Setting a manageable budget is hard enough on a fixed income. After all, emergencies or unplanned expenses can add a lot of variables to your budget, even if your income doesn’t change. So what happens when your income changes from month to month? How can you set a budget that works for you?
I often hear that “budgets won’t work because my income always changes.” While it’s true that commission-based and other variable income make budgeting tricky, you can still make a budget that keeps your finances on track. In fact, following a few simple steps can make the process of budgeting feel virtually the same as it would on a fixed salary.
How to Manage Your Budget with a Variable Income
Do you struggle to create a sensible budget with a variable income? You’re not alone, as nearly 40% of Americans live on fluctuating incomes. Thankfully, there are a number of steps you can take to create a budget that works for you:
Step 1 - Build Cash Reserves and Set Minimum/Maximum Boundaries
When you have a variable income, you’re probably going to have months when you make more than you need, and months when you make less. This is why it’s important to set aside cash while you have access to it. That way, when a low-income month arrives, you’ll be prepared.A good rule of thumb is to set aside 3-6 months of living expenses. I encourage my commission-based clients to set aside a minimum of 4 months and set your “base” at 2 months in the family checking account. To keep yourself on track, set up alerts on your checking account balances that notify you when your balance moves above or below certain preset boundaries.
For example, let’s say your family needs $5,000 per month to live. I would set a minimum checking account balance of $10,000, but a maximum as high as $25,000 to account for monthly income swings. If your account consistently moves above $25,000, you can transfer money over to other various longer-term investment vehicles. On the other hand, if your balance falls below the $10,000 base, then you may need to consider temporarily pausing certain savings contributions to fill that base back up.
Step 2 - Estimate Your Income on an Annual Basis
When your income is variable, only looking at the numbers month to month won’t give you a complete picture of your finances. You also need to estimate your income on an annual basis. This way, you can set aside funds based on your average yearly income.
In order to determine how much you should set aside, we recommend taking your anticipated annual earnings and subtracting 10%. Use the previous year’s income as a benchmark, but try to be realistic with how much you expect to make this year. For example, if you think you will earn $150,000, then subtract 10% and start building your budget based on a $135,000 income.
Step 3 - Develop Your Savings, Debt, and Insurance Goals
It’s nearly impossible to create an effective budget without certain goals in mind. Work with your online tools or financial advisor to develop these goals. Anything that grows or protects your net worth should be identified FIRST and maintained in a separate budget tab.
If you’re in need of additional assistance with developing your goals, our Wealth Builder Template is one tool that can help. By using the Wealth Builder Template (or similar online tools), you can rest easy knowing that your future is protected. This will help you make progress toward the life and future that you want.
Step 4 - Make Another List or Column for All Consumption Expenses
Consumption expenses can include cable, gas, utilities, cell phone, food, and entertainment, among other things. While some of these (like cell phone or cable) will remain pretty consistent on a monthly basis, others (like utilities and food) are more variable. In any case, you’ll want to track these expenses individually so that you can keep your regular expenditures within a given range.
You may be wondering how to accurately track such a wide range of expenses. Thankfully, tools like Mint.com can link various accounts to provide accurate numbers for every category. Once you have all of your consumption expenses listed out, you can build your total budget to fit within the confines of the income target, minus the 10% we took out in Step 2.
Step 5 - Evaluate. Evaluate. Evaluate. And If You Hit Your Target Income, Celebrate!
When you make a budget, you should never just set it and forget it. Instead, monitor your expenses in relation to your target. Don’t obsess about your income; you can worry about that during working hours. After all, you already know that there will be high months and low months. Simply focus on using your money within the confines of your predetermined spending limits.
Don’t forget: your income will not always outpace your expenses. Expect to spend more than you make in certain months and to make more than you spend in others....you estimated your income on the low end (10% below your actual estimated income), so it should all work out! The low months are exactly why you have excess funds in your checking account and why you set minimum and maximum alerts.
If you hit your target income, feel free to celebrate by dedicating a 10% bonus to your savings or even a vacation! There’s a reason that you’re working hard to manage your budget on a commission-based or variable income. You should be able to enjoy the fruits of your labor!
Are you looking for a financial plan that fits your circumstances and maximizes long-term benefits? Consult the experts at Afton Advisors today for more information!