Three and a half years ago, when I resolved to quit my day job as an editor at a web startup to become a fulltime freelance writer, I kept imagining I might go months and months without any income.
I created a special in-case-I-fail-at-freelancing savings fund, which could support six months of my living expenses before I even needed to tap into my emergency fund. I had a few gigs lined up before I left, but what would happen after my projects ended? If I made money this month, would I be able to make money next month, too?
In my opinion, the hardest part of working for yourself is the unpredictability (and thequarterly estimated tax payments). The feast-and-famine cycle can be exhausting. So how can you budget and save if your income is irregular?
How much should you save? What the experts recommend.
According to Certified Financial Planner™ Alan Schoenberger, the first step to successfully budgeting when you have variable income is to create a list of all your expenses.
“It doesn’t matter if you use an app, Excel spreadsheet or the back of a napkin. Whatever works for you,” he says.
Once you have a comprehensive list, single out the necessities, such as housing, food and insurance. And don’t forget to set money aside for those pesky quarterly estimated taxes, lest you get hit with a gigantic tax bill down the road.
On months when you’re doing well — your income exceeds your total expenses — aim to save the difference. Let’s call that your reserve fund. Financial planner and Registered Investment Advisor Jaycob Arbogast says, “Even if you have a huge payday one month, live like it’s any other month and save the difference.”
On months when you don’t make as much money, you can use your reserve fund to pay for necessities. Schoenberger says there’s no set amount that you should aim to hold in your reserve fund, but the more erratic your income from month to month, the more you should set aside. Six months of expenses is a good general benchmark, he says. Once your reserve fund is high enough, you could use the money for savings goals like a new car or home.
Importantly, this reserve fund shouldn’t be confused with an emergency fund. “An emergency fund is if you lose your job completely, your car blows a gasket or some other serious situation… The reserve fund is just for those slow months when your income dips below what you expected,” Arbogast says.
Schoenberger suggests that people with irregular income save up double the normal recommended amount for emergencies — 12 months instead of the usual six — to account for the additional income volatility compared to a traditional 9-to-5.
One way to make your budget more predictable is to make your income as regular as possible. “When I first started financial planning, I charged an hourly fee,” Arbogast says. “That ended up being very irregular because not everyone would need my help every month, so I changed my fee to a monthly retainer for individuals. That allows me to plan ahead more easily.”