How to Deal With Unpredictable Income
One of my concerns with the possibility of leaving my day job and pursuing self-employment through writing and managing websites is the unpredictable income. At the extreme, my biggest concern is the idea that it’s quite possible that the income could drop off permanently due to forces beyond my control. But even if that doesn’t happen, the ability to earn income from blogging and such could vary widely from one month to the next.
Budgeting can help, but the problem with a budget is you have to assume a certain amount of income. That’s the first suggestion from Money Magazine in a recent article about living well on a “flexible” income. The article suggestions taking your lowest annual earnings from the last five years, divide that number by twelve, and use the result as your monthly spending limit.
It would be a good idea to inflate your emergency fund. The typical advice for an average person calls for three to six months’ living expenses in a liquid savings account (though you might prefer a more tiered approach to an emergency funding plan). People with unpredictable income may benefit from beefing up the emergency fund to cover one year’s worth of expenses.
Is that too much? If I were approaching a year without income, I probably would have found another job by then, taking what I could if necessary. I suppose it depends on the marketability of one’s skills.
The Money Magazine article warns about underestimating your financial needs in retirement. Rather than anticipating that you’ll need 80% of your income once you retire, a rule of thumb touted by some, look at your current expenses and try to determine what they might look like when you no longer have the desire to work. Perhaps there are some expenses you could reduce while other expenses might increase. Focus on the necessary expenses rather than the income needed.
If you plan for a conservative income, it’s likely you’ll have excess some years. Money Magazine suggests using your surplus cash to build or replenish your emergency fund first and pay off debt. Additional extra cash can be saved or spent.
Insurance should be a concern, too.
For life insurance, consider what portion of your yearly expenses won’t be covered without your salary. Multiply that by the number of years you want coverage (until your kids finish college or you hit retirement is typical). Add in any big stuff like kids’ college costs.
While the article is geared towards people who work for an employer and have an unsteady income, like someone who works on a 100% commission basis, the advice works for independent consultants who need to find clients and other self-employed individuals.
5 ways to manage a ‘flexible’ income, Amanda Gengler, Money Magazine, September 2, 2008
Article comments
Don’t quit your day job until you satisfy the 5 criteria below.
1. Need to have at least enough income to pay your expenses coming in on a predictable basis.
2. Need to have purchased your own health, disability and life insurance coverage.
3. You have saved up enough “cushion” to get you through the lean months.
4. You have qualified for a HELOC on a personal residence if you own one, or are not planning on purchasing a house for over 3 years.
5. You’re absolutely sure that’s what you want to do.
Good luck!
I think that a good way to start diverisfying your income streams is to focus on investments as well ( which I think Flexo has done).
First, if your monthly expenses are $1000 ( nice round number) and you know that your online ventures can generate $500, you can generate $500/month with interest, dividends, rental real estate.
A popular method for short term budgeting is using CD ladders. If buy a $10,000 one year CD yielding 5% every month for one year you will have achieved the extra 500 in monthly income..
When I look at investment income versus work income I see how much money I need to save and invest before I could live off my investments..
Usually, all my non-paycheck money goes into savings, then into a money market account or CD short term (6 months). I sometimes have to keep my money not liquid because my wife and I both have a habit of spending it if we have it…heeh
I’m self-employed and have a wildly irregular income. I deal with this by keeping my monthly fixed bills as low as possible and pay annually whenever the option is there. Sometimes when I get paid a sizable chunk of money, I’d lock it in a certificate of deposit (don’t know the American equivalent, sorry) to pay an upcoming major bill – better return than a regular savings account, and less temptation to use it for something else.
I also keep a big savings cushion, not just for emergencies but also to take advantage of any good sale on the stuff that I need. (Frugality and a healthy stockpile can help you weather plenty of lean times.) I save up for major purchases and then sit on that money some more until a good deal pops up. I have no debt, pay my credit card bill in full every month, and avoid payment plans since they’d undermine my flexibility.
One thing you might want to watch out for is the lifestyle inflation when you’ve just got yourself a big paycheck – like the article said, you can’t maintain the utopian view that things will forever be as good as they are now.
Flexo,
I think it’s great that you are looking to jump into a self-employed status. Here’s one thing that I would recommend to help reduce risk:
“Make sure you have multiple streams of revenue”
This is key. For instance, if a regular employee lost his or her day job, they would be in a worse situation than you possibly having a bad month running your online ventures. Just make sure you have multiple streams of revenue from multiple online ventures. I don’t know exactly what websites you run, but you will most likely want to expand them and create new blogs or websites. Then if one completely fails, you can rely on others. Also if one big advertiser cancels a contract, you will have many others to help lighten the load.
If you do that, you shouldn’t need to worry at all. Courage isn’t the lack of fear, it’s just facing fear head on and not letting it overtake you. You can do it!
Heh. Thanks for the comments and support! I’m strongly considering making the jump but not until I work out a strong plan that covers all the basis, from all types of insurance I’ll need and related expenses to a “re-entry strategy.”
Just quit the job already – you make sh** wages at it and you make 2x as much with the blogging.
If the blogging doesn’t work out then you shouldn’t have any problem going back into the work force at the same wage you are making now or more.
Do it!
Flexo – unless you have big plans on the table for expansion of your online ventures, I don’t think it’s a bad idea to hold on to your dayjob if you can handle the load. With the dual income stream and the coming capitulation of the markets, you ought to see some serious net worth gains over the next 2-5 years.
As a small business owner, I ran a web design shop. Sometimes the clients didnt always pay on time. Other times a project was long and drawn out. And when you have to wait until completion to get paid, that can space out your paydays. I have on occaision had to use a payday loan to get a cash advance from my paycheck. That way when I had a business bill due, I was able to take a cash loan from my next paycheck, get it in the bank, and write a check for an upcoming bill on time. It was a simple way for me to ensure I never had late charges or dings to my credit score cause I didn’t have the cash to pay a bill.
My biggest thing is the insurance. We’ve got 2 and are expecting a 3rd kid here shortly so the insurance is a big one to think about absolutely. Being able to show a “low” number over 12 months would at least give me a better feeling of letting go of the corporate gig for sure…
My income is too half flexible, I work on contract bases and my contract expires three times a year, even though I know I will get paid, I never know the exact amount of my paycheck right after the contract expiration. So budgeting with an unknown number is a challenge. In some cases also I do not get biweekly, instead I get paid monthly, that also affects my budget and bill payments. I found that what works for me is to keep liquid assets (cash) in easy to reach savings accounts, even though I can make more out of the money in a CD, I can’t risk it.
Another problem with fluctuating income is insuring against its loss, e.g., disability insurance or business interruption insurance. If a claim is made, teh carrier will tend to skeptical as to the level of income being claimed as a loss.
Thanks for this great post! I, too, have an income that is somewhat “flexible.” I am lucky enough, though, to have some regular writing gigs that ensure that about 2/3 of my income is set. Of course, I could suddenly lose those jobs…
We recognize that we need to pad our emergency fund, and maybe cut back so that we are living on less, though. This will help up be better prepared.