It’s easy to “adapt” to a huge rise in income. And even if your income falls, you can find a way to deal with the change. At least you know what you are dealing with. But how do you manage your financial life if your income is so unpredictable that it resembles a wild balloon that’s just had its air let out? The answer is careful planning…that’s how.
1. Run Your Numbers
Rather than react to huge income fluctuations, let’s introduce some order into our spending plan by looking at your income data. When you do, you may find that it’s less “unpredictable” than you think. Indeed, even if your income fluctuates significantly from year to year, chances are still good that there is some order there.
Jot down on a piece of paper what net income you brought home each year over the last 10 years. If you think that the next 10 years might look the last 10 years, calculate the average annual income you earned over that period. That will be the number we’ll work with during the next phase.
If you see anomalies that aren’t likely to be repeated, pull those numbers out of the data set. For example, let’s say you normally earn $50k to $75k. But if you earned only $25k one year because there was a strike or you were ill and out of work, you might disregard that year when you calculate your average annual income.
It’s not the number so much as the circumstance to consider. If you think the strange and non-recurring circumstances caused you’re income to be vastly out of line one year and you think those circumstances won’t likely impact you again, just remove that number.
Just remember that this works both ways. If you hit the ball out of the park one year and earned $125k because you landed a once-in-a-career sale, strike that number out too if you don’t think it can happen again. Keep it real Pilgrim but rest assured this doesn’t have to be perfect. Just do the best you can. It’s a lot better than doing nothing.
2. Build Your Buffer
Now that we know what your average income is, we can reasonably create a spending and savings plan around that number. Let’s say your average income works out to be $48,000 a year after tax – or $4,000 a month. Your next task then is to build a budget (including your “pay yourself first” investment savings plan) around that figure.
Of course there will be months where you earn more than $4,000. That’s great – we’re counting on that. The extra cash will be used for future spending; those months when you earn less than $4,000.
When you earn more than the $4,000, put that excess in a special buffer account so you won’t spend it. This way, when the tough times come, you’ll have the resources you need to get through.
Note: This buffer account is not your emergency fund. Your emergency fund is meant for unexpected non-recurring expenses. These income ups and downs are expected so please don’t combine this buffer with your emergency fund. Thank you.
Of course if you start this plan during the lean times, you may not have a large enough buffer built up. In that case, there is no magic bullet. You’re going to have to cut your spending my friend. Please do not hurt yourself by financing your spending with debt. I know this may not be easy. But in order to get off the launching pad we’re going to have to keep you out of debt – especially credit card debt. So if you don’t have excess cash laying around to tide you over, just suck it up and cut the spending for a month or two. .
This way when the good times roll, you will be able to create that buffer. If you get into debt to get you through the low tides, you’ll have to use the extra money you generate in the good months to get out of debt. If you do that it will be very difficult to ever escape this terrible cycle.
If your income jumps up and down like a kangaroo, don’t fret. Take a sober look at your income and determine what your average income really is. Then, set up a spending plan around that figure. During times when you earn more than that amount, use that extra money to build your buffer. During times when you earn less, draw money out of your buffer – but only up to the target budget amount.
The big problem that people with fluctuating income face is they don’t know how much they should spend every month and then making sure they have the cash they need to do so. If you follow this approach, you’ll solve both those problems.