Does an annual bonus or commission payments make up a large part of your overall income? Do you own your own business or get paid based on a nine-month academic calendar? If so, you, like many other Millennials in similar roles, must learn to navigate a variable income dynamic at some point during the year.
Welcome back to Financially Well, the finance podcast for Millennials. How can you invest with confidence amid variable income?
Personal finance website The Balance describes variable income as a financial circumstance in which you struggle “to predict how much money you will have coming in during a given month.”
For certain professions and industries, variable income is inevitable or even required. For example, private-sector lawyers typically earn large bonuses each year based on the firm’s and their personal productivity. Entrepreneurs may draw income from their companies in fits and starts, based on business growth and personal financial needs. And athletes and teachers, meanwhile, may only receive a consistent, fixed income during certain times of the year.
In a city with a high cost of living like Washington, DC, how you manage your variable income can significantly impact how soon you become a homeowner, invest in a college savings plan, or make meaningful progress on your desired retirement timeline.
As the team at You Need a Budget (YNAB) notes, “Not knowing how much your next paycheck will be or when it will come in injects uncertainty into your financial life.” Financial uncertainty takes many forms. But for our purposes today, let’s talk specifically about how variable income creates uncertainty around how to invest with confidence.
An entrepreneur or a teacher may know in advance that his or her salary will look different from month to month. But you understandably may still feel lost about what to do when that time actually arrives.
You may struggle to create a money management system that empowers you to invest consistently during lower income-generating months. And you may conclude that variable income is a problem that you must escape as soon as possible. But this thinking shortchanges the saving and investing benefits that variable income can (counterintuitively) offer.
From the outset, variable income will demand effort from you. It will require you to remain disciplined and organized. And you’ll need to get clear on your personal values and priorities. If you’re willing to navigate this dynamic, though, you’ll probably feel good about your long-term investment trajectory. In fact, you ultimately may be better off than if you received a more consistent salary.
How is this possible?
Variable income forces higher-level financial planning that most Millennials never get around to. Young adults who can make this situation work for their lives may achieve their financial goals faster than a peer with a more “typical” – and less challenging – salary structure.
“Variable income forces higher-level financial planning that most Millennials never get around to“
In many cases, your personality and lifestyle will drive how you handle your variable income. To consistently invest with confidence under these circumstances, you don’t need to obsess over budgeting. And you may not need a line-item budget at all. Instead, start the process by asking yourself four critical questions:
Ultimately, the key for many Millennials to investing more consistently depends on us treating each periodic investment like a fixed, high-priority expense.
Even so, many Millennials face a particularly challenging hurdle with the next step. An effective system for managing variable income requires patience. You need to create a plan for investing consistently that you may not act on immediately. The reason is that your primary bank accounts first need to contain enough money to cover both essential monthly expenses and offer an emergency cash reserve.
Plus, automated money transfers will play a key role in you starting to invest with confidence. And automated transfers require a sufficient cash balance to avoid over-drafting your account. But once you’re there, automation will take the burden of investment consistency and discipline off your shoulders. And automated investing will reduce the risk that economic headlines (unnecessarily) scare you into postponing or altogether stopping your new investment habit.
From this point, the actual variable income strategy begins to take shape. First, direct your wages into a high-yield savings account. This account holds no other purpose for you; it’s your vault. You won’t want to set up any bill payments, Venmo transfers, or Amazon purchases for this account. Instead, you’ll want to automate monthly transfers from this account to three other bank accounts (or sub-accounts) that you hold. Together, they will help you to satisfy your financial obligations and invest in your future with confidence.
The first account transfer is a fixed biweekly or monthly payment. Congratulations! You’re no longer tied to a paycheck frequency and amount that your employer unilaterally dictates. Instead, you’ve created a paycheck for yourself that fits your life specifically.
Each month, you’ll use this money for your living expenses. You’ll base the specific amount on the four questions that you answered above, which you’ll continue to review over time. More specifically, this account will cover two types of spending.
First, you’ll use the money in here for those essential expenses that you absolutely must pay each month. And second, you can include an allotment for your discretionary expenses, such as fun date nights. Give yourself permission to be generous (within the confines of your total income) in how you calculate the amount for this second set of purposes. Spending the money you earn shouldn’t feel stressful or induce guilt.
The second account transfer also covers expenses. But in this case, we’re creating a reserve to handle large, irregular expenses that periodically arise during the year. The calculations for this account rely on both past payments and your expectations for future payments.
Past credit card and bank statements can remind you of lump-sum payments from last year that you couldn’t pay incrementally. Taxes often fall into this category. You also may have had large insurance or education bills that you had to pay at irregular intervals. Looking ahead, your personal calendar can show you upcoming events, such as a vacation, that may require a sizable deposit in advance.
To start, calculate the total amount of expenses that fall into this irregular, lump-sum category. Then, divide that number by 12 months. The result will determine how much you transfer into this lump-sum account each month. Then, when those large bills do come due, you have money to transfer into your checking account to make the payment.
The third and final account transfer is about saving and investing. With this account, you’re making money available for the life you want to create for you and your family. There’s no single correct amount to transfer here. But you don’t want to shortchange yourself over the long term. Initially, pick an amount that feels sustainable, based on how much breathing room you typically find in your monthly budget. The ultimate objective for this account, though, is to increase your contributions steadily over time. And your variable income may actually make this task easier. Once you have a system in place, any unexpected compensation becomes unplanned savings that you can transfer here.
In order to successfully invest in your future, you don’t need to become a financial expert. You don’t need to love managing money. Frankly, you don’t really need to enjoy the task much at all.
Even so, you need to remain organized and committed. And you need to trust yourself. Consistent investing – and the compound growth that can take place over time – makes our financial goals possible. Different account types, such as Roth IRAs, 529 college savings plans, and health savings accounts (HSA), all seem to capture most of our investment attention. But you’ll have a much harder time reaching financial milestones without a strong decision-making process in place for when you receive a bonus, commission, or atypical paycheck.
At first glance, variable income appears to add an unwelcome wrinkle to any strong investing habit you’re building. This may be especially true if lump-sum or sporadic payments are new for you. You may resent your circumstances and eagerly look forward to a more “mainstream” alternative.
Viewed differently, though, variable income empowers your desired investing habit. You need to become proactive, so you actually do. Many Millennials never reach that point with their personal finances, which stymies their progress throughout adulthood. If you can embrace the challenges that variable income throws at you, you’re likely on a faster track to growing your money to live the life you want.
Thanks for listening to the Financially Well podcast.
[Editor’s note: this article reflects the transcript (which I’ve edited for clarity) of a recent Financially Well podcast episode.]
Kevin Mahoney, CFP® is the founder & CEO of Illumint, an independent firm in Washington, DC that offers financial planning for Millennial parents. He specializes in navigating the new financial decisions that arise during our 30s and early 40s, such as repaying student loans, buying a house, saving for college, & investing for the future. In addition, Kevin also leads a financial wellness benefits program for Millennial employees around the country, including group speaking engagements.
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