Big changes to your income (up or down) can throw you for a loop and bring up puzzling questions. If the income suddenly inflates, does that give you license to spend like a drunken sailor? If your income drops all of a sudden, should you ignore it and hope for the best or should you respond with severe spending cuts?
Balance is key friend. And in order to approach these challenges with proper balance, you need to look at these issues without getting emotional. Let’s first talk about what to do when you income balloons up. After that, we’ll hammer out a strategy to deal with a huge cut to income.
Big Income Bumps
This is a fun problem to have. But it’s an expensive lost opportunity if you don’t handle it properly.
When you get a nice income bump, ask yourself if it’s a one-time event or a possible start to good times ahead.
Whatever you do, don’t miss the opportunity to take a meaningful step forward. (In other words, don’t blow it all on a weekend in Vegas.) Don’t get me wrong. It’s OK to take a small percentage of the windfall and spend it. Do whatever you like with that dough. But take the lion’s share and invest it. This is especially important if the income bonanza is unlikely to be repeated.
Side Note: This assumes you’ve already paid off your bills and set up your emergency account. If not, I strongly suggest you address those concerns before doing anything. I’m super serious about this Pilgrim. First things first.
If on the other hand it looks like that the extra income is probably going to keep coming your way, it’s time to re-evaluate your spending and savings plan. There is nothing wrong with spending more as your income goes up – and in my opinion, it’s quite unavoidable. But you want to do this in a measured way.
The easiest way to handle this blissful situation is to re-run your financial projections. Run your numbers and see what could happen to your financial life if you pump up your savings. Could you retire earlier or under improved conditions? That’s tasty.
Once you do the calculations and understand what an impact that extra savings could have over the years, get your investment plan in action.
My suggestion is to take a large portion of this extra income and add it to your monthly savings goal. And take whatever is left over and spend it. As long as you automate your monthly savings and investments, that’s all you have to do.
I’m a huge believer in paying yourself first (putting away your savings target every month before spending a dime) and if you take advantage of this tool, it will be easy to handle this extra income.
When you follow this “pay yourself first” plan, you don’t have to worry about spending. You’ve automatically hit your savings goal at the start of the month. So as I said, spend whatever’s left if you want. Knock yourself out. Enjoy.
Over time, if you see that you don’t spend that extra cash, just bump up your monthly savings even higher. Yeh you!
How to Adjust When Your Income Goes Down
When your income drops, you may have to take more drastic action and you may have to do so much faster. And it probably won’t be as much fun either. Sorry.
Depending on how much income has been lost, suspend your automatic savings plan immediately. I know this isn’t the best way to save for the future, but right now, NOW is more pressing.
Of course, once the dust settles and you get your bearings, the time will come to restart your monthly savings plan. Maybe you’ll start off with a lower amount, but you’ll still want to restart your saving plan. That means you’ll probably have to cut spending.
I know this is easy to say but often very difficult to do. Sometimes, there is a great deal of social pressure to spend money. It can embarrassing to tell friends you can’t afford to do something. But rather than hide the truth, share what’s going on and explain that certain activities are no longer in your budget. You could be doing them a big favor by modeling this financial intelligence and bravery. And it will be easier to follow your lead if your friends ever find themselves in a similar situation. Again, you’re probably doing your friends a big favor by being upfront about what’s going on.
You’ll be able to cut some of your spending by simply calling the vendor and canceling the service. Other expenses take time to wean yourself off of.
That’s OK. My experience tells me that people who reduce their spending over a period of 3 to 6 months are much more apt to stick with the reductions compared to those who slash their spending cold turkey. What’s important is that you create a spending reduction plan, have an accountability partner, and stick with your plan.
If you see that your income is going to remain low it might be time to dust off your resume and hunt for a new gig or launch that side business you’ve been dreaming about for all these years.
If you know that you are going to have to deal with less income for a while, it’s critical to get your spending in line with the new reality ASAP. The last thing you want is to ignore this problem for too long and end up with high credit card balances and a credit score that’s stuck in the gutter.
Life delivers all kinds of surprises; some are pleasant and others are not. That’s OK. It goes with the territory. And as you already know, it’s not the circumstance that defines you but how you deal with the circumstances that demonstrates who you really are. If things turn out better than expected, show your gratitude by harnessing that positive surprise into something meaningful that can help you and your family over the long-run. If the situation gets tight, stay present and take the steps you need to take in order to keep yourself afloat.
Has your income ever changed dramatically? How did you deal with it? Would you do something different today? What?