Riding the Waves

He who never sacrificed a present to a future good, or a personal to a general one, can speak of happiness only as the blind do of colors.

~ Olympia Brown, American Minister and Suffragist

Question: My income varies monthly. What strategies do you suggest to add predictability?

Answer: Whether it's due to seasonality, commission flows, or payout for a business venture, unpredictable income adds a layer of complexity to an already challenging goal of effectively managing your money. Here are four tips on how to help create stabilized income which contributes to monitoring other financial planning. 

Understand Income and Expenses

The first order of business is to gain clarity on your monthly and annual income and expenses. You and your financial team can coordinate to prepare this analysis. Start by distinguishing between essential versus discretionary spending (needs or wants), and between recurring and infrequent expenses. Identifying income trends and the range of variation allows you to see highs and lows of monthly and annual income.

Build an automated, predictable system

Once cash flow trends are identified, you and your team can build a system of rules and automated transfers to defined accounts or buckets within accounts. Designating buckets or accounts for different expense categories (quarterly taxes, healthcare spending, vacations, etc.) as well as creating an emergency fund for truly unplanned expenses can reduce stress while consistent cash flow needs are now planned and funded.

Err on the side of over-saving

With variable income, some periods may be better than others. You may want to identify a specific savings percentage to set aside from strong months and years. This will then help cover periods when your income expectations may fall short. Rather than treating your established wealth as its own cushion, your goal is to avoid eroding your wealth in any way during lean periods.

Let’s say you and your financial advisor find that your income varies by 25% from year to year, and your annual expenses can fluctuate up to 30%. In a bad year then, when income is at lowest and expenses are at their highest, you might have as much as a 55% total change in cash flow. To prepare for such contingencies, you could establish a specific savings account to cover worst-case scenarios in addition to your emergency fund. At the same time, look for expenses to reconsider and opportunities to grow income, while reviewing how your investment portfolio compliments your planning.

Foundation of predictability

With your new cash flow system in place, your financial team can turn their attention to optimizing your tax and retirement planning. Your new system will have already set up automatic savings for tax payments as well as automatic investments in retirement accounts.

Now, your advisors can discuss various strategies to minimize your taxes, such as tax loss harvesting, and discuss income as well as growth for your future. Your advisors might suggest maximizing your retirement accounts, favoring Roth contributions, and pursuing alternative investments.

Thanks to the comprehensive picture you have of your cash flow, you’ll be able to make these investment decisions knowing that they won’t jeopardize payment of other expenses. The clarity of your overall financial health will help facilitate your planning for generational wealth transfers as well as your legacy and estate. Stay focused and plan accordingly.