According to a survey by the Pew Charitable Trusts, more than half (53%) of American families experience wide income swings. From 2014 to 2015, 34% of U.S. households had income shifts (up or down) of 25% or more. There’s a good chance that you, too, will experience some degree of financial inconsistency during your lifetime. Therefore, knowing ways to manage income volatility should be a priority for you and your family. (For more, see Surviving on an Irregular Income.)
Reasons for Wide Income Swings
If you are about to get married or divorced, your household income is going to change. Getting a job, changing jobs, receiving a raise, taking a leave of absence – all can affect pay and benefits a little or a lot. If you are self-employed, subject to fluctuations in the number of hours you work each week or dependent on commissions for much of your compensation, income inconsistency is a never-ending fact of life.
Step 1: Create a Budget
The first step in solving the problem is to list your monthly household expenses in one of three columns on a sheet of paper. The first column is for recurring bills, such as a car payment, utility bills and so forth. In the second column list all of your discretionary spending, including groceries, dining out, cable TV, etc. The third column should contain savings, investments and known future big-ticket expenses, such as medical procedures, home or car repair and so forth.
For anything that tends to fluctuate, use past invoices or receipts to find an average. Always err on the side of the “worst-case scenario” if you are not sure. At the end of this step, you should know how much you need on a month-to-month basis. (For more, see Budgeting Basics.)
Step 2: Create Steady Income
When money comes in, deposit it in a savings account – not your checking account. Each month, transfer exactly enough to cover your budget expenses for the upcoming month. The idea is that your income will fluctuate, but the amount you draw out each month will be the same. You will be paying yourself a set monthly salary, with any extra income remaining in savings, so you can draw on it in lean income months.
Step 3: Pay Bills and Get to Zero
The concept involved here is known as a zero-sum budget. You will start each month with exactly what you need in your checking account, and you will spend or designate all of it, eventually ending up with very little in your checking account .
Your budget should include both investment and debt repayment. It should also include saving (for those known big-ticket expenses). As almost all money has to leave the checking account each month, big-ticket savings should either go back into the savings account (and be accounted for) or into a separate savings account.
Step 4: Adjust – Rinse – Repeat
How you track your spending is up to you. You can use a pencil and paper, do-it-yourself spreadsheet, smartphone apps or software such as YNAB (short for “you need a budget”). If you have discretionary funds left over, put them somewhere – debt repayment, big-ticket savings, investment or back into regular savings. It might take a few months before you know exactly what salary to pay yourself. Track and adjust as you go.
Step 5: Prepare for an Emergency
No matter how well you plan, there will always be unexpected expenses. You can plan to replace car tires when they wear out in six months but not a transmission that breaks down while you’re on vacation. Most experts suggest having three to six months “salary” set aside for emergencies or sudden temporary unemployment. Alternatively, a home equity line of credit or something similar can provide you with access to emergency cash if needed.
The Bottom Line
Managing wide income swings is not rocket science. It’s mostly a matter of smoothing out the financial “hills” and “valleys” by filling in the latter with extra income from the former. It will take time – likely a minimum of two to three months – to settle on your “salary.” Even then you will find yourself tweaking amounts in specific categories on a regular basis. The hard part will be sticking to a budget when you know you have additional funds in savings. Avoid temptation and be inspired by the fact that you have turned the problem of inconsistent income into regular, reliable pay. And you will have done it all on your own. (For more, see 4 Best Personal Finance Apps.)