3 Easy Steps to Maximize Your Monthly Income: Part 1
Do you want to know how we paid off $110,000 of debt in three years time - without adding another job to our lives? We maximized our monthly income by budgeting.
Wait! Don’t stop reading just because I said the B word.
“But,” you say, “budgeting sucks. It’s boring and takes too much time.”
Would you like to learn where all of your money was going each month? Would you like to tell your money what to do based on your priorities instead of letting debt manage your life?
“Of course I do”, you say. “But my problem is that I need to make more money.”
Friends listen to me, I’m telling you something important. I have friends who make $30k a year and friends who make $300k a year and I hear the same comments about needing to make more money to fix the problem from all of them.
I can tell you from my own experiences and from talking to people for years about theirs, that being financially fit has nothing to do with waiting until you make more money.
Compare your current income to what you made back when you first started working. It’s probably much, much bigger! Your teenage you would think that your current you was banking big bucks and should have zero money worries! But your current you wants to make more money. Because as you got older, you made more money, you could afford more expenses, and you took on more responsibilities (house, family, utilities, etc.) that tied up your income.
We all know how easy it is to out spend our income, and it can seem like the way to fix it is to just make more money.
One of my favorite Dave Ramsey quotes is, “You cannot out-earn your stupidity. You must make a change in your life.”
Here is how to change your life in three easy steps - you can do it by learning to budget your monthly income.
The first step to budgeting is knowing your income.
This is the most important step.
Budgeting your expenses is step number two.
This is the most important step.
Living within your budget is step number three.
This is the most important step.
1 - Know your monthly income
2 - Budget your expenses
3 - Live within the budget
That’s right! They are all important and your budget will FAIL if you get one part wrong. But failing is learning, so it’s not the end of the world. Because you will get to do another budget for each month, you have plenty of time to get it right!
In fact, I am going to focus on each step in a separate article, so that I can give each enough attention. This post will discuss step 1 - Knowing your monthly income. I will post links here when they are written! Subscribe here so you don't miss out!
Part 1 - Knowing your monthly income
The very most important part of establishing your budget is knowing your monthly income. All the parts of creating a budget are based off of that monthly dollar amount. It is one of those things that seems so simple; so obvious; so easy - that it is not discussed. But, if you want to stop worrying about money; start paying off your debt; and investing in the future you need to pay attention to every little detail in a way that you didn’t before.
"The devil is in the detail" - something might seem simple at a first look but will take more time and effort to complete than expected
What would you do if I gave you a blank form and said, “write down your monthly income”? How would you go about providing me the information?
Would you divide your yearly salary by 12?
Would you tell me when you were paid (weekly, every other week, bimonthly, and what each paycheck was?
Would you average your paychecks? Over what periods? How far do you go back?
Would you give me the gross dollar amount (total payment) or the net amount (total minus taxes, Social Security, Medical, 401k, etc.)?
What if you worked on commission and you are due money but don’t know when it will be paid? Do you count money due to you?
What if you have irregular income from sales, commissions, or tips?
What if you only get paid twice a year?
What if you are currently unemployed?
I’m sure that you can see how this seemingly simple request quickly gets bogged down by the details.
So lets take a detour and discuss why the answer that you give me matters to getting you on the path to financial wellness.
Your budget it based on your income.
Your spending limit is capped by your income.
Your ability to pay off debt is based on the gap between your income and expenses.
For example, consider Bob and Sue. They each make the same amount of money.
In this image Bob is spending more than he makes. His gap is negative dollars. His gap is the amount that he goes into debt each month (on top of whatever other existing debt he has).
Sue, spends less than she makes. Her gap is the number of dollars that she has ‘extra’ each month. Her gap is what can be used for creating an emergency fund, paying off debt, and setting herself up for retirement.
Your monthly income will be the upper limit of what you're able to spend for the month. If you over estimate your limit, the gap will change - possibly from ‘extra’ money to debt.
So, if Bob and Sue were both equally overestimating their income the image shows that Bob is going more into debt than he originally thought, and Sue isn’t getting extra money, she is actually overspending, and gaining debt.
Here is an example framed in a different scenario.
I got a fitness tracker for Christmas two years ago and wore it all the time. My plan was to measure my physical activity, track the food I was eating, and then lose some weight!
The app for the Fitbit let me put in my age, gender, height and weight and then it calculated my Basal Metabolic Rate (BMR) as 1590. BMR is an estimate of how many calories your body burns at rest.
So if [Calories Burned at Rest (BMR) + Calories Burned in exercise - Calories Eaten] is greater than zero (positive gap) then I would lose weight because I burned more calories than I consumed. If that number is less than zero, (negative gap) then I would gain weight because I ate more calories than I burned.
For example: Let’s say that in one day I ate breakfast, lunch, snack, dinner and a sugar cookie for a total of 2000 calories. I also exercised and burned 500 calories. Based on the Fitbit app, my body burns 1590 calories at rest.
1590 (calories at rest) + 500 (calories burned) = 2,090 calories burned
2,090 (calories burned) - 2,000 (calories eaten) = 90 calorie burned
So, for that day, I burned 90 calories more than I took in, so I should be able to lose weight.
It seemed very mathematical (and you know how much I love math)!
But, even though I was doing a good job tracking my calories, and was making sure that each day I didn’t eat more calories than I was burning, I was not losing weight.
C’mon math! You’re better than this!
I decided to go see a dietitian to find out what I was doing wrong.
The first thing she did was to hook me up to a machine that measures my actual resting metabolic rate.
She confirmed that my Fitbit estimate of 1590 was what I should be burning, but told me that my measured rate was only 1290 cal a day. So I was off by 300 cal every day! My body wasn’t burning what I had thought it should be burning, and by using that BMR, I had been letting myself overeat by at least 300 cal a day, or 2,100 calories/week. No wonder I couldn’t lose any weight! My assumption was wrong.
Here’s a funny side note - to get my Fitbit to give me the correct BMR, I had to reprogram it to think that I was 4’6” instead of my 5’11”!
But the moral of that story is that even though I was tracking like a champ, I was overestimating my calories burnt. My upper limit was wrong, so my gap wrong.
Obviously the same thing goes for your financial health. If you think you have $10,000 a month to spend but you're only getting paid $9,000 a month you'll be over spending by at least $1,000.
Calculating Monthly Income - Regular Payments
As in my calorie example, it is better to err on the lower side, so that you can ensure that your planed spending falls below that line.
For some people determining what monthly income to use is an easy step because you have a regular income. Your paycheck is probably about the same each month.
Use the information in this chart to help you determine your monthly income.
If you are paid every other week, then there will be a few months a year that you get paid three times! Be sure to budget based off of the normal twice a month numbers.
When you hit the month with an extra paycheck, you will have a much larger gap than usual and will be able to use it to get ahead in creating an emergency fund or paying off debt.
Calculating Monthly Income - Irregular Payments
People with irregular income often tell me that they cannot budget, because they don’t know what they will be making.
So I ask, “Do you have regular expenses? Do you spend money each month on food, housing, phone bills?”
Of course the answer if yes.
“How do you know you’ll have money to pay for those things?”, I ask.
Common answers: based off of past experience; we just spend and hope that it all gets covered eventually; if I have a low month now I will probably have a higher month later and it all evens out.
Ah ha, so you do have some idea on your income, even if irregular! You typically can look at your past performance numbers to find trends, averages, highs and lows.
With an irregular income, it is a little trickier to decide what numbers to use for your monthly income number but it is possible to still budget.
Consider this imaginary income graphed over a year. Yes, the numbers are huge - it’s intentional!:
If you used the lowest monthly amount of $30k for your monthly budget, you would hit that number every month and would have huge gaps (extra money) in 9 out of 12 months. Imagine how fast you can start to pay off debt with that!
If you used an average of around $44k for your monthly budget, you would hit that number all but three of the months. During those three months though, if you are spending $44k and only bringing in $30k, you will go into debt $14k. And, you will be paying interest on that $14k in October, so the debt actually becomes more than $14k/month.
The only way to use a past yearly average for your current monthly income level, is if you can establish reserves from the high months to help in the low months. And, it is hard to control your spending and stay on a budget if you are getting those $65k checks! Imagine yourself in March and April of the chart getting $65k paychecks. Who would be able to know in advance that May, June and July would only be $45? And, who would, after making $65k in March, April, and May could imagine the $30k months?
It is very tempting with an irregular income to spend as though your ‘highs’ are your average.
You lie to yourself and think, “My best month is my every month.”
No - I’m not being mean when I say that. I come from a family of salesmen and I know that you need confidence in yourself to make sales (and those are the people who usually have irregular incomes). But, having confidence in yourself doesn’t mean that you are allowed to have unrealistic spending habits.
But back to the question, how do you know what to use for your monthly income number? To really do this well, you need to go through your bank statements and find out your monthly income for the last year. Look for patterns. Calculate the average and the lows and decide on your game plan for budgeting going forward.
The safest monthly income to use for budgeting is the lowest number.
What if you are currently unemployed?
In this case, your income goes to zero and no averaging of past paychecks is necessary. If this is your scenario, then budgeting your expenses becomes even more important. In addition to looking for a job, and for extra sources of income, you should gather information on your financial situation.
What non-retirement savings do you have?
What are your assets?
Will you be getting a severance package?
Is there any money due to you (unpaid vacation hours, etc.)
Status of your health insurance? How long until you are un-insured?
What are your monthly expenses? Note which of these are flexible and which of these are mandatory.
We will use that info to build your budget. Be sure to read this article about what bills to pay when you are struggling to pay your bills: Here’s what no one tells you about paying bills.
BTW, your worth as a person is not based on your paycheck.
Details: Net Pay, Taxes and Extra Money
In each case, look at the dollar amount paid to you per paycheck - after taxes, social security, insurance, and retirement have been deducted. You will need to take note whether or not these items have been deducted for you. If not, you will need to include them on your budget.
If you work any overtime, do not include it in your monthly average, unless it is something that you regularly do, and can safely assume that you will be able to continue to do so at the same rate.
NOTE: Any extra money (side hustles, tips, commissions, bonuses, selling your unused stuff, etc.) that you make will not be included in your monthly income amount. This 'extra money' (gap between money in and money out) will be used to pay off debt, start an emergency fund and other important things necessary to have financial fitness.
In my next blog post I will focus on using your monthly income number that you figured out in this post to build a budget that will work for you.
With your budget in place, you will learn to stop spending more than you make, create an emergency budget, start paying off debt, and more! Financial Fitness is in your future!