It’s usually during the beginning of the year when employees have their annual performance reviews.

For those of us who tend to perform well, and based on our employer’s budget, we may be granted a merit increase (raise) and/or a bonus. Often times, I’ve found that many folks are happier with the bonus than with the raise.

It’s important to understand the difference between the two, and also to understand why a raise is likely more powerful. However, this isn’t always true as different industries and companies have varying compensation structures, and in some cases a bonus may be much better than a raise.

The Difference

A raise is typically an increment in your annual base salary. It is your new foundation of compensation moving forward. For example, if your base salary is $50,000 and you get a 5% raise, your new base salary moving forward will be $52,500 .

A bonus is typically a monetary award granted based on your and your employer’s combined performance. The bonus is usually not guaranteed, and does not increase your base salary moving forward. As an example, if you were granted a 10% bonus on your salary of $50,000, you would receive $55,000 total in gross income for that year. Note that your base salary the following year will still be $50,000.

The Winner

The raise is by far the winner, in contrast to the bonus. The primary reason for this is the compounding effect of an annual raise. If your company offers a 401k match, a bonus, and so on, they are usually based on a fixed percentage of your base salary. The sheer notion of a raise indefinitely increasing your base salary means that all of these such benefits mentioned above will also proportionately get that “raise”. And, if you tend to get a raise each year, this will have a compounding effect. For example, year 1 your $50,000 base salary got a raise of 5% and is now $52,500. Year 2, your base salary got a raise of 5% again and is now $55,125. Note that in dollar value, Year 2 income increased by $2,625 versus year 1 where income increased just $2,500. The percentage increase remained the same, but the dollar value went up. This is the power of compounding, and this also translates to derived benefits such as the 401K match and bonus.

What makes all of this possible are two properties of a raise that a bonus does not always boast.

1. The benefit of a “raise” is guaranteed in subsequent years.

2. A “raise” elevates, in perpetuity, the foundation upon which your total compensation is built.

CONCLUSION

While it’s always an exciting time of year to have an awesome performance review, and get a mediocre raise but sizable bonus to splurge on something we otherwise wouldn’t have, it’s important to acknowledge that the raise generally still possesses a stronger compounding effect on your total compensation as your career progresses.