One benefit of being a salaried employee is having a steady paycheck to look forward to. But when you run your own business or work as a freelancer, you're forced to contend with the perpetual upheaval that comes with having variable income. The Federal Reserve Board estimates that 30% of working Americans have a household income that changes from month to month. Meanwhile, 10% of adults with variable income have experienced financial hardships as a result.
If your earnings tend to fluctuate significantly, it can be difficult to get a handle on your finances. Here are some tips for overcoming the challenges you might be facing today.
1. Arrange your budget around the low end of your income
First thing's first: If you're not already following a budget, stop what you're doing and create one immediately. Otherwise, you'll have a hard time keeping tabs on your money regardless of whether your paycheck is steady or not.
But assuming you have that budget in place, review your monthly earnings from the previous year, identify the three months in which you earned the least, average that amount, and use it as the basis for your ongoing budget. In other words, let's say your three lowest months of income gave you $4,000, $4,500, and $5,000. If you take the average of $4,500 and arrange a budget around that figure, you'll put yourself at less risk of not managing to pay your bills. Then, during the months when you earn more than that, you'll have plenty of cash left over to add to your savings or use as you please.
What should you do if your current budget requires a minimum of $5,000 of income? It's easy: Cut $500 in expenses. You may need to downsize your living space, cancel cable, or avoid restaurant meals, which are far more expensive than those cooked at home. It doesn't really matter which categories you slash as long as you're keeping your spending in line with what your new budget allows for.
2. Limit your fixed expenses
Our budgets generally consist of fixed expenses, like rent or a car payment, and variable expenses, like leisure, clothing purchases, and even food. It therefore stands to reason that when your income tends to fluctuate, the fewer fixed expenses you lock yourself into, the less financially squeezed you'll end up being.
How do you eliminate fixed expenses? You don't. You can, however, work to keep them as low as possible, thereby buying yourself the maximum amount of wiggle room. So take a look at your budget and see which fixed expenses you have the option to cut. Can you trim your rent by moving elsewhere? Eliminate your car payment by taking the bus rather than driving your own vehicle? Cancel your monthly gym membership and find a place that offers pay-as-you-go classes instead? There are probably at least a couple of expenses you can play around with, so work on committing to as little money as possible to allow for those periods when your income isn't stellar.
3. Have an ultra-loaded emergency fund
We're all supposed to have money set aside for a rainy day, and while most Americans are behind on emergency savings, as a general rule, we're told to have three to six months' worth of living expenses in the bank. If your income tends to fluctuate significantly, however, you'd be wise to sock away even more cash. There comes a point when you can only cut so many expenses in your budget, or reduce your living costs to allow for those months when your workflow slows down. So if you don't want to go too extreme in either regard, have a healthy amount of money available in the bank -- perhaps even a year's worth of living expenses or more.
In fact, you may want to consider opening two separate savings accounts -- one for true emergencies, and one as a supplemental account of sorts to tap when your income drops during the year. For example, imagine you spend $5,000 a month on living expenses, and manage to save up $60,000. The first $30,000 should go into your true emergency fund and remain untouched unless a catastrophe strikes. The second $30,000 can then go into that supplemental account so that when you have a month in which you only earn $3,000, you dip in and pay your bills without worry.
Dealing with a variable income can be a financial nightmare -- but it doesn't have to be. Be smart about the expenses you take on, budget wisely, and save aggressively so you're covered when work slows down. It's a great way to buy yourself some financial protection and peace of mind.