“If we can understand the laws of cause and effect, anyone can predict the future: what we do today leads us to tomorrow's destination.” – Celso Cukierkorn
One of the things we often take for granted is a steady paycheque. After years of being self employed and working multiple jobs, it’s taken me a while to get used to the rhythm of having the same amount of money deposited in my bank account twice a month. This week I was talking with a friend who works as a substitute teacher. With the end of the school year rapidly approaching, he’s getting a little nervous about the prospect of 10 weeks without a paycheque. Between his part-time summer job and his savings, he has enough to cover his expenses but it’s still unnerving for him to know that his next decent cheque won’t arrive until the fall. His situation got me thinking about how challenging it can be to manage your finances when your income varies from month to month so I came up with the following suggestions based on principles that have helped clients (and myself):
Know Your Range
The first step to managing money is to understand your cash-flow. When your income varies this can be tricky so a good place to start is by calculating your average monthly income. However, depending on how much your income fluctuates from month to month, the average might not be a good number to base your budget on, so you should also check to see what your minimum and maximum income amounts have been over the previous 12 months. Once you have those three numbers, you'll be able to determine a reasonable number to use as your “average”. Then you can plan to save more during your “high income” months so that you can “top up” your lower earning months and this makes your cash-flow more stable.
Build a Buffer
When your income is inconsistent, it’s especially important to create a buffer zone so that you can avoid going into debt during your lower earning months. Ideally, you should have enough money saved to cover at least 2-3 months of expenses. Make it a habit to put money aside in your higher earning months so that you have a pool of money to dip into during lower earning months.
Manage Your Debt
Debt not only increases your stress it also increases your monthly expenses, which is a problem when your income varies from month to month because you want to keep your fixed expenses as low as possible. It can be tempting to use credit as a way to cover expenses during lower earning months but, as anyone who's ever carried debt knows, it's all too easy to overspend and you end up paying a lot of money in interest.
When your income is unpredictable, you often don't know exactly how much you're going to earn from paycheque to paycheque and so you make assumptions based on sales you expect to close or clients you expect to work with. The challenge with this is that it only takes a couple of cancelled appointments to really mess with your predictions. This makes it very important to only spend what you've earned and to avoid paying for things on credit based on the assumption that you'll be making enough to pay it off with your next paycheque.
Avoid the “Catch-up” Trap
One of the challenges with having inconsistent income is that, if you don't have a buffer zone, you can end up using your higher earnings months to catch up on debts that were run up during lower earning months. Ideally, you want to use your higher earning months to get ahead and build savings that you can use to supplement your income in lower earning months.
Plan for the Predictable
This is a suggestion that applies just as much to those with consistent incomes as it does to those with inconsistent incomes. We all have those expenses which come up on a regular basis but seem to take us by surprise every year: birthdays, Christmas, vacations etc. If your income is inconsistent, it's even more important to make sure that you plan for expenses such as taxes that come up every year as well as slow earning periods (such as the summer for substitute teachers) so that you have enough. Building these expenses into your regular savings plan is important for your financial health and for your stress levels.
Systems are the foundation of every money management plan and they're especially important when your income varies from month to month. Setting up a system for saving allows you to make sure that you have enough to cover your expenses every month and allows you to create a buffer zone that can be used to cover unexpected expenses as well as supplement your income in lower earning months.
While having inconsistent income can create stress during lower earning months, it can also create opportunities to save more during higher earning months. If you're realistic about your earning expectations, live within your means and commit to creating systems (and sticking to them!) it will make it much easier to achieve your financial goals and avoid getting into debt.
Is your income inconsistent? Do you have strategies you use to manage your finances? If you have suggestions to share, I'd love to hear them!