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On dams and water towers (budgeting on an irregular income)

Often, introductions to budgeting make it sound soooo simple: “What do you make each month? Divide it up. Boom! Done!”

There are a number of flaws with that — you probably don’t know what you actually spend money on, you probably aren’t factoring in that dishwasher that’s about to die, you’re gonna fudge your numbers to make the total expenses fit the income number, and so on. But there’s one problem that hits a lot of people in the very first sentence of those instructions. “What do I make each month? Well … which month?!?”

When you make a different amount of money each month, it can be very difficult to budget your expenses.

How will you know whether you can buy those shoes you need this month? Will you need to cancel that haircut? Do you really have to go see the doctor about that cough right now, or can it wait a few weeks? It’s what I call “budgeting in the dark” — you don’t have all the facts, which means you’re trying to make rational decisions through an irrational process.

Budgeting in the dark is no fun, and it’s one of the reasons a lot of people completely give up on budgeting. (Pro tip: that’s not going to make things better.)

Today we’re going to look at how to throw some light on the situation, how to get things under control, and how to drop that bucket of stress you’re probably carrying around with you.

The Dam and the Water Tower

Water discharging from the Sengari Dam.
Photo by Satoshi Kaya

Before we get into talking about money, I want to touch on something else. Water.

Cities have people. People need water. Unfortunately, there aren’t many places in the world where the amount of water needed by the city magically shows up each morning, ready to be used for cooking, cleaning, and watering gardens. No, cities have to plan for their water usage. And while there are lots of ways that cities can manage their water, the two most visible ways are through dams and water towers.

With a water tower, a city pumps water in every single minute of every single day, filling the water level higher and higher. Then, at peak moments — like 6-8am and during the halftime of the Super Bowl (or, I guess, during the actual game) — all the people in that neighborhood start using the water, and it drains out of the tower. Then, slowly, the pumps fill it back up and the cycle repeats. Think: a little bit of water in, steadily and constantly, means it’s there when it’s needed.

Dams also provide water to cities, but they do something else as well: flood and drought control. Sometimes, spring rains come, the snows melt, and a lot of water comes rushing down the river towards the city, and it needs to be contained. Other times, rains are light, the summer sun is hot, and not as much water flows down. In both cases, a dam — and the reservoir of water it holds — helps regulate the level of water the city has access to.

You’ve probably made the mental leap already, but dams and water towers are perfect metaphors for you and your money. But I said we’d be specifically talking about irregular incomes. How does this metaphor apply?

Step 1. Create a “reservoir” (open a bank account)

Cars parked along the top of a dam, and a large reservoir of water.
Photo by James Marvin Phelps

Some of you make the same amount of money every month. You should think of your money flow like a water tower. Or, actually, a collection of water towers. Each month, you push a little bit of money into the “groceries” water tower and the “clothing” water tower and the “replacement dishwasher” water tower. Then, as you need it, you draw down on the money that’s collected and you get the thing you need.

Then, when more money comes in the following month, you push it into the water towers again. If you’re a “cash-only” household, your envelopes are your water towers. If you use credit/debit cards as well, you might use a couple of different bank accounts for that. Tsh talks more about that in her post on “sinking funds.”

Those of you with irregular incomes need to add a step into your process. You’ll still use water towers, but you also need a dam somewhere to feed them. I recommend setting up a new bank account — the “Orange” accounts at Capital One 360 are good for this, but you might prefer a local bank or credit union with bank tellers you can interact with directly — to act as your “reservoir.”

Money goes from your paycheck to your reservoir, then from the reservoir to the water towers, and then you’d spend it. You won’t ever actually spend money directly from this “reservoir” account. You’d also get to say things like “Oh, we need more dam money.”

Step 2. Fill up the reservoir (Gather money into this account)

Photo by Doctor J. Beam

So we’ve opened up the bank account to act as your reservoir. But it’s currently empty. That’s okay. A dam doesn’t start out on Day 1 full of water. Similarly, you’ll need to gather money into this account. It could take a few months. (While that’s going on, that’s a great time to track your spending if you aren’t already doing that.)

You should make it a habit to put some money from every check that comes in into this account. The goal is to end every month with a little more money in this account, and, eventually, to have a little more than a full month’s worth of expenses stashed away here.

Getting to that point can be tricky, and I don’t mean to suggest that it won’t take some work. But the peace you’ll have when you get there will more than make up for it. One thing you’ll want to do is to “ration your water use.”

In a drought, cities employ “water rationing” — they basically figure out what uses of water are necessary and which ones are simply nice to have. In the same way, as you’re building up your reservoir, think about which of your expenses are needs, and which ones are wants. Sometimes you even need to divide a single expense category up — maybe you need to have “groceries – needs” and “groceries – wants” categories. Tsh actually goes more in-depth on this in a post she wrote a few years back, How Do You Budget On An Irregular Income?.

Step 3. Draw Water from the Reservoir (Pay yourself out of this account, not directly from your paychecks)

A dramatic photo of a water tower.
Photo by Wojciech Przybylski

There are two ways you can go about this. One way is to figure out what, on average, you make each year, and to give yourself a regular “salary” out of your reservoir. The other way is to only pay yourself what you brought in the month before.

If you give yourself a regular “salary” out of your reservoir, you simply transfer the same amount out from one month to the next. Sometimes your reservoir will dip down a bit (if your income has been light). Other times, it’ll get a bit high (when you’ve been making more than usual). Either way, though, you should only pay yourself the same amount every month.

If you go with the “pay yourself what you brought in last month” approach, your reservoir will probably end up staying at about the same level. It’ll fluctuate up and down, but if you’re drawing that money out, it’ll all balance out in the end. My friend Jesse, at YNAB, encourages this approach, and many people find it works well for them.

Planning for the Future

An old photo of water falling down the front of a dam.
Photo by

So if you’ve gone through these three steps, and you have your “reservoir” account ready to go, where do you go next? In truth, you’re now ready to follow just about every other (good) budgeting article that’s out there. You’ve created a way to regulate the money that flows in each month. You’ve pulled yourself out of the dark, and can now make good decisions and have a less-stressful plan as you move forward.

For those of you in this situation, good luck with it. And in the comments, we’d love to know: Are there any tips you have for working with an irregular income? What other obstacles stand in the way of you feeling peace about your finances?

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  1. Alia Joy

    This is a really good concept. We live on a completely irregular income because of self employment and dips in the economy and this is essential. And of course it is fun to say “We need more dam money.”

  2. Digital Mom Blog

    Irregular incomes are so hard, especially with kids. The best thing to do is creating that reservoir BEFORE switching to a regular income. #lifelessons

  3. Marcie

    This is the ONLY way to budget so our expenses don’t completely fill our incomes, regular or not. This frees us up to be generous and to plan for the future. We also have irregular income and make small (organic or non organic celery this month?) and big decisions (another child — are we there yet?) based on actual data and faith. We don’t have to guess what it costs to live our (modest) lifestyle. It’s very liberating!

  4. Anne @ Modern Mrs Darcy

    Thanks, Charlie, this is so helpful. We’ve been discussing recently what transitioning over to self-employment may look like in my house, and I’ve not been real comfortable with the budgeting advice for irregular incomes I’ve been reading up on. (Pay the essentials first, pay the rest if you have the funds–I hate the sound of that!)

    I love the visual of dams and water towers. We already have sinking funds in place; now I can imagine doing the same thing on a grander scale if we do make the switch.

  5. Audrey @ Mom Drop Box

    Interesting analogy. We have a regular income stream, but – sticking with the water analogy- my concern is that our dam isn’t large enough to carry us through what may be an extended drought if one of those income sources dries up. We would need a large EF for me to feel totally at peace with finances in the current economy.

  6. Nicki

    Thanks for this great article. I read a lot of personal finance stuff, and financial budgeting is one of my big goals for 2012 – but I’ve not read anything that made me more comfortable about the possibility of becoming self-employed than this. It seems much more manageable with this analogy!

  7. Laundry Lady

    We have an interesting situation with a small steady income (my husband’s full time job) that covers most of our expenses but leaves little or nothing for savings, but a side very irregular income that helps to fill in the gaps (my freelance work for my old non-profit job. The problem for me is estimating taxes on the irregular income. When I started working last year I didn’t know how long my irregular work would last. My hours varied from 40 hours a month to 2 hours a month. Since I’m paid as a contractor I have a file taxes. Now I find that perhaps I should have filed estimated taxes quarterly. How on earth can you estimate quarterly taxes with such a wide range of irregular income? I didn’t even know in May if I would still be working in December and therefore wouldn’t have even made enough to file. We are in such a low tax bracket that I think we will be OK, but I’m still quite worried about owing penalties and interest. I did set aside approximately 1/3 of my income for paying the tax bill, but now it may not be enough. Personally I think the way the US tax system works for self-employed people really stinks. By the time you’ve paid federal, state, local and social security taxes you’ve lost nearly half of your income. Considering the huge sacrifice it is to my time and energy to do this it all, the thought of losing even more to penalties and interest because I didn’t file quarterly last year (how much exactly would I have estimated for the quarter where I made only $4o or $50?), it takes a lot of motivation out of working at all. I admire those of your whose main income is self-employment or contract work. How do you handle all the red tape? I made less than $3,000 last year and I’m finding it overwhelming.

    • Charlie Park

      I’m not a tax professional, so I can’t give actual tax advice, but I can say that every IRS agent I’ve ever spoken with on the phone has been helpful, friendly, polite, professional, and knowledgable. I think they know most people have a negative view of them, so they work really hard to overcome that. In terms of this year’s taxes, I’d give the IRS a call (1-800-829-1040) and talk to one of their agents. I promise, you’ll end the call with a better sense of what you should do next.

      Regarding next year’s taxes, I’d suggest looking at what you end up paying this year and making a plan based off that. The first year is always tricky. And the IRS actually understands that. Give them a call. They’ll help out. Also, getting a program like TurboTax would probably be a good investment, so you can make sure you’re getting the various credits you qualify for.

  8. Jessica @ Quirky Bookworm

    I used to HATE having to budget for dams and water towers when my husband was in real estate! My income was steady, but miniscule, and it used to stress me out. I’m thankful that nowadays he has a regular, steady paycheck. 🙂

  9. Meg

    Once again, has left me feeling empowered. Thank you so much for your lovely, straightforward approach to the money issue.

    Just so fabulous.

  10. Brad Kinder

    I like the terms “dams” and “water towers” you use. I have advised people with irregular income to use this approach, but didn’t know what to call it. That is awesome!

  11. Kate

    My husband has been self-employed now for the past four years. His income has fluctuated from one month making $50.oo to once making over $10,000 another month. It is that extreme. Early on, we always tried to pay bills 3 months in advance, which worked for us. We also payed paid off as many annual bills as we could, like our car insurance because when we paid it off in one large chunk for the year, we received a discount. We have now built up a reservoir, but continue to try to stay at least one paycheck cycle ahead on bills. We’ve read so much on budgeting, paying off debt, etc., but this is one of the most helpful articles on doing that on an irregular budget. THANKS!

  12. Mary

    That was a great way to explain a concept that is difficult to teach. I linked to your post on the Dave Ramsey boards. I think the question of how to budget irregular income comes up at least once a day!

    My tip is to start with the fewest budget categories (obviously only the most essential ones) until you get your reservoir built up. Then you can slowly add the categories that are more fun as your finances get more stable.

  13. Patty Gardner

    Great article. I loved the phrase “budgeting in the dark”. Sometimes it’s hard to explain to other people what I have to do to make it work. My husband is self-employed and I am a homemaker.

    We have a similar system to what you described. Everything earned during the current month is set aside. At the end of the month, I pull out the designated amount and anything over goes to the “business surplus account”. If we’re under, I pull the difference from the “business surplus account”.

    I’ve been doing this for a couple of years and it is SO much easier than just spending everything as it came in. When we did that, we never knew if we had any extra or not. Everything we spend frivolously made us feel guilty. This way, as long as it fits in the budget, it’s okay. Freedom.

  14. Steph

    We’ve spent many years juggling irregular income budgeting and it’s very frustrating. Right now we have a regular income (which we’re very grateful for) but this information is very helpful if we’re ever back in the self-employment category.

  15. Jadah {family sponge}

    I love this! I have definitely been guilty of this one “…you’re gonna fudge your numbers to make the total expenses fit the income number…” It wasn’t until last summer that I really examined our spending habits by going through the last 3 months of bank statements. It’s definitely a lot more stressful having a fluctuating monthly income and it does make it hard to plan. I have created a budget in excel, and anytime a bill increases, an expense decreases or income changes, I make the quick changes in the excel sheet to see if we need to make any changes to our budget. Just recently it looked like we were going to be $400 short, so we had to look at things like our daughter’s ballet class, my gym membership, etc. Luckily God always provides in time, so we were able to make it work. My husband and I give ourselves salaries, but we call it “fun money.” That’s basically our allowance to spend on eating out, hair cuts, fun activities, etc. It does help to have a system in place. I used to revolt against having a budget because we had a fluctuating monthly income. I’m so happy we have one now. Now I just need some dam money! 🙂

  16. Julie @ The Family CEO

    Wonderful analogy! We’ve been on commission income our entire marriage – 25 years – and it definitely is a challenge. The best thing we’ve ever done to deal with an irregular income is pay off all non-mortgage debt. (We’re almost there.) That makes it easier to deal with the lean months and the flush months are used to fund goals, not make up for the lean months.

  17. Hillary

    This makes me so happy. We’ve always lived on irregular income and it can be challenging. This is very similar to what we do. Dump any incoming money into a second bank account and at the beginning of the month we transfer our monthly funds from teh second account into our checking account. At a glance we can see how many months “ahead” we are.

    Unfortunately due to the economy and an injury things have been much tighter the past year or so, but I look forward to building back up into a place of abundance.

  18. Christie McLaughlin

    WOW that is a fantastic way to work an irregular income. And best of all, I personally am a Dave fan and that would still work within his plan. Awesome! I am self employed and my husband is working his way out of his j-o-b to come work for my company, and this plan will be a lifesaver! Thank you!

  19. Heather

    Great advice! I grew up the daughter of a self-employed artist who had constant work, but who had clients who weren’t consistent in paying for that work, so our family knew quite a few lean times. I don’t remember my parents ever having enough to set up a savings account… they had one, but as soon as there was some money in it, a car broke down, or there was a medical expense (they still don’t have health insurance, and don’t want it).

    I do know my dad created our family budget by taking last year’s total salary (after taxes) and dividing it by 12… so we still stayed within our budget on “months of plenty” which left money for the lean months. It was still tight.

    I also lived as a missionary, and sometimes support was just enough to buy basics, and other times I lived without soap or shampoo for months, so I guess that would count as living with an irregular salary, as well.

    Now we do have a regular income and live debt free, but at some point we may return to the mission field and we might again have that irregular income. I would love to print out this article and save it in my household notebook for future reference.

  20. Mandi @ Life...Your Way

    We have recently overhauled our budget, and the one thing I’d add is that we project up to 3 months out.

    So at the bottom of my budget, I list the expenses that are coming up — both the necessary and unnecessary fun stuff — as well as income I anticipate or know for sure is coming. That helps us decide when to spend on the extras and when to focus more on building the reservoir.

  21. Sarah

    Great advice! We’ve lived at least half our marriage on irregular incomes and it is definitely more challenging. Your analogy is very helpful!

    We use Excel to track all of our funds with categories and columns. We set aside a portion each paycheck for each fund so that when we spend money on anything from clothing to car maintenance to groceries or dental work it is accounted for.

    Thanks for sharing!

  22. Lindsey

    Love this analogy! Thanks for adding in another picture I can use when thinking about finances.

    As someone with 8 years of experience with self-employment (definitely still learning), the one tip I’ll make is to make sure you pull your taxes out first. Set them aside in a savings account that doesn’t get touched until tax day. As tempting as it is to use these funds until then, it can get you into deep trouble!

  23. Emily @ random recycling

    My husband works in finance so we are blessed with better than the average knowledge of how to invest our money.
    I love the water analogy, it’s so easy to understand.

  24. Tracy Selle

    This is an excellent post. I’ve never thought of it like this before. I’m a piano teacher and the summer months are slim. I like the idea of figuring out a “regular” salary to get from my reserve. So totally new and interesting. Thank you!

  25. Kate S.

    We live with an irregular income, but we do it a bit differently. We are always 1 month ahead, so that we’re paying all of our expenses with the previous month’s income, a known number, while we’re earning the current month’s income. That way, we always know how much money we have to work with and how best to divide it to meet our immediate and future needs. If we have an emergency we can always deduct our monthly expenses from what we earned last month and see if we’ll have enough to comfortably cover it, rather than immediately dipping into our savings. I like your method, but it seems unnecessarily complicated.

  26. Sleeping Mama

    I have regular income so I don’t have to worry too much about variations as those with irregular incomes do. I have a little bit of freelance money that comes in once in a while, but nothing crazy to live off of. For those extra checks, I add it to my monthly income, and whatever is leftover goes into extra savings. I’ve already “paid” myself with all sorts of savings (retirement, vacation, car, house, etc.) in the beginning of the month, so what’s extra at the end of the month is really extra. The freelance money goes towards that.

  27. Bernice @ The Stressed Mom

    What an awesome way to explain this, and I love the visuals! I am going to share with my young daughter and her boyfriend, they are struggling to budget, this may help!

  28. Brent Pittman

    Great article and a method we also use. I love the analogy of dams. An emergency fund is a barrier to debt.

  29. Bill Swan

    This would be a great method to use for teachers and kids in junior high school. Actually the high school kids might make use of it too.

  30. Jamie

    I’m a little late reading this but found it very helpful! My husband is straight commission and I am a SAHM so we have really struggled with a budget. One question I have with this is how it works with debt snowball. How would I know how much excess I have each month to go toward my debt snowball.

  31. EmilyInTheGreen

    My husband used to work seasonal – while it is not as irregular an income as commission work it was more variability in our budget than we prefered. Unemployment was roughly 50% of his seasonal income. During his working months we put away money to supplement the unemployed months so that yearround we had an income at 75% instead of 100% 9 months of the year and 50% three months of the year. What a relief!

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