Income changes—whether a raise, a bonus, or an unexpected decrease—can bring excitement or anxiety. However, how you manage these fluctuations in your income can significantly impact your long-term financial health.
As a financial advisor with years of experience helping clients navigate these situations, I’ve seen the effects of both income surges and declines. Here's how to proactively handle each scenario to maintain financial stability and growth.
When Your Income Increases: Stay Grounded
A rise in income brings new opportunities, but it also comes with challenges. The most common pitfall is "lifestyle creep," where individuals increase their spending to match their higher income. This can result in missed opportunities to strengthen long-term financial security.
Here are five steps to keep your financial health on track:
- Boost Savings and Pay Down Debt: With the additional income, it's tempting to indulge in luxuries, consider increasing contributions to your retirement accounts (like a 401(k) or IRA) or building an emergency fund. Use this opportunity to pay down debt faster, especially high-interest debt.
- Invest Wisely: This is an ideal time to reassess your investment strategy. Consider diversifying your portfolio and aligning it with your long-term financial goals. By doing so, you can protect against market volatility while capitalizing on growth opportunities.
- Avoid Lifestyle Creep: The more you earn, the easier it becomes to justify spending more on non-essentials. Stay disciplined. By keeping your spending habits in check and redirecting extra income towards savings and investments, you’ll avoid lifestyle inflation that eats away at future wealth.
- Consider Tax Implications: Increased income might push you into a higher tax bracket. It’s essential to review your tax strategy—adjust withholdings, explore tax-efficient charitable donations, and consider working with a tax advisor to ensure you’re optimizing your approach.
- Develop/Update a Written Plan: Work with a financial advisor to create a comprehensive written financial plan. This plan will help you allocate your increased income wisely, ensuring it contributes to your long-term goals rather than slipping through your fingers.
When Your Income Decreases: Stay Resilient
On the other hand, a reduction in income—whether due to a job change, economic downturn, or unexpected life events—can feel overwhelming. But with a well-thought-out plan, you can manage the transition effectively without derailing your financial progress.
Here are five steps to take when income decreases:
- Revise Your Budget: Start by cutting back on non-essential expenses. Prioritize essentials like housing, utilities, and groceries. This is a good time to review subscriptions and memberships, eliminating what’s not necessary.
- Reevaluate Debt Payments: Consider refinancing or consolidating high-interest debt to lower your monthly payments. If needed, explore temporary deferment options. Keeping debt manageable is crucial when your income declines.
- Use Emergency Funds Wisely: If you've been diligent in building an emergency fund, now is the time to tap into it. Be strategic and ensure you’re covering the most pressing expenses first, giving you breathing room to adjust.
- Explore New Income Sources: Diversifying your income can be a valuable strategy in challenging times. Whether it’s part-time work, freelancing, or turning a hobby into an income stream, exploring new avenues can help offset the financial strain.
- Update Your Financial Plan: A reduction in income calls for revisiting your written financial plan. With a clear strategy, you can prioritize your expenses, adjust your goals, and ensure you stay on track, even with less money coming in.
The Importance of Proactive Planning
In both scenarios, whether your income rises or falls, having a written financial plan is key to long-term success. A plan not only guides your financial decisions but also keeps you focused on your goals, even when circumstances change.
If you’re facing an income change or expect one in the near future, working with a financial advisor can help you navigate these shifts with confidence. Together, you can create a strategy that turns potential challenges into opportunities for growth.
