Tips for uncertain income
Popular budgeting advice such as the 50/30/20 rule — which allots a set percentage of income to necessities, wants and needs — is meaningless for people whose paycheques go up and down.
Freelancers, the self-employed, and those who depend on tips or commissions can have a great-paying month or a bad one, and that leaves them vulnerable.
Financial experts’ best advice is to plan ahead as much as possible, using creativity. Here are three tips for managing money when your paycheque fluctuates.
1. Build an emergency fund People with sporadic income should save nine months’ worth of expenses in an emergency fund, says Todd Youngdahl, managing partner at Washington Wealth Advisors in Falls Church, Virginia.
That’s more than the standard recommendation of three to six months’ worth. The extra allows you to “dip in to cover expenses in a month that you don’t get paid as much,” Youngdahl says.
It might take time to reach that goal, but research shows that even a small cushion improves financial health.
2. Budget what you spend “When you have irregular income, you must live below your means,” says Mark Kemp, a certified financial planner in Harleysville, Pennsylvania.
Because you don’t know your income for a given month, construct your budget around your baseline spending.
Add up the costs of your necessities, including housing, utilities, food, insurance and transportation, and include a monthly amount for annual bills, such as property taxes.
Do not include extras such as restaurant meals or taxi rides, just the minimum amount you need each month. An app that tracks spending can help you estimate.
Then find out if last year’s earnings covered this baseline. If not, you might need to trim expenses. And use surpluses from peak months to build your reserve for lean months, says Barbara O’Neill, a certified financial planner in Newton, New Jersey.
3. Create a steady paycheque Take control of your cash flow by setting up separate accounts for deposits and spending.
Deposit paycheques into one account. Each month, use it to pay yourself a “salary” that covers expenses.
“This creates a steady monthly income that goes into the chequing account your expenses are paid from,” says Clayton Shearer, a certified financial planner at A&I Financial Services in the Denver area.
If you tend to receive many small cheques each month, and your reserve fund isn’t fully funded yet, try weekly transfers.