While few people would ever put their hands up for a pay cut, the reality is, at some point during our working lives we may experience a dip in our income. Some dips we can plan for, others may be out of our control, which is when a cut can really hurt.
Do you really want to leave this to chance?
Given the choice, most will say ‘no’, which brings to mind what someone once told me, “it’s not what happens, it’s how you handle it that counts”. So, how can you prepare for those income dips?
The reality is that not all of us are naturally good at planning our finances, and many learn by experience, which includes watching others succeed or fail. Perhaps you have a sister, brother or cousin, who shows you ‘what not to do’. Who knows, maybe you have been your own worst example? In reality, what matters is what you do now.
There are many reasons why we might experience a cut in income. Even the ones within your control may mean some sort of sacrifice. So, let’s look at four possible reasons why you might experience a dip in income:
- Family – You may choose to leave full time employment to spend more time with your family, to care for a sick parent, or to start a family. What if your child was critically injured and you needed to take extended leave to assist their recovery?
- Career choices – You may realise at some point that the career you have chosen is not the one you want, or you may have done the same thing for so long you need a change, or you may want to do some training to boost your career chances and this would mean time off work. Perhaps you want more of a challenge, or the opposite, you might want to slow down.
- Redundancy – Over the past ten years some of you, your friends or family, may have experienced a redundancy. While this could represent a golden handshake, being worth tens of thousands of dollars, if you haven’t worked there very long the payout may be small – the low hanging fruit are often the first to go. This may mean you need to find another job quickly. However, with the unemployment rate in Australia rising, and likely to get worse over the next few years, finding a job may be tough.
- Experiences – ‘Girls just want to have fun’. I’m showing my age I know, however this was a great song, and today more women are travelling the world for the life experiences. At some point you may want to take some leave without pay for recreation.
How much do I need?
If you experience a pay cut, you will find that bills keep coming in, and thinking that you may be able to rely on some form of government handouts for support is not, in my opinion, a good option. Wouldn’t you prefer to be able to know that you are going to have enough and be able to pay for whatever you need, or to at least maintain your current lifestyle?
Also, in the current climate, with all of the budget cuts, even if you were eligible for some form of support, will you be able to rely on government payments in future anyway? Possibly not.
You could instead take matters into your own hands, or at least speak to someone who may be able to assist you to create your own income buffer.
Estimate how much you need
To work out how much you might need, estimate your current expenses, necessities and the incidentals, and then add a little more for the rising cost of living, which could increase by say 3 per cent per annum. Also, estimate how long you may need to cover expenses for. It’s your best guess.
How to create your own buffer
You might be able to save the money from existing earnings, or better still, think of something that you could do to earn an extra $150 per week say. After five years, you would have an income buffer of around $39,000, plus interest. Assuming 3 per cent interest, you would have around an extra $3000*. So, is that enough for your income buffer? You may have to tweak the weekly amount to cover the required expenses.
If you have a loan on your home you may be thinking, “with interest rates so low, why wouldn’t I just pay off the mortgage?”. Well you can do that, however, it often makes more sense to set up an offset account than to go hand out to borrow the funds later on.
You can also get your money working harder for you by investing. If you were to save the $150 a week for two years at 3 per cent, you would have around $16,050*. To get a better return you could invest in say 8 of the top twenty Australian shares, by market capitalisation, paying good dividends at around, or above, 4 per cent. That’s around $2,000 into each share.
As an example, over five years, suppose that your shares were to return 8 per cent per annum, including dividends, and you continued to save the $150 per week, you would have around $71,600**. So, investing your money has the potential to make a massive difference to your savings power.
To have a go at the calculations yourself you could use the ‘Compound interest calculator’ on the Money Smart website.
You might say that investing in shares is higher risk than cash, and you would be correct. However, to get a higher return you have to take some level of risk, but you can control it. You can learn some simple rules to manage your risk and help you to confidently build your own income buffer.
One of the quickest ways to get this knowledge is by reading the book ‘How to beat the managed funds by 20%’ by Dale Gillham. Or, you might like to complete the Your Trading Mentor course.
Armed with this information, an income dip isn’t as daunting as you perhaps thought.
Janine Cox is the Senior Analyst at Wealth Within
*These calculations are based on interest compounding monthly.
**Assumes that shares are held for the entire period and does not take into account the tax consequences if you were to sell the shares.