on this front. We graduated 5 years ago with $50,000 of student/car debt, eliminated the $30G student debt in less than one year, paid off the car in four years, and put 20% down on a house 3.5 years ago. We have seen raises every year, and our gross income is 68% higher than upon graduation. Our monthly expenses have only gone down as time has progressed (probably has a lot to do with staying away from Home Depot lately). Tax refunds and bonuses simply go into the savings account, for future redirection to the mortgage/RRSP’s.

    This always increasing gap between our net income and expense has allowed us to maximize RRSP’s & TFSA’s, build a substantial emergency fund, and chew off another 25% of home equity. We also seem to manage to go somewhere warm once or twice a year. Our lifestyle is not one of penury and thrift, but we do try to make sure we are getting the best value for our dollar, regardless of the size of the purchase.

  • Canadian Finance April 8, 2009, 12:08 pm

    I could do better at this. I have increased my savings each year so in a way I’m sort of doing it… but it’s not a straight ‘I’ve got a $6000 raise so now I will save $500 more a month.’

  • DAvid April 8, 2009, 12:26 pm

    FrugalTrader & Ben,
    Great to see you realized this benefit early, when the advantages are multiplied. Usually pay increases (as a percentage of income) are greatest in the first few years, as you gain those experience increments. Once you have been in the workforce some years, the increases are smaller. However, it makes sense to apply increased income to reduce debt, rather than increase spending.

    We used cost of living increments to increase our bi-weekly mortgage payment each year, and applied lump sum income (tax returns) as well to reduce it’s amortization. By taking these steps over 5 years, we reduced our amortization from 25 years to about 9.5 years, gaining major savings in interest costs.

    It’s a painless way to get rid of debt!

    DAvid

  • Scrotzy April 8, 2009, 12:49 pm

    srichardhfx : I have to agree with you in regards to Gails Magic Jar approach. I used it for a full year while changing careers and it is the best way to stop the Tim Horton’s. Unless you have a massive amount of Timmies stock its IMO the biggest waste of money out there. Basically has replaced smoking.. People are addicted.

  • Kirk S. April 8, 2009, 1:16 pm

    For myself, for each raise I get, I save approximately 50%, put approximately 25% on loans (whether it be upping the mortgage or paying off student loans), and the last 25% I just leave for myself (so I get a bit of a raise)

    I have been doing this for my last three years worth of raises and it has not been difficult (and the spreadsheet looks better each month!)

  • QCash April 8, 2009, 2:12 pm

    FT is right. All our saving and debt reduction early on helped us create a frugal atmosphere around our house. The flipside is that we are also not afraid to splurge on the things that bring us enjoyment (see my 350Z as an example <- as an aside, I apologize to everyone for the lousy weather this week, I pulled the car out of the garage last weekend and that is why it snowed yesterday).

    My wife and I enjoy the holidays with the kids and we don’t mind eating out from time to time knowing we are able to afford it.

    DGI – I also put a percentage of our income back into the market to keep growing the value of my investment income, but you also have to have a goal in mind.

    Qcash

  • Al April 8, 2009, 2:55 pm

    QCash – thanks for taking responsibility for the weather. I knew someone was to blame.

    To all those who put their window scrapers away. GET THEM BACK OUT, or at least use your arm to wipe off the back window.

    Save on.

  • rob April 8, 2009, 5:24 pm

    I use a budgeting software that is similar to the jar approach as in Til Debt Do Us Part. It’s a great show (all the episodes are on the slice.ca website).

    I’m a recent university grad and have been working since June, so I haven’t really dealt with this yet! However, when I generate income outside of work I usually like to set it aside for things that I want to purchase, or may in the future. This is one of the reasons that I take on these extra jobs, along with resume building. There are very few things that are on my “want” list, and most of them are items that will last me for several years or decades.

    My general plan with increases in salary is to allocate a large chunk towards savings and some for vacation. In the next few years I’ll either be moving to a bigger place, or looking to purchase some sort of dwelling, so that part of my budget will have to increase, as well.

  • fern April 8, 2009, 6:29 pm

    i was very good this year. I took my net $4500 bonus and partially funded my IRA with it. I took my $600 IRS refund and put that in my emergency savings account.

  • mgronqui April 9, 2009, 2:39 am

    My 4k income tax return is going all to one of my credit cards which I used to pay off my car with an interest rate promotion. I should be debt free by 2010!

    I’ve chosen to pay my debt first before saving anything.

  • Lyne April 9, 2009, 9:14 am

    I just got a raise of 150$ per pay. As soon as I saw the first pay check, I increased the automated transfers to the emergency fund by 50$ and increased the investment into TD e-funds by 100$. I don’t need that money, I already live comfortably.
    Now I’m trying to decide what to do with the income tax refund that I should get soon. I’ll probably put half on the car loan, and maybe put the rest to help pay for my next vacation in June (I’m planning a week in Paris).

  • srichardhfx April 9, 2009, 10:15 am

    Lyne: A $150 daily raise? May I ask what type of work you do? That`s wicked!! Your industry is definately recession-proof ;) Oh and go to Paris, c’est magnifique!!

  • Scott April 9, 2009, 11:25 am

    Any ideas on how to get a raise if you do not work in the private sector? What if someone (I’m sobbing already) works in the soul-crushing, salary-capped/controlled world of public service?

    p.s. — WHY, oh WHY, does ANYONE still pride themselves on getting a tax RETURN?!? mgronqui stated a $4000 return! Yikes! That’s a $4000 interest FREE loan you just gave the government! If anything, you should get NO tax refund, or even OWE taxes. Use that money throughout the year to make YOU money — it is YOUR money after all!

  • DAvid April 9, 2009, 12:25 pm

    srichardhfx,
    Lyne states $150 per PAY, about $10 per day, or $1.20 per hour, not an unreasonable increment for someone who has recently entered their field, and is gaining the “experience” increments contained in many contracts.

    Lyne appears single (MY next vacation), which further suggests recent entry to a profession.

    DAvid

  • DAvid April 9, 2009, 12:31 pm

    Scott,
    Possibly now is when you compare your job & stress situation to that of a forestry worker, mill worker, manufacturer, or auto worker, and balance the greater certainty of continuing employment, against the spectre of job loss? Historically, government employees exchanged industry standard wages for job security, and although this has been put to the test in recent times, the public’s demand for the services provided by the public sector largely continues through all stages of the economy.

    DAvid

  • Canadian Finance April 9, 2009, 1:46 pm

    Scott’s right about the huge tax returns. If this is money that you have coming to you, why pay that much in taxes from your paycheque in the first place?

    I wrote an article in February about the two forms you can fill out to reduce the amount you pay in taxes…

    http://canadianfinanceblog.com/2009/02/23/tax-refunds-are-a-bad-thing.htm

  • Lyne April 9, 2009, 3:17 pm

    srichardhfx, DAvid,

    per PAY, not per DAY! I wish…

    And I’m a federal agency employee, this is an increase in level (to the top level of the group) and is according to my collective agreement, so not a huge jump, no.

    As to the rest of the assumptions, I’m not exactly entry-level in my field as I just hit 6 figures (and I won’t even talk about my age ;-)), and am going on this vacation with a special someone, but after a failed relationship many years ago, I have decided that I prefer to keep finances, and homes, separate :-)

  • Patrick April 10, 2009, 1:35 pm

    Looks like your strategy would fit one of the last two diagrams I’ve got here.

  • SingleGuyMoney April 12, 2009, 6:34 pm

    Great post. Starting last year, I made a conscious effort to make sure my expenses didn’t magically increase to meet my new income. So far, I’ve been successful and I’ve even lowered my monthly expenses.

  • Stephen April 15, 2009, 11:15 am

    My wife and I tend to get large tax refunds due to large charitable donations and contributions to RRSPs. While I am fully aware of the ability to reduce taxes at the source and do almost anything I can to reduce interest costs on fees on all the services in my life … this is one area that I purposefully do not touch.

    I don’t find the extra hassle and administration to be worth it in reallocating the smaller amounts monthly. I also like the psychological effect of having a lower income that encourages tighter spending control. I figure that the small cost in lost interest or other benefit to be worth it to have this forced savings plan. When I get the large refund I can then give some serious consideration to how this money can best be used as a lump sum or how it can be split accordingly.

    Chances are I might be losing out slightly because of this over time … but I wouldn’t be surprised if the numbers were crunched including behaviour and decision making that I am actually ahead because of this. With interest rates so low rate now that probability is even higher.

  • Bankruptcy Saskatoon May 29, 2009, 11:39 am

    I agree! It is a great way to save up for something important you wish to purchase or invest in the future. There are many banks that offer savings account with a unique feature of breaking down your funds into different sub-accounts. For example, you can have one sub-account for your car fund which will tell you exactly how much time it will take to reach your goal with your current monthly savings. Accordingly, you can choose to save more and reduce the wait time! Saving any additional income may it be a GST cheque or a pay raise can be put to use efficiently.

  • Darren October 19, 2010, 8:55 pm

    We spend it on vacations while the kids are young enough to want to spend time with Mom and Dad. I watched a friend of mine die of cancer in his forties. I watched others who saved and saved and then were struck down before they had time to enjoy it.

    Does that mean you shouldn’t save…of course not. But don’t stop living. I had the chance to go t Rome the other week. It wasn’t in the proverbial budget…but I went. I could be hit by a bus tomrrrow..and my stock portfolio would be absolutley meaningless/

    Have fun…it is truly later than you think..

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