Over the years, I’ve worked as a full-time employee along with several contract jobs on the side. Recently, I’ve become a full-time self-employed professional. Needless to say, my fluctuating income has made sticking to a budget a huge challenge—and with three kids it’s even harder to budget for all of their little surprise emergencies.
Thankfully, I’ve learned to protect myself from income "surprises" with a simple tip: I always underestimate my monthly income and overestimate my monthly expenses. Learn how this tip will make sticking to your budget a lot easier!
Most of us have expenses in three major categories. We can use our spending history to estimate our monthly expenses in each category.
1. Fixed expected expenses: Expenses that come at regular intervals (weekly, monthly, annually, etc.) and don’t vary are called "fixed." Examples can include mortgage payments, insurance premiums and car note payments.
2. Variable expected expenses: Expenses that come at regular intervals but can vary are called "variable." Examples can include utilities, phone bills, grocery costs, gasoline bills and tuition expenses.
3. Variable unexpected expenses: Otherwise known as "emergency expenses," this category is the most likely to trip up even the best budget plans. For example, no one plans for their son to come home from school with a broken arm (but it happens and it’s costly).
- Why overestimate expenses? In a nutshell, it’s necessary to overestimate monthly expenses in order to account for the possibility of variable unexpected expenses. So take your total expenses, then add at least 10% to that to cover category 3.
If you work for an employer full time, there’s a good chance you know exactly what your net take-home pay is each month and per year. If you work part-time or if you’re self-employed, your income may constantly fluctuate.
In either case, you may also have additional income coming in from other sources. This can include capital gains from the sale of a property, interest-bearing investments, annual company bonuses, a small side business, overtime pay, contest winnings, or the use of rewards cards.
- Why underestimate income? Underestimating your income will protect you from over-reliance on income "extras" (for instance, a performance bonus that never materializes) and ensure that you have sufficient funds on hand to meet your monthly expense obligations. So take your net monthly income and subtract at least 10% from that to ensure you’re living within your “known” income means.
How this strategy helps you save
If you continually budget like this—with your expenses higher than they are and your income lower than it is—then you can use any "extra" monthly income to pay off debt, build your emergency fund, or start saving for retirement.
This strategy is so effective that many professionals recommend it to their clientele. Here are just four of the many articles referencing this budgeting approach.
- Colorado Mesa University advises students to use this plan to afford their tuition and fees.
- The Journal of American Bankers Association advises this approach in Volume 12.
- Wells Fargo Works for Small Businesses advocates this approach for small business owners.
- U.S. News names this strategy as a best practice for the self-employed.
Need more budgeting tips? Make sure to keep up with our Budgeting Survival 101 series: