Are you equipped to handle a sudden change of income? Most people aren’t prepared for any sort of drastic change that could happen today, tomorrow, or a week from now. And it almost certainly will at some point. You could get a better job offer or a raise in the next week, or your income could be slashed in half for the next six months due to an injury. Here’s how to prepare for sudden income change and handle it when it hits.
Change Can Go Both Ways
Change can be good or bad, both are usually unexpected. Good changes are unexpected rises in income like a raise, an "employee of the month" bonus, or a policy cashing out that you might’ve forgotten about. Bad changes in income are sudden drops, such as unexpected and unpaid leave, being retrenched or demoted, or having to change your job for whatever reason.
Where You Are At Now
It’s vital for both your financial future and well-being that you always know what state your finances are in currently. Know how much money you have coming in versus what you should have going out. Also, be sure of what you (and your partner) owe and how much money is put away in the bank.
Money Going Up
Income rising even a little creates the illusion that you have more money available to spend. Your standards will likely rise as well. You might be more likely to spend an extra $10 on that coffee, or you might choose to move to a more expensive place because you can afford it now. It’s called “Sudden Wealth Syndrome,” and you are wise to avoid it. It’s commonly associated with lottery winners, but it is also commonly seen when someone’s salary goes up or they inherit money. Don’t be too quick to change your living expenses just because your income has gone up.
Handling the Increase
People who are truly “rich” on their bank statements are more often the ones who don’t flash it. When you get access to more money, don’t increase your standards immediately. Beyond fixing the most urgent, treat your budget as if it were the same. Some of the extra money (whether salary change or inheritance) should ideally go into diversified investments, or it should be put into an account and ignored entirely.
Or Money Going Down
We’ve already mentioned why your income could suddenly drop. For these occasions, having money put away can take the edge off a sudden drop in income or being entirely unable to work. Your liquidity ratio tells you how long your assets (what you have) will cover your expenses should your income stop completely. To calculate it, add your assets and divide them by your liabilities. That, in months, is your answer. Are you prepared enough?
Handling the Decrease
When your income goes down or stops, your first step is to go back to the beginning of this article. Where are you at now? Take a look at what you have been spending and see where you could be cutting or omitting. Take a look at what you have been saving, investing, or have in salable assets or marketable skills. This is what gets you through these changes. Some insurance companies offer income protection insurance, and this is highly recommended. You won’t need it until you do.
Change Can Change Again
Up or down, one should never get too used to any kind of change. Remember that the change itself was sudden, and it can change back to something else just as quickly. Once you get too comfortable in a higher income bracket, the drop down is often much, much harder to deal with. Why? This is because your standards have gone too high up, which is where most people have been spending instead of saving. If you hit a low patch, keep in mind that it is temporary as well and you will get a chance to go back up.
Remember that prevention is better than cure. It applies to your finances as much as anything else. In the case of an income raise, you should have a clear investment plan, so you know not to go overboard. This is something you can discuss with a financial adviser at your bank, often for free. During a time when you have a raise in your overall income, it’s a good time to prepare for the income drops, which are inevitable. Put the money away now and take the sting out of what might happen later.