Don’t be fooled into irresponsible spending after a pay rise

Increasing their standard of living at the same rate or faster than their income is one of the key reasons why more than half of South Africans are in serious debt, with millions of people being unable to save sufficiently for retirement.

According to Anil Jugmohan, CFA Investment Analyst at Nedgroup Investments unfortunately for many people, an increase in income is usually accompanied by an even bigger increase in spending. He warns that while this is often put down to human nature, it is a reaction that, if not carefully controlled, could lead to a dangerous financial position very quickly.

“Often, people whose incomes have recently risen, tend to buy things that they don't need or can't really afford once all the additional costs are considered. It’s the mentality of ‘rewarding oneself’ that usually motivates people to spend more than they would usually – for example, upgrading to a new car when their current car is in perfectly good condition,” he says.

Jugmohan says South Africans should take a page out of pop-star Lady Gaga's book when it comes to keeping spending under control, even when income is rising. Gaga reportedly still lives in a one-bedroom flat she has had in New York since before she became famous and continues to spend frugally on her credit cards.

“This does not necessarily mean that you should not upgrade your standard of living at all as your income increases, but it is a good example of the mind-set that this does not need to be an automatic reaction,” says Jugmohan.

He says that one of the mistakes that people make is failing to take into account the effects of inflation on their cost of living. "It’s crucial for people whose income has increased recently to carefully consider the impact of inflation on their monthly expenses before increasing their spending patterns. With inflation currently at 6%, it means that on average it costs 6% more just to maintain the same standard of living than it would have a year ago.

According to Jugmohan, instead of increasing spending after an increase in income, individuals should rather use the majority of the additional money to increase their savings.

"People who belong to a company retirement fund usually contribute a percentage of their salary to the scheme, which means their contributions each month increases along with their salaries. However, people who save through unit trusts or other savings products usually contribute a fixed Rand amount to these investments, which are often not adjusted in line with their income levels. This results in a smaller percentage of monthly income being saved, resulting in huge shortfalls at retirement age."

Furthermore, Jugmohan stresses that many investors will not even be aware of these shortfalls until it is too late. "It is therefore critical to engage with a professional financial planner at least once a year, who can advise you on the correct course of action to take as your income levels change.

“When people get seriously sick or require surgery, they will not self-medicate or operate on themselves – they will consult a doctor. In the same sense, when you are dealing with important investment and savings decisions, you need to seek assistance from professionals who can help you make the right choices," he concludes.