Hi everyone! Welcome back to Melissa Making Cents!
As a CERTIFIED FINANCIAL PLANNER™ and financial coach, I believe in budgeting. Budgeting is a healthy financial habit that helps pays off in the long run. Budgets seem to work for some people, and for others budgeting can be a struggle. More than often, I find the reason for the struggle can be tied to a few main reasons:
- Unrealistic Budgets
- Underestimating Expenses
- Irregular Income
Last week I talked about budgeting--including why everyone should have a budget in their financial plan, and how to get in the habit of tracking all income and expenses. For people who earn a regular paycheck and know exactly how much money they will make each month, budgeting is a fairly straightforward process. But what if your income changes from month to month, as might the case for contract workers, small business owners, freelancers, or people with multiple jobs? The good news is that there are still ways to budget--it just requires a little more financial creativity!
Here are some special considerations for creating a budget based on irregular income.
Review your pay stubs, and find your lowest monthly income to determine your budget
Go through your pay stubs (or bank statements) for the past two years to determine your lowest monthly income, your highest monthly income, and your average monthly income. This will give you a fuller idea of your finances throughout the year, especially if it’s affected by seasonality. Then focus on the lowest amount you earned in a month. If you are self-employed and need to pay estimated taxes every quarter, subtract the amount you would have to pay in taxes from your lowest monthly gross pay. The result is going to be the number that determines your baseline budget.
Now, you might be wondering why you don’t make a budget based on the average income you’re pulling in. Well, it’s always better to prepare for the worst and hope for the best! Basing your budget on the lowest number helps you to keep your expenses in check.
List out your expenses in date order
If you’ve heard of the 50/30/20 rule for budgeting, you’re probably familiar with grouping expenses into categories (50% for needs, 30% for wants, and 20% for savings). While you should still understand the difference between wants and needs, with an irregular income I recommend taking a slightly different approach to budgeting that isn’t as firmly based on percentages.
Instead, start by listing your expenses in date order. Make sure you prioritize your “needs” (housing, food, insurance, etc) before any of your “wants” (entertainment, dining out, etc.). You’ll want to make sure that your baseline budget covers all your necessities. In addition, try to allocate at least some of your income for savings, even on your baseline budget. Then increase that number during months when your income is higher.
Adjust your budget throughout the month, based on your actual earnings
If you have an irregular income, creating a budget based on your lowest projected monthly income means that most of the time, you will be pleasantly surprised by how much more you’re earning! But that means it’s just as important to have a plan for that extra money. If your baseline budget didn’t cover all your discretionary expenses, refer back to the list you created and use that extra money to cover those expenses you want. If you need to pay taxes on this extra money because they are not deducted from your paycheck, make sure you plan for that too so you don’t overspend! I also recommend putting a portion of that money earned above your baseline budget into your various saving goals, including your emergency fund and retirement account.
Create an additional fund to cover expenses during a slower month
Remember that exercise you did at the beginning to understand the ebbs and flows of your income stream? Maybe you will see clear patterns, like having a substantial increase or decrease in income during the winter holidays. Or perhaps, there is no discernible pattern and you can’t predict when your income will dip. This is why it helps to create an additional savings fund--beyond your emergency fund--to make sure you always have ready cash on hand to pay your bills while waiting for the next paycheck to come in. This is especially helpful if you’re a contractor or freelancer who works with clients that might take a bit longer to pay their bills! The extra savings fund also provides a financial cushion in the event that your lowest monthly income doesn’t cover all your essential expenses.
A financial coach or a financial planner can help you create your budget on an irregular income
Working for yourself or having variable income can be an exciting adventure, but it does make it a little trickier to stick to a budget. I’ve worked with clients in a wide range of employment situations, and I can tell you that it truly is possible for anyone--with any type of income--to create a successful budget. My financial coaching program Making Cents of Your Money can also help you learn how to budget, no matter how irregular your income is. If you want assistance in learning how to create a budget that meets your needs, please call or email to schedule an appointment with me.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor in Dallas, Texas.