Budgeting on a Variable Income: Strategies for Financial Stability

Managing your finances on a fixed salary can be challenging enough, but budgeting on a variable income adds a layer of complexity. Whether you’re freelancing, working a side hustle, or earning commissions, fluctuating earnings can make it difficult to plan. However, with the right strategies, you can create a budget that helps you stay on track and achieve financial stability.

1. Determine Your Baseline Expenses

The first step in budgeting on a variable income is understanding your essential expenses. These are the non-negotiables that you must cover each month, such as:

• Rent or mortgage payments
• Utilities (electricity, water, internet, etc.)
• Groceries
• Insurance (health, car, home, etc.)
• Minimum debt payments
• Savings*

Savings may not be a non-negotiable if you plan on saving more in the months that you have a higher income. For example, instead of saving $500/month every month, you plan on saving $750/month if you have 4 months with a lower income and 8 months of higher income. I find it easier to set up automatic transfers to my investments and savings accounts so I don’t need to remember to move it over so I would include it in my non-negotiable.

How to Do It:

• Review the past 3–6 months of bank and credit card statements.
• Identify and categorize fixed and variable expenses.
• Calculate the average amount spent on essentials.

Your baseline expenses should serve as your minimum monthly income goal. If your baseline expenses exceed the lower amount of your monthly income, you’ll need to set up a “Hill and Valley” account to help cover your expenses in the lean months. You’ll also want to see some of the more advanced strategies for budgeting with a variable income.

2. Calculate Your Average Income

Next, determine the average amount you earn monthly. If your income fluctuates widely, take a conservative approach by calculating the average of your lowest-earning months.

How to Do It:

• Review your income from the last 12 months (or as many months as possible).
• Add up your total income and divide by the number of months to find the average.
• Use your lowest earnings as a backup figure to plan for lean months.

3. Prioritize a Monthly Minimum Budget

Set up a bare-bones budget that focuses solely on covering your baseline expenses. This ensures you can meet your essential needs even in months with lower income.

Include:

• Baseline expenses (as calculated earlier)
• Savings contributions for emergencies
• Debt payments above the minimum if possible

This minimum budget acts as your safety net.

4. Establish a “Hill and Valley” Fund

A “hill and valley” fund is a specialized savings account to manage income fluctuations. During high-income months, save a portion to cover expenses during lower-income months. Having a separate fund that you have allocated to take money out of can be easier if you want to automate as much of your savings as possible. You can move money from your “Hill and Valley” fund to your regular account and have an automated savings amount come out each month. This can help put money towards savings goals (e.g., vacation or house) while still having a fund for lower-income months and an emergency fund.

How to Build It:

• Set aside 10–20% of your income during peak months.
• Store these funds in a high-yield savings account for easy access.

Using the Hill and Valley Fund in Your Budget:

In high-income months, deposit any surplus into your hill and valley fund after covering essentials and other financial goals. For example, if your baseline expenses are $1,500 and you earn $3,000, allocate $1,500 to essentials, $500 to discretionary spending and debt repayment, and deposit the remaining $1,000 into your hill and valley fund.

Then in lower-income months, use the hill and valley fund to supplement your earnings. For instance, if your income drops to $1,800 but your baseline expenses remain $1,500, withdraw $200 from the Hill and Valley fund to ensure you meet your savings and discretionary spending goals.

5. Allocate Based on Percentages

Instead of assigning fixed dollar amounts to your budget categories, use percentages of your income. This ensures flexibility when your earnings vary.

Example Breakdown:

• 50%: Essentials (rent, groceries, utilities, etc.)
• 20%: Savings (emergency fund, retirement, etc.)
• 10%: Debt repayment (if applicable)
• 20%: Discretionary spending (entertainment, dining out, etc.)

Adjust these percentages based on your financial goals.

6. Plan for Irregular Expenses

Irregular expenses, such as car repairs, medical bills, or annual insurance premiums, can disrupt your budget if you’re unprepared. Don’t forget any gifts that you want to buy throughout the year. We celebrate four birthdays and Christmas in the same month, so if I’m not prepared, that month destroys any budget I’ve created for the month. If you have kids, don’t forget about any back-to-school purchases you might need to make. Create a sinking fund to spread these costs over multiple months so it’s not a sudden hit to your bank account.

How to Do It:

• List all irregular expenses you expect over the next year.
• Divide the total cost by 12 and save that amount monthly.
• Keep these funds in a separate savings account.

7. Save Windfalls and Bonuses

When you receive unexpected income, such as tax refunds, bonuses, or gifts, resist the urge to spend it all. Instead, allocate a portion of it toward your hill and valley fund, debt repayment, or long-term savings goals.

8. Use Budgeting Tools and Apps

Technology can simplify the budgeting process, especially budgeting on a variable income. Many apps are designed specifically for people with irregular income streams.

Popular Tools:

• You Need a Budget (YNAB): Focuses on giving every dollar a job and planning for the future.
• PocketGuard: Ensures you don’t overspend by showing what’s safe to spend.

Choose a tool that fits your financial style and needs.

9. Review and Adjust Regularly

A variable income requires frequent budget check-ins to ensure you’re staying on track. I like to do mine when I get paid. This allows me to adjust my spending based on how the last two weeks have gone. If I end up spending less than I expected I can plan a small treat to reward myself. Schedule a monthly or semi-monthly review to:

• Compare actual income and expenses to your budget.
• Adjust your savings and spending based on current earnings.
• Reallocate funds if necessary.

10. Set Financial Goals

Clear goals can motivate you to stick to your budget and save consistently, even when income fluctuates. Examples include:

• Building a 3–6 month emergency fund
• Paying off high-interest debt
• Saving for a large purchase or vacation

Write it down and put it somewhere you can see it daily. Keep track of how close you are to meeting your goal and set up mini celebrations as you hit milestones to help keep you motivated.

Advanced Strategies for Managing Variable Income

For those seeking to take their financial management to the next level, consider these advanced strategies:

• Diversify Your Income Sources: Add side hustles or passive income sources to reduce your reliance on a single income stream.
• Create a Tiered Savings System: Divide savings into short-term, medium-term, and long-term goals, allocating funds accordingly.
• Tax Planning: Work with an accountant to plan for tax liabilities, especially if you’re self-employed, and take advantage of deductions.
• Automate Financial Decisions: Use technology to automate transfers, bill payments, and investment contributions.
• Track Income Patterns: Analyze income trends over multiple years to predict seasonal highs and lows more accurately.

Sample Variable Income Budget

Here’s an example of how a budget might look for someone earning $3,000 in a high-income month and $1,800 in a low-income month:

Hill and Valley Fund Usage:

• In the high-income month: Contribute an additional $500 to the Hill and Valley fund after covering all budget categories.
• In the low-income month: Withdraw $200 from the Hill and Valley fund to supplement the budget and maintain savings and discretionary spending goals.

Final Thoughts

Budgeting on a variable income might seem daunting, but it’s manageable with careful planning and consistency. Start with the foundational steps of understanding your baseline expenses, building a hill and valley fund, and allocating income wisely. As you become more confident, incorporate advanced strategies like diversifying income streams and leveraging automation to optimize your financial management.

Remember, every step you take brings you closer to financial freedom. Whether you’re stabilizing your finances or aiming for ambitious financial goals, a well-structured approach will empower you to thrive, even with an unpredictable income.