Smart People With Irregular Income Do This During the Good Months
Budgeting can be hard for freelancers and others with irregular income. Psychologically, the temptation to spend can increase during good months, in part as a feeling of “reward” for the belt-tightening that’s required in slower months. And it can be confusing to know what to do with “extra” money when it comes in.
The key to solving these problems is to treat unexpectedly good months as irregular, not the norm. With some practice, you can learn to smooth out the ups and downs and live off an appropriate budget.
Here’s how.
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Determine What an 'Average' Month Looks Like for You
If you keep a good budget, you should be able to determine what your average income and expenses are over the course of a year. If you earn $10,000, $2,000 and $6,000 the first three months of the year, for example, you earn $6,000 per month on average.
A good strategy in that scenario would be to set aside your money into two buckets, your “normal month” money and your “above-normal” money. Draw from your “normal month” bucket to pay your regular bills and spending and use your “above-normal” money for things like an emergency fund, general savings and investments in a "below-normal" month.
Keep Some Liquid
With irregular income, you’ll, by definition, have some up months and some down ones. By keeping some of your extra reserves liquid, like in a high-yield savings account, for example, you can draw from it to help fund living expenses in months when your income doesn’t quite keep up. Just be sure to segregate this income from any other category of spending in your life, especially discretionary spending.
Invest the Rest
Once you’ve built a sizable “slow month” fund — a year or more of average expenses is suitable — invest any remaining excess. If you’ve got a well-planned budget, you should already have a category for investments on a monthly basis using your regular paycheck. But when you have unexpectedly good months, a portion of that money should be used to boost your long-term retirement savings. Over time, these small, irregular additions could add up to a significant amount of money.
Allow for Small Extravagances
You should consciously avoid blowing all of your “good month” money on things like eating out, traveling or buying things you want and don’t really need. But that doesn’t mean you need to live a barren, stripped-down life. If you’ve worked hard and earned a large amount of money in a given month, don’t be afraid to reward yourself a little bit. Go out for that special meal, watch that new movie in IMAX or buy that new pair of shoes you’ve been eyeing. Just don’t drain your entire excess fund on little extravagances.
One technique is to set aside a firm spending limit: either a flat number or a small percentage of any windfall months. By budgeting for fun, you can enjoy the days of plenty guilt-free and without risk.
Cover the Costs You Can Count On
Once you’ve determined your baseline amounts, stick to them.
Before you invest, splurge or make extra debt payments, ask one question: “How many months could I cover if next month came in low?”
For people with steady paychecks, an emergency fund is mostly for surprise expenses. For people with irregular income, cash savings also smooths out the normal ups and downs.
After a great month, a smart first step is to move part of the surplus into a separate savings account labeled something like “income cushion” or “slow-month fund.”
This is not necessarily your forever emergency fund. It is more like a personal payroll buffer. When income is strong, you fill it. When income is weak, you use it to keep your life steady.
A good target is at least one month of basic expenses. Over time, two to three months can give you a lot more breathing room.
Consider a 50/30/20 Plan for All Your Money
Some budgeters allocate 50% of their money to needs, 30% to discretionary spending and 20% to debt and savings. If you find yourself with extra money after a good month, consider allocating that money in the same way.
Imagine that you earn an extra $2,000 in a good month, for example. You could set aside $1,000 in your “future needs” bucket, $400 to pay down debt and save or invest and spend the remaining $600 on yourself. This way, you don’t need to invent a separate method for dealing with the excess money you earn in good months.
Don’t Rewrite Your Budget Every Month
If your job pays you a different amount every month, you’ll never get ahead of the game if you keep changing your budget. Since you can’t know in advance what you’ll earn every month, you’ll never be able to successfully balance your income and expenses. The best thing to do in this scenario is to embrace the uncertainty and use long-term averages to smooth out the ups and downs.
Otherwise, you’ll be upgrading and downgrading your life every month and some months you’ll run out of money before you even pay your bills. This is the scenario you need to avoid at all costs.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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