As we approach a new calendar year, many of us will receive or note that we didn’t receive a “pay raise.” The trouble is that the overwhelming majority of people don’t understand why an annual raise is necessary – management included. I recently heard a manager talk about the process of “awarding” them as if people didn’t automatically deserve them. But here’s the funny thing – if your business raised its prices or found ways of cutting costs, you deserve a “pay raise.” Here’s why.

There are really two types of raises: cost of living adjustments (COLA) and performance/longevity raises. People generally make no distinction between the two because they don’t under how inflation works. Costs go up (really it’s the dollar becoming less valuable) by design. That’s how our fiat currency system works. A regular COLA “raise” is necessary just to keep you from taking a silent pay cut, as the $50k you agreed to work for was really $50k at a particular point in time. Because the dollar is worth less today than when you started, they have to pay you more dollars for you to have the same purchasing power. Since the dollar is worth less each year, a COLA raise is how to keep pace with the dollar’s devaluation. It has nothing to do with performance and everything to do with continuing to pay your people what you agreed to when you hired them.

So how is that different from a performance or longevity raise? In just about every way. These are about rewarding certain behaviors; these are actually earned. Maybe your company rewards service (longevity increases) or maybe you got a raise when you were given more responsibilities. What’s important is that you have to earn them by some action; whereas COLA is about keeping pace with the banking system.

Do yourself a favor. Make the distinction between cost of living adjustments and actual pay raises. If you’re an employer or have some say in payroll, make sure you hand out COLA raises.