One of the unique challenges that attorneys face, particularly contingency-fee attorneys and law firm owners, is irregular income. If your income is irregular, life can feel like a constant cycle of “feast or famine.” You may go weeks or months without seeing much money come in, then, when you do win a big case, you experience a sudden cash windfall.
This cycle is difficult to manage psychologically, not to mention the damage it can do to your budget. It can even lead to poor money habits and behaviors that are detrimental to achieving your long-term goals. Our natural tendency is to splurge when we get a sudden cash infusion because we feel wealthier. As a result, we end up having less money to meet our real needs and put toward our goals.
Here are some ideas that can help you master your irregular cash flow situation and avoid poor money choices.
Wrap Your Head Around Your Cash Flow
Start by analyzing your cash flow for a full year. Whereas most people budget month to month and are accustomed to regular bills and a monthly or semi-monthly paycheck, if your income is irregular, you need to look at the full year to get a true picture of what happens with your money monthly, quarterly, and somewhere in between.
As you analyze your cash flow, create a detailed list of discretionary (non-essential) annual expenses and non-discretionary (absolutely essential) expenses. This can get tricky when certain line items fall into both categories. For example, buying your regular food supplies for the week at your grocery store is non-discretionary, but spending money on dining out is probably discretionary. You will need to decide what is necessary and build your budget around that. After you have looked at the full year, you can divide these expenses by 12 to determine your average monthly discretionary and non-discretionary expenses.
Build Your Emergency Fund
Once you have determined your discretionary versus non-discretionary expenses, you will know how much you need in an emergency fund to carry you through leaner times, such as when your income slows down or even stops when there is a lull in business activity or the loss of a job. It can also be used for sudden, unanticipated expenses like a large medical bill or car repair.
For most people, we financial planners generally recommend at least 3 months’ worth of non-discretionary expenses in a liquid, easily accessible cash savings account. If your income is irregular, it is wise to have a larger emergency fund than most and aim for 6 months’ worth of non-discretionary expenses. If you don’t have this amount set aside, start building it up today. You’ll never regret having money at the ready when you need it.
Create A Cash Flow Account
A strategy to help you even out the ups and downs in your income is to turn it into regular income by creating a separate cash flow account.
Here’s how it works. When you get a large influx of cash from a settlement fee or an abundance of legal work, you deposit this money into your cash flow account. From this account, you then “pay” yourself a regular monthly or semi-monthly income. The idea is that, although the amount of money in the cash flow account may fluctuate, your stream of income will be constant (at least in your mind).
This will help you avoid overspending when you get an influx of cash and help you stick to your budget and goals. If your cash flow account gets too low, you can supplement it from your emergency fund, but the goal is to avoid dipping into your emergency fund on a regular basis and instead save this fund for real emergencies.
What About Credit Cards?
Some people use credit cards to manage their irregular cash flow. They put expenses on the card and then when they finally get a large payment, pay off the cards, or at least try to. While the idea makes sense in theory, it rarely works out in your benefit. It’s problematic because while your cash flow is irregular, credit cards have interest charges and minimum payments that are very regular. If you pay off your credit card each month, you can avoid interest charges. However, if your income is irregular, making on-time payments may not be possible for you and you could face late penalties and hefty interest payments.
On the other hand, if you are disciplined and have followed the steps of analyzing your cash flow, creating a cash flow account, and paying off your credit cards each month, this might be an acceptable approach for you. Using credit cards can provide additional benefits if handled appropriately, such as cash-back rewards and building your credit score. But relying on credit cards to manage your irregular cash flow itself can lead to carrying a balance on your cards and interest charges eating away at your hard-earned money. This becomes a very expensive way to manage your cash flow—at the least—and at the worst can lead to a dangerous buildup of credit card debt.
Should You Invest Your Emergency Funds?
A common question clients with irregular income ask is whether or not it’s wise to invest their emergency funds, especially in our current low-interest-rate environment. I get it. It’s difficult to earn much interest on cash deposits at the bank. You can invest your emergency funds, but you’ll want to make sure that the way you invest these funds is on the conservative side.
There are two reasons for this. First, and most obvious, you cannot afford to take a lot of risk with these funds. You want these funds there when you need them. If the stock market takes a dip right when you need to withdraw money, you’ll be in trouble. Second, difficult economic times tend to be the very times that we need to invade our emergency funds; oftentimes, that correlates with market dips. Therefore, there is a high probability that the time you need these funds is the same time the market will be languishing.
Is there a win-win solution? You could invest with some stock market exposure, but you’ll want to keep this exposure limited. Understand that stocks can decline in value precipitously over the short term and that’s not a risk you can take in full. Case in point, during the 2008-2009 financial crisis, the S&P 500 declined by over 50%. Keep stock exposure limited to no more than 10%. The bulk of any kind of investment of your emergency funds should be in short-term treasuries, which will present the least risk.
However, in today’s interest-rate environment, the yield on treasuries is minuscule. You may be better off finding a high-yield savings account for your emergency fund. High-yield savings accounts are online accounts offered by some banks and credit card companies. These banks often do not have physical branches and can keep their expenses exceptionally low. As a result, they can offer above-average interest rates. High-yield savings accounts do not require you to lock up your money like a CD—which would not be wise to do with your emergency funds—and they usually do not have expenses.
Plan For Estimated Tax Payments
Many attorneys, especially if you are a law firm owner or partner, are required to make their own quarterly estimated tax payments. You do not have the benefit of a payroll department withholding these funds from your paycheck. Because these estimated tax payments happen quarterly, they can be difficult to plan for. That’s where the cash flow account comes in handy. You can simply use the money in your cash flow account to take care of these payments. If you need help mentally accounting for these funds, you might consider opening a separate account to hold the money until it is time to withdraw the funds and pay your estimated payments.
What Solution Is Right For You?
Planning your finances when you have irregular income can cause some hiccups, but it is still possible to secure your finances and live without worry of running out of money. At Wurz Financial Services, we specialize in working with attorneys and have a deep understanding of the financial challenges and opportunities they face. We can help you develop a strategy for your short-term cash reserves. If you’d like to talk through some options or see if we can help you on your journey to a comfortable retirement, schedule a no-obligation consultation by contacting us at 859-291-9879 or email@example.com today!
Also, join us at one or both of our free webinars:
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Darren Wurz is a co-owner and financial planner at Wurz Financial Services, an independent, family-owned and operated financial services firm dedicated to helping its clients transition from their working life to a comfortable retirement with confidence. Darren received his Master of Science degree in financial planning from Golden Gate University and also holds the CERTIFIED FINANCIAL PLANNER™ (CFP®) designation. He operates the Northern Kentucky/Cincinnati office of Wurz Financial Services and is an active member of the Covington, KY rotary club, the Northern Kentucky Chamber of Commerce, and the Covington Business Council. To learn more about Darren, connect with him on LinkedIn.