7 Principles for planning around income fluctuation

Income fluctuation is a reality for globally mobile families. While we focus a lot on lowering the expenses associated with international relocation and settling into a new home, the fact is that the lack of income stability of one spouse has the most impact on your family’s financial wellbeing.

In recent years, there have been more advocates and resources to help trailing spouses build a career path and an income stream. (You can find my contribution in the Income Strategies for Trailing Spouses series.) Nevertheless, even if we have developed some kind of income stream, it may not be as predictable as we would like. You may have found that this makes budgeting, and your overall financial planning, unconventional and challenging. The worst part is, not many people understand our struggle and provide useful strategies.

This is why I decided to present the 7 principles for planning around income fluctuation in a seminar hosted by AAFSW in February 2016. (The presentation was originally titled “Planning for Income Fluctuation in the Foreign Service”, but I think the principles apply to everyone who deals with income fluctuation.) You can watch the 30-minute recording below.

You can also download a copy of the presentation slides to follow along with the recording. Just sign up on the form below. Once you’re registered, you will receive a link to download the PDF file.

(In the presentation I also eluded to the one page financial plan, although I didn’t actually have time to go over it. You can now find the details in my previous blog post, “How to create a one page financial plan.”)

For those who are strapped for time, here’s a quick review of the 7 principles and how you can apply them in your life:

#1: Live within fixed income

We all know that we should live within our means, but it’s harder to do that when you don’t have a good idea of what your total income will be year to year. The more practical solution is to plan to live within your “fixed income”, which may be one spouse’s stable salary, or other sources that do not vary much year after year.

But what does living within a fixed income really mean? I recommend further dividing your entire cash outflow into two categories- “must-haves” and “good-to-have”. Must-haves are the things you need to survive at a minimum, now and in the future. They include not just your current food and shelter, but also debt obligations, minimum emergency fund, and retirement savings (so you can survive in the future.) Everything else may be “good-to-have”.

The beauty of this system is that you make your own decision on what is a must-have. Some may think that having access to American groceries at a higher cost overseas is a must-have, while others may think it’s good-to-have. A car may be a must-have in a city and good-to-have in another. Only you know what your must-haves are, and whether you have enough fixed income to cover them.

Don’t forget you still have variable income, which can be a full salary but only for one year, or irregular self-employment income. You are free to allocate this to the good-to-have category, whether it’s a longer vacation, more savings to send your children to private school, paying your student loan faster, or more retirement savings to buy a boat.

If you have a large fixed income to cover all your needs and wants, then great! But if you, like many of us, have a large chunk of income that is variable, making sure the fixed income covers all must-haves can help you streamline your financial decisions because you know you can easily cut the good-to-have spending or savings when the variable income fails to appear.

#2: Diversify your income source

For globally mobile families, one spouse’s income may be stable, but that could be the sole source of stability. Together, the family should look for additional income sources that are not dependent on the one stable job or employer, so you can minimize the risk of your wealth creation relying 100% on one source. (I talked about the concept of diversifying your income source more extensively in this previous post.)

#3: Increase your fixed income over time

When we are still younger and in our prime working years, we have more capacity to try different life paths and opportunities that may increase our variable income relative to our over all income. One good example is one spouse leaving a career with a stable salary to follow the other for his/her career. Another example may be trying out different business ventures and enduring periods of low profits, hoping one of them would become financially successful.

As we get closer to retirement, however, that risk capacity also decreases. We have less time to accumulate wealth to sustain our lifestyle when we no longer work, either voluntarily or by being pushed out of the workforce. Our need for having relatively fixed income grows over time, and it’s prudent that we plan to shift our income that way.

For example, the social security benefit is a fixed income source in your retirement years. The amount is predictable (as of now) and you can increase that amount by making sure you continue to pay into social security. Not only is the payment stable, it’s also guaranteed and inflation adjusted.

Ideally, you should look for ways to increase the portion of relative stable income like social security over time. You can choose to save heavily so you have enough dividend or interest paying financial assets to withdraw from without decreasing the capital too much. Or you may choose to invest in multiple real estate properties that may give you a steady stream of rental income once mortgages are paid off. Whatever looks like a more appealing option for you, you should know that you are able to transform your currently variable income stream into something more stable, even if you never return to having steady paychecks again.

#4: Save at least 50% of future income

When one spouse’s income is uncertain, it also presents a perfect saving opportunity. If you are able to follow Principle #1 and fit most of your must-haves in fixed income, whenever you have additional income, much of it can be saved.

You don’t even have to commit to save 100% of this uncertain income. In fact, this is exactly what we do. Since I became a trailing spouse, my entire income, big or small, is saved or used to pay for special vacations. Even if you only make $5,000 in after-tax income a year, you can save an additional $2,500 just by planning in advance to save at least 50%. That’s more than $200 a month, which many people struggle to find in their budget.

I talked about this concept more deeply in the Save More Tomorrow posts if you are interested.

#5: Expect the unexpected

Income uncertainty is not the only uncertainty we face in this lifestyle. Whenever we move, we face new unknowns. So much so that we know the unexpected will at some point happen, and that’s likely to cost us something.

Instead of scrambling to find resources to meet the unexpected needs, you need to have a comfortable cushion to deal with uncertainties. I found that personally, having a larger than normal, liquid cash reserve in this globetrotting lifestyle gives me more peace of mind; that is, more mental capacity to deal with uncertainties. Even if I incur the opportunity cost of not making a return on the cash reserve, it gives me more mental capacity to be flexible in the unexpected situation.

On the other hand, if you don’t have the capacity to build up that cushion, cut some slack in your budget. Don’t plan it so tight that you don’t have wiggle room for some extra costs that invariably appear when you are overseas. Don’t save everything in accounts that you may have to pay a penalty to get access to, such as in an IRA or 529 plan account, should you really need the money.

Even if you don’t have savings to help you with emergencies, make sure you have good credit that you can access when all else fails. Have a low cost credit card or Home Equity Line of Credit ready in case you really need to borrow, and check your credit report at least once a year.

#6: Plan for goals, not just retirement

We talked about in Principle #1 that the must-haves should include savings for the long-term. To take it one step further, it should include savings for the goals that are really important to you. Of course, saving for retirement is usually one of them, because it’s for your financial security in your old age; however, it’s not the only goal. Defining your goals up front before you allocate your fixed income to necessary saving is crucial. I discussed more about goal-based planning in the one page financial plan if you are interested.

#7: Manage your risks

When you’re already dealing with income fluctuation, having an unexpected disruption to your fixed income, either due to death, disability, or divorce, is huge. These situations extend beyond your normal emergency situation and need some advance planning. In addition to income risks, you may also face the risk of loss of property in the process of relocation, and the cost from lack of proper estate planning. I discussed these “what-if” scenarios in the one page financial plan if you are interested.