Question. I currently have a pre-authorized contribution (PAC) set up for my investment account, and contribute $500 on the 1st of each month. I’ve never had a problem with this in the past, but I’ve changed jobs recently, and it’s becoming a problem now. The problem is that I’m a commission-based real estate sales agent, and my income fluctuates considerably from one month to the next. I want to keep making regular contributions to my investment portfolio, but some months I just feel like it’s not realistic, given my income, or lack thereof. Any idea how I can make this work given my new reality?
Answer. First and foremost, kudos for setting up your PAC, and making a commitment to fund your investment plan regularly.
In theory, personal budgeting is fairly simple – keeping track of monthly cash inflows and outflows, and living within those parameters. However, when the inflows are variable, and therefore neither consistent nor reliable, meeting fixed outflow obligations can be tough. Indeed, personal budgeting presents a significant challenge for those who earn a variable income. This is the reality for many who are employed in a commission-based sales role, such as real estate sales, or also for entrepreneurs and business owners, particularly in the early years of operation.
Earning a variable income presents challenges, not only for investing, but also for meeting any and all other non-discretionary payment obligations – rent or mortgage payment, car payment, utility bills, groceries, daycare, etc.
So, how can you overcome the challenge of meeting fixed expense obligations, when you’re not sure how much income you’ll receive from one month to the next? One of the best ways to address this issue is to setup a structure where you pay yourself a fixed income from your variable earnings. Although some try to do this as a form of mental accounting, a better strategy is to actually open a second bank account specifically for this purpose. Let’s look at an example of how this might work.
Variable Income: An Example
Jennifer is a commission-based real estate agent. She opens two bank accounts, which we will refer to as account #1 and account #2. Account #1 is where she receives her real estate commissions, which are paid monthly. Account #2 is the account she sets up for all her pre-authorized bill payments, including her pre-authorized contribution (PAC) to her RRSP account.
Let’s assume that Jennifer requires a net (after-tax) income of $3,000 per month, in order to meet her obligations. In this case, the goal would be to transfer $3,000 from account #1 to account #2 on the first of each month. However, two key issues arise:
First, what if Jennifer simply doesn’t have $3,000 in account #1? This is especially problematic in early months, before there is much opportunity to build a buffer. Which brings us to the second issue – discipline. In the months where Jennifer receives more than $3,000 in commission (into account #1), the challenge is to transfer only $3,000 to account #2 for spending, and not touch the rest.
That’s often easier said than done, especially for commission-based sales professionals and others with variable income. When you have a few lean months, and then have a great month, the temptation to splurge will reward yourself will be strong. However, the key to the whole strategy is not splurging, because it is exactly the excess income that isn’t spent during the good months that will help bridge the gap during the not-so-good months.
The gist of this strategy is therefore to “pay yourself” a fixed income, even though your actual income fluctuates. Essentially, the key is spending less than you require during months when your income is high, so you can augment your income and make up the difference during the months when your income is low. Although some people have the discipline to execute this strategy all from within a single bank account, the process is often much easier, and much more likely to succeed, if you set up a second bank account to pay yourself a fixed amount. By doing so, you’ll be able to smooth out those ups and downs in your income, provide yourself with a structure for meeting your fixed expenses, investment contributions, and other payment obligations.
Making a commitment to your investment plan, and sticking to it, takes discipline. This is especially true for those of us who work on a commission income basis. Paying yourself a fixed income can be a simple yet effective strategy to help overcome the challenges of earning a variable income.
If you have any other questions about personal budgeting, or about any of our other products and services at ModernAdvisor, just ask us.