Today marks the day that most Biglaw associates are seeing a raise in their paychecks for the first time since 2007. Whether that’s you or not, it seems like a good time to talk about raises and strategies for protecting your hard-earned income.
The Money Keeps Rolling In Year After Year
One of the benefits of being a lawyer is that pay raises often follow a set formula. This is true even for lawyers working in the public sector. There’s just something about the legal profession rewarding lawyers based on years of service rather than merit. Of course this changes completely when you’re a business owner, but salaried legal jobs seem to follow this pattern.
Knowing that you’ll have automatic pay raises in the future and planning for it is a great strategy for strengthening the discipline muscle that allows you to convert more of your income into wealth.
After all, that’s the goal right? You want to convert as much income into wealth as possible.
Many young lawyers confuse having a high income and being wealthy. They seem like the same thing, but they’re really not, especially if and when the high income disappears. True wealth will occur if you can successfully convert the stream of income into assets.
Automatic Pay Raises Make It Easy
No matter how much you’re making today, you’ve probably already adjusted to that amount of money. Whether you’re a budget ninja or you spend based on your bank account balance, you have an innate sense of what’s coming in and going out each month.
Lucky for you, you won’t miss a raise if you never see it. It’ll have zero impact on your standard of living and yet you can watch your net worth balloon! All you have to do is take a couple of steps now (and this is really the hard part) to set yourself up for the future.
7 Ways to Handle Your Recent Raise
So, I’ve come up with a list of things you can do today – before the raise hits your bank account and you’ve become used to it – to make yourself wealthy:
- Immediately start maxing out your 401(k). If you’re a junior associate, the raise in your base salary is $20,000. What a convenient number! The maximum you can contribute to a 401(k) is $18,000 a year. If you’re not contributing today, you can open a 401(k) account and bank the entire $18,000 without missing a beat. Don’t know what to invest in? Throw it into a Target Retirement Fund with low fees (i.e. less than 1%) or any broad based low fee index fund (Vanguard Total Stock Market, any S&P 500 fund, etc).
- Max out an HSA. If you’re on a high deductible health plan, you can divert the extra money from your raise into maxing out a Health Savings Account (aka The Stealth IRA). It’s the only triple tax-advantaged account around.
- Fund a Roth IRA. You might need to wait a few months to get the extra cash, but with a raise on the books that shouldn’t be a problem. In a few short months you should have the $5,500 you need to open and fund a Roth IRA.
- Start or build your emergency fund. Many lawyers benefit from the piece of mind that comes with an emergency fund. What’s an emergency fund? It’s a few months of living expenses saved up in case you get fired or decide to press the Biglaw eject button. Knowing that you have a safety net which will last you for a long time is priceless. If I pared down my living expenses, I could easily survive for a year on my fund. It’s invested in VSCGX.
- Start a car savings fund. Borrowing money to buy a car is for poor people. Even if you live in a big city without a car, you may need one someday. Throw all of the raise money into a high-yield savings account or some other liquid investment. You won’t earn much of a return, but when it’s time to buy a car you’ll be able to do so in cash.
- Accelerate Payment on Student Loans. Multiply your raise by 0.55 and then divide by 12 to get a rough idea of how much extra you’ll be bringing home each month. Sure, refinancing student loans saved you thousands in interest but now you can increase your automatic student loan payment by that amount. In other words, a $20,000 raise means an after-tax increase of about $11,000 a year or $916 a month. Increase your student loan payment by $916 a month and watch your student loans melt away that much faster.
- Start saving money for a wedding or engagement ring. That’s going to cost you some cash at some point. Do you want to fund it out of current cashflow or know that you have a few grand saved up when the time is right?
Let’s talk about it. What other ideas do you have for how to use your raise? There’s a million things to save for and if you don’t take action who will? What strategies have people employed to make sure to keep as much of a raise as possible?
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Personal Capital keeping track of his money and is currently fascinated by the JD Mortgage service connecting lawyers with lenders offering no to low down payment options.