Building Consistent Wealth on an Inconsistent Income

If you’re a contractor, freelancer, entrepreneur, or seasonal worker, one of your biggest challenges is likely consistently growing your net worth on an inconsistent income.

The first challenge of living on an inconsistent income is making it last through the lean months. But once you’ve gotten a handle on paying your bills each month even when you don’t necessarily have money coming in, how do you take it a step further and start actually making progress on your financial goals?

Many self-employed or seasonal workers pride themselves on having hacked a system that lets them get by without too much financial inconvenience in the months they earn less or don’t earn at all. However, very few actually make progress on their long-term financial goals.

The goal is not survival

If you work for 4 months and earn $10,000, then don’t work for the following 3 months and spend it all, you might want to pat yourself on the back for not living in overdraft or missing a car payment despite not having an income for 90 days. However, you’re not actually any better off than you were before because you have nothing to show for it.

In order to really be able to live and thrive on an inconsistent income, it has to be serving you by increasing your net worth over the long term. If the balance of your long-term savings accounts isn’t getting bigger each month and your debt isn’t going down every month, you’re doing it wrong.

It’s time to fix it.

If your income is project based or seasonal, your budget is calculated as if you worked the whole year

If you are paid a lump sum, or for only a few weeks or months per year, the first thing you should do is take a large percentage of your pay from every cheque and stash it in a savings account for the months when you will not be working. How much you need to save depends on how many months you will have to go without a payday.

In order to calculate how much you need to save, you need to treat your seasonal or short-term income as your annual income.

For example, if you will be paid $45,000 for a 7-month project, you should divide the total amount over 12 months, then multiply that number by how many months you will not be earning an income. This will give you the amount you need to save for your non-working months. Here is the math:

$45,000 / 12 months = $3,750 per month average income

$3,750 x 5 months not working = $18,750 savings required

If you’re depressed by the reality that you need to hide nearly half your pay from yourself, you’ve been in denial about your real income. If you cannot live the lifestyle you want on $3,750 per month, then you need to increase your income or find another way to earn money for the 5 months when you will not be working.

If your income is inconsistent, your budget is your average income

Maybe you never go months without work, but you never actually make the same amount each month. If this is the case, you need to budget your average income. Ideally, you would take a 12-month average, but if you’re new to self-employment or your income is rapidly changing, a 3-month average will suffice.

For example, if you make $1,500 one month, $4,500 the next, and $3,700 the third month, your total income over 3 months is $9,700 and your average monthly income is $3,233. Therefore, you need to make your monthly budget with an income of approximately $3,200 per month. If you earn more than your average income in a single month, put it into a savings account you can withdraw from in the months that you earn less.

The savings you set aside to get you through lean months is NOT wealth, it’s not even an emergency fund. It’s a buffer, designed to give you the sense of a regular paycheque even when there isn’t one.

You have to save a fixed amount even on a variable income

The secret to having money in the bank for the long haul, even if between jobs or between projects, is to save the same amount on a regular basis.

If you sometimes go months without pay, this might seem an impossibility, but it really is a matter of choosing a small enough amount that it doesn’t throw the rest of your finances off-track in order to stick to it. After all, you still manage to make your monthly rent or mortgage payment during your months of no pay, so there’s no excuse not to be able to come up with a smaller payment for yourself.

You should begin with an amount that feels relatively painless to tuck away, like $50 or $100 per month. This is enough to seed your long-term wealth, without making you feel too cash-strapped to pay your regular bills. If you get an unexpected cash windfall or secure a higher-paying contract, you can top up your savings then, but in the meantime, you need to focus on developing the habit.

This regular savings contribution has to go to an account that you never raid for any reason. Lock it in a registered account like an RRSP/401K or TFSA/IRA with another bank, where you won’t see it every time you log into your online banking. Put it in mutual funds or stocks or ETFs that you would find psychologically painful to sell.

Having money set aside for your long-term financial security is equally important as having money set aside to get you through the weeks or months you have to go without pay.

Neglecting to save for your future is the same as neglecting to save for groceries. Just because the consequences are not immediate, doesn’t mean they aren’t dire.

I suspect you make your car payment or your student loan payment every month. Now you can make your retirement savings payment.

Keep your Emergency Fund fat and healthy

This should really be advice for everyone, but it’s particularly important for people with inconsistent or unpredictable incomes. I usually say most millennials can get away with a small Emergency Fund of only $3,000, but this is not sufficient for those that aren’t earning a steady paycheque.

If your income has dips or gaps, you need to keep an Emergency Fund of $5,000 to $10,000.

This is savings on top of your buffer account where I already encouraged you to put the surplus of particularly profitable months or extra savings to get you through lean months. You need to save above and beyond a pile of cash for your months without a paycheque. Why?

Going without pay when you’re a freelancer or contractor is not an emergency, it’s normal life. But emergencies can still happen, and you need savings for those.

If you’re overwhelmed at the prospect of saving up a buffer for low or no income months, saving up an emergency fund, and contributing regularly to retirement savings, I don’t blame you. That’s a lot of savings for an income that already feels stretched. But the reality is that it’s necessary. The alternative is financial insecurity, now and in the future.

If you’re worried about getting it all in order, remember: it doesn’t have to be done today. It doesn’t even all have to be in place in one year. It takes time to get into good financial habits and build an emergency fund that can actually protect you in times of need. But you have to do it, and the best time to start is right now.