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