Which is More Important -- A High Starting Salary or Higher Average Salary Increases?

We've talked about the importance of beginning your career with a high starting salary and managing your career to maximize your annual increases but we haven't talked about which one is more important -- until now. Let's look at some numbers assuming that a person's career starts at 25 (for ease of calculation -- 40 years until retirement). Consider these options:

• Option A: If he makes $30,000 a year and gets an average annual increase of 3%, he'll earn $2.3 million in his career.

• Option B: If he makes $30,000 a year and gets an average annual increase of 7.5%, he'll earn $6.8 million in his career.

• Option C: If he makes $60,000 a year and gets an average annual increase of 3%, he'll earn $4.5 million in his career.

• Option D: If he makes $60,000 a year and gets an average annual increase of 7.5%, he'll earn $13.6 million in his career.

Given these scenarios, it's much better to have a lower starting salary but get higher average annual increases. That's because of the power of compounding. The higher average increases keep compounding and compounding until they overcome the advantage of starting with a much higher salary. So despite Option B starting with only $30,000 in annual income versus Option C's $60,000 (only half as much), B ends up with $2.3 million more in lifetime earnings (51% more than C.) Furthermore, it's much more likely that you can achieve consistent, higher increases (as long as you manage your career appropriately) than starting with a starting salary that's double what you'd earn otherwise. So I'm declaring the "higher average salary increases" option the winner.

That said, you'll certainly want to try and do both -- beginning with a higher starting salary as well as work towards the highest possible annual salary increases. Why? Just look at how well Option D does. That's what I'm shooting for!!!

Comments

[Ben Brumfield]

The math checks out, but this is a difficult rule to apply in real life as an employee. You have a lot of leverage when you're negotiating a job offer, but very little when you're being considered for raises. This is one reason employees are well served to change jobs frequently in a rising market -- they have the power to reset their salary to market rates, rather than relying on management to do it for them.

[Foobarista]

This is also an argument for moving to areas where your skill is prominent, such as Silicon Valley for technology or NYC for finance. Salaries typically start higher, and it's easier to drive your salary up since job-hopping is easier due to a deeper job market.

[Tyler McKinna]

Have you factored in the lost opportunity cost of investing the extra $30,000/year right off the hop?
If the people in both scenarios have the same living expenses, which would be reasonable to assume since you are comparing them to each other in your examples, the person making $60,000 would have $30,000 to invest immediately.
You may then add the continual difference in the salaries as an additional investment each year and compund that number by an average of say 6-8% (conservative given historical figures) and voila!
I'll take the higher starting salary any day of the week.

[Gates VP]

When good math goes wrong! Sure, your math is correct, but your math simply doesn't model reality. You're assuming pretty impossible growth rates.

If inflation is 2%, then 7.5% would be a net of 5.5% additional pay/year. To earn this type of pay raise, you would need to be 5.5% more efficient each year to justify the increase in cost.

So if you could make 100 widgets/hour today then in 10 years you'd need to be able to make 170 widgets/hour. In 20 years, you'd need to make 292 widgets/hour. By 30 years you're at 500/hour and by 40 years you're at 851/hour. That's a little absurd b/c it simply doesn't scale like that in most fields.

Given these scenarios, it's much better to have a lower starting salary but get higher average annual increases

This statement is only true b/c your scenario is poorly designed and fails to account for volatility of growth. Your example also works b/c the "target date" is after the break-even point and you're somehow assuming that a really high growth rate is sustainable.

You haven't really proven anything here, except that your math is pretty sketchy.

[FMF]

Gates --

"You're assuming pretty impossible growth rates."

Not true. I've averaged 9% for almost 20 years now and I think I haven't pushed it as much as I could have.

"If inflation is 2%, then 7.5% would be a net of 5.5% additional pay/year. To earn this type of pay raise, you would need to be 5.5% more efficient each year to justify the increase in cost."

This is why I say you need to MANAGE your career. Most people just let their careers drift along and get what they get (by accident.) But if you manage your career, you certainly can make 7.5% or more gains each year. (remember too that these aren't 7.5% gains each and every year, but 3% gains some years and 15% gains a few times in your career.)

"So if you could make 100 widgets/hour today then in 10 years you'd need to be able to make 170 widgets/hour. In 20 years, you'd need to make 292 widgets/hour. By 30 years you're at 500/hour and by 40 years you're at 851/hour. That's a little absurd b/c it simply doesn't scale like that in most fields."

This scenario may be true for many blue collar jobs, but not white collar positions. I write mostly for the latter since that's who reads this blog and what my experience is in.

"You haven't really proven anything here, except that your math is pretty sketchy."

You haven't proven anything yourself -- other than you can critcize without offering a different solution.

[Gerty]

Who has heard of any increases over 3% in the past few years??? NOT ME !!! These senarios are unrealistic, get real, it's a recession !!!!!!!!