Successful budgeting tends to depend on two things: careful planning and a steady income.
The first, anyone can do. The second isn’t so simple.
If you’re self-employed, you might be asking yourself: “But I don’t have a regular paycheck coming in. Can I even set up a budget? Should I bother?”
You can. And, yes, you should.
A budget is simply a way of figuring out how much money you need to go about your daily life, and arranging things so that you don’t exceed that number. No matter your situation, budgeting is a critical part of making sure your finances are sustainable. (And it no longer requires a pen and paper: The free LearnVest Money Center and corresponding app will do it for you automatically.)
Budgeting is especially important if your income is irregular, such as if you’re a freelancer, a temp worker, a consultant, an artist, a permanent employee with fluctuating hours, or a commissioned salesperson. Or if you do seasonal work, if a big part of your income depends on tips, if you own a small or startup business, if you’re on call, or if you are simply an odd-jobber, then this article is for you.
Use this simple three-step plan to set up a budget you can stick with. For more guidance.
Step One: Know Your Baseline
When you have a steady paycheck and a predictable income, you budget by allocating spending categories within that limit. But those with unpredictable incomes must work “backward”—starting with the amount of money you’ll spend to figure out how much you need. If your income is unstable, then it is your expenditures that must be stable, predictable and repeatable.
According to the 50/20/30 rule, there are three categories of expenditures: essentials, priorities and lifestyle. Your baseline expenditures are those in the essentials category—those that must be paid every month, without which you can’t live. The first costs you’ll want to estimate are:
For your baseline, include the lowest food cost that is reasonable for your circumstances. Plan your grocery expenditures without any extras, like restaurants, coffee shops (unless you must use them to have business meetings or to avoid paying for internet at home), wine or fast-food pit stops. If you’ll be couponing and cutting back your food costs, take that into account, but if you know you won’t clip a single square, be realistic about your cost estimates. One of the best ways to get an estimate is to track your spending for at least a few weeks to get an idea of how and where you spend.
2. Housing and Utilities
For almost everyone, essential expenses include rent or mortgage. If you’re responsible for either, or if you house-share, live for free or have a sliding rent arrangement, include your minimum monthly housing cost in your baseline. Make sure to include the monthly amount for homeowner’s insurance and property tax bills in your total.
“Those with unpredictable incomes must work “backward” to budget—starting with the amount of money you’ll spend to figure out how much you need.”
If you live in a geographic region in which heating or air-conditioning is a life essential, include these average monthly bills in your baseline. In moderate regions, utility costs are a lifestyle choice—but heat isn’t optional in January in Vermont.
The same goes for internet and phone costs: If you work from home, they’re most likely a necessity, and should be included in your housing and utility estimate.
3. Medical Costs
A note about health insurance: The number-one reason people go bankrupt is because of medical costs, so it could not be more important that you have some form of health insurance. You should include these costs in your baseline estimate, as well as payments for any outstanding medical bills.
Do you need to include transportation to work in your baseline? Consider the lowest possible transportation cost given your job or jobs. Do you absolutely need a car, car loan payments, auto insurance, maintenance, garaging costs and gas expenses? Or is there great public transportation in your city? Can you walk to work? Telecommute? Can you infrequently taxi, Uber, ride-share, Zipcar or call for delivery? Again: Be realistic with your estimate. If you’re actually going to drive your SUV alone, round-trip, every day, factor that into the costs.
Add up the baseline numbers, and you have the amount of the monthly “paycheck” you’ll write to yourself.
Step Two: Set Your Income Target
This step is easy (well … sort of). Once you know your monthly baseline expenditures—and thus the paycheck you’ll write to yourself each month—use an online tax calculator to get a rough idea of how much you’ll owe in taxes. Add this new number to your baseline costs.
This figure represents your bare-bones monthly income requirement.
The tricky part, of course, is guaranteeing you have enough income to meet your expenses.
Anything above the bare-bones income target goes first to your financial priorities savings; second to your emergency fund savings; and third to you as “bonus” to spend on lifestyle choices.
Step Three: Set Up Separate Bank Accounts
To make this plan most effective, you’ll want to set up separate bank accounts. Your bank will let you have as many accounts as you need, and if you maintain a minimum balance in all the accounts combined, it should waive fees (just as it would if you maintained a minimum balance in a single account).
1. Business Checking
Here you’ll have your checks auto-deposited, you’ll plunk your daily cash from tips if you get them, and you’ll deposit your invoice payments from clients. You’ll make only three transfers from this account each month: one to each of the below accounts.
2. Personal Checking
From this account, you’ll pay all your bills—essentials, priorities and lifestyle—but you won’t spend more than you’ve paid yourself any month. This account will also receive any monthly “bonus” you might want to pay yourself when your income exceeds your target, and you have money left to spend beyond your savings (which is technically a fourth transfer).
3. Emergency Savings
Every month, after you’ve paid yourself for your baseline and transferred amounts for financial priorities, you’ll put money into your emergency fund.
You should be aiming to save at least six months of net income in this account, to be used in the following situations only:
- You’ve lost your job, and need to continue paying rent, bills and other living expenses.
- You have a medical or dental emergency.
- Your car breaks down, and it’s your primary form of transportation.
- You have emergency home expenses—e.g., your AC breaks down in 100°F-plus weather, your roof is leaking, your basement is flooded, your toilet is overflowing, etc.
- You have bereavement-related expenses, like travel costs for a family funeral.
4. Priority Savings
This account holds money for annual or semiannual payments (income taxes, property taxes, home insurance) and for important goals—payments on student loans, the down payment for a house, or college savings for your child.
That’s it! You now have a basic budget, your income target and where exactly your money should go … no matter how it comes in.