Helpful tips and tricks to plan for budget challenges related to unforeseen expenses.
Helpful tips and tricks to plan for budget challenges related to unforeseen expenses.
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Chelsea says, "I just signed up for your newsletter and podcast. My question is how to budget for things that change monthly, like gas and electricity, which always trip me up. Any advice would be appreciated."
Thanks for your great question, Chelsea! I'm so glad to have you as a new newsletter and Money Girl podcast subscriber. Yes, budgeting would be much easier if you only had fixed expenses that never changed from month to month. Likewise, many people have jobs or run businesses with unpredictable incomes, making budgeting challenging.
This post will answer your question with strategies for budgeting and managing money in the best way possible, even with irregular expenses and variable income.
Hi, everyone, and thanks for joining me this week! I'm Laura Adams, a personal finance expert hosting the Money Girl Podcast since 2008, with over 42 million downloads. I'm the founder of The Money Stack, a weekly newsletter helping you build your bank account and live rich on your terms. I also work with select brands doing on-camera and writing work as a financial spokesperson and female money speaker.
As always, you can reach me using my contact page at LauraDAdams.com. That's also where you can learn more about my newsletter, books, and money courses. Got a money question or idea for a show topic? Call 302-364-0308 and leave me a message.
Tips for Budgeting with Unpredictable Income and Expenses
Use these tips to take control of your budget even when you have unpredictable income and expenses.
1. Set your financial goals.
No matter what you call your money system, such as a budget or spending plan, it should be based on what you want to achieve with your money. For instance, you must cover your living expenses and fund your short- and long-term financial goals.
Whether you want to retire a multi-millionaire, buy a beach house, or be debt-free by a certain age, building it into your money system is critical. Time passes quickly, so if you're not making steady progress toward your goals, they aren't likely to happen.
An excellent way to get started is by downloading my free Financial Planning Workbook (PDF) and setting aside at least 30 minutes to complete it. It's a free gift when you subscribe to The Money Stack, my weekly newsletter.
If you have a spouse or partner who shares your financial life or goals, review the workbook together. It will prompt you to ask important questions and answer them as thoughtfully as possible so you can set the right financial goals.
If you're not sure what your financial goals or vision should be, here are some to get you started:
Adding dates for when you want to achieve each of your financial goals helps guide your budget. For instance, if you want at least $1,000 in emergency savings within the next year, you could save $85 per month for a total of $1,020. Maxing out an IRA for 2024 means contributing $7,000, or about $580 per month.
READ ALSO: How much debt is too much? 8 warning signs
2. Know your budget baseline.
Before creating a realistic budget, you need to know your baseline living expenses. Start by collecting at least the past three months of your financial transactions. Having several months of data at your fingertips will make seeing your fixed and variable expenses easy.
You might jot down your living expenses on paper, enter them in a computer spreadsheet, or categorize them in a personal finance program like Quicken or YNAB. These are your necessary costs, such as rent, groceries, utility bills, gas, loan payments, insurance, and healthcare. Since some will be different or not paid regularly every month, you must create an estimated monthly average.
For instance, if your utility bills over the past three months were $125, $150, and $175, you can add them up and divide by three for an estimated average of $150 a month. If those bills vary considerably by season, total a year's worth and divide them by twelve for an accurate monthly estimate.
If you have expenses paid quarterly or annually, like auto or life insurance, break them down into monthly amounts so you can account for all your costs on a monthly basis. For instance, if you pay $400 in auto insurance twice a year, divide $800 by twelve months for a monthly estimate of $67.
Creating your budget baseline is an excellent way to see where you may be overspending and could cut back. Constantly reconsider what's a necessity and which expenses you can live without.
3. Add your financial goals.
Once you know the minimum income you need to cover your average monthly living expenses, add your financial goals to your budget baseline. While these aren't necessary for short-term survival, they are critical for long-term security and happiness, so don't forget them!
If you don't have a steady income, it's even more critical to allocate monthly amounts for goals like building an emergency fund, saving for retirement, or buying a home. If you don't, it's easy to fritter away any extra money and never get ahead financially. So, make a commitment to your future self by incorporating your financial goals into your baseline spending plan now.
At a minimum, I recommend saving 5% of your estimated gross income for emergencies and investing at least 10% in a tax-advantaged retirement account. Consider those goals as "expenses" you owe yourself monthly.
If you're self-employed, remember to include taxes in your baseline expenses. In general, you must pay estimated quarterly taxes throughout the year. If you're unsure how much you'll earn, you can estimate based on what you earned last year. A good rule of thumb is to set aside 25% to 30% of your self-employment income for taxes.
READ ALSO: 2024s big savings and retirement rule changes
4. Identify your discretionary expenses.
Once you've identified your baseline living expenses, including your goals and any self-employed taxes, everything else in your budget is discretionary. It may feel like you can't live without cable TV or dining out, but these are not critical for short- or long-term survival.
If you're struggling to save money or pay off credit cards, you likely have discretionary expenses that should be reduced or eliminated. While you can also cut necessary baseline costs, like housing and vehicles, they're typically more difficult to reduce than discretionary expenses.
Remember that the purpose of budgeting is to use your financial data to make better decisions and positive changes in the future. You can't change what you don't measure in your financial life.
5. Create an ultra-conservative budget.
Now that you've thoroughly reviewed your necessary and discretionary expenses review
your income. If you have unpredictable income, look at what you made last year, identify the three months with your lowest earnings, and take the average.
For example, if your lowest three months of income gave you $3,000, $4,000, and $5,000, add them up and divide by three months for an average of $4,000. If your monthly expenses exceed that amount, it's time to radically cut your living expenses, discretionary expenses, or both. It's your job to ensure you create a solid plan never to spend more than your low-end average income.
Budgeting with the low end of variable income doesn't guarantee that you won't have some challenging months. But it does reduce the likelihood that you'll come up short. And when you earn more than your low range, you'll have a financial cushion.
6. Set up a holding account.
The secret weapon for sticking to a budget when you have variable income is using a holding account. That's where your income should go until you transfer it to another account. In other words, it's a secondary checking account linked to other accounts, such as your primary checking, high-interest savings, and retirement accounts.
The way to smooth out your finances when you have irregular income is to pay yourself a set amount from your holding account regularly. Transfer no more than your low-end average income into your primary checking account. For instance, you could transfer it all on the first of the month or half on the first and fifteenth. Then, you can pay your expenses, including your financial goals, according to your desired budget.
Using my previous income example, let's say you make $5,000 and put it into your holding account. You would only transfer $4,000, your low-end income, into your checking. The leftover $1,000 would remain in your holding account as a cushion that you only tap if your income dips below $4,000.
Make a goal to build up at least two months of your high-end average income as a reserve. For instance, if the average of your three highest-earning months from the previous year is $6,000, be vigilant about slowly building up your holding account to $12,000.
This strategy will allow you to pay yourself a consistent monthly amount instead of struggling with variable income. You allow the good months to balance out the bad ones. Plus, you'll accumulate a nice surplus over time.
Will it be easy? Probably not. You must adjust your spending until the amount you pay yourself covers your living expenses, financial goals, and discretionary expenses. Budgeting with irregular costs and income is an ongoing process. Be patient and experiment with different methods, apps, and budgeting programs until you find a system that keeps you on track.
Life always throws curveballs, so building an emergency fund is essential for managing unexpected expenses without derailing your spending plan.
If you struggle to build up cash in your holding account, you may need to get a second job or do seasonal work until you get ahead financially. Don't count on racking up credit card debt while you get your money system in place. With the steps outlined here, you should be able to continue chipping away at debt as you go.
No matter what financial goals and dreams you set your sights on, accomplishing them can be as easy as creating a consistent money system. Focus on doing the most important things first and sticking to good habits, no matter how small the accomplishment. Any sacrifices you make now will be worth it when you take control of your cash flow, build wealth, and achieve your financial goals.
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That's all for now. I'll talk to you next week. Until then, here's to living a richer life.
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