August 18, 2020
A lot of the mainstream investing advice available centers around traditional 9-5 employees who make a (mostly) steady paycheck on a recurring basis. Freelancers and entrepreneurs may have more flexibility than their employed peers when choosing when and where to work, but this flexibility can often translate into uncertainty when it comes to finances.
To that point, 34 percent of entrepreneurs don’t currently have a retirement savings plan, according to a 2017 survey. This can be due to a variety of reasons, some of which we’ll address below. Mainly, it’s because most entrepreneurs invest a large part of their existing savings into their business or plan to sell their business in order to retire. The biggest drawback to this plan, no matter how passionate you are about your business or your freelance career, is that you will not be able to take advantage of the time value of money.
Time value of money (TVM) is the concept that money you have now is worth more than the identical sum in the future due to its potential earning capacity. If you invest $100 that you have now and earn interest or capital gains on that $100, it will be worth more in, say five years, than if someone just handed you a $100 bill in five years.
Entrepreneurs and freelancers often use their investments and savings in order to build up their business or freelance career, which can be a great alternative to taking on debt. They should, however, prioritize building their investments up as soon as they are able to, in order to take advantage of time in the market.
Whether you’re just starting out as a freelancer or have a few years and a prospering business under your belt, there are a few money concepts you can use to maximize the wealth you work so hard for.
Most freelancers and entrepreneurs are mindful of money and make an effort to live frugally, but non-recurring or unplanned expenses can throw a wrench in the best budgets. Additionally, because revenues don’t follow a set schedule or come in chunks—like whenever you make a sale or when a client pays you per milestone—it can be difficult to budget.
This signifies the first difference in how you need to manage your money as a freelancer or entrepreneur. Calculate an estimate of how long it can take you to get paid for a sale or contract. For example, if your contracts are two months long, there can be times when you don’t get paid for two months. It can vary by industry or business, but you essentially need to have enough in your checking account to cover all necessary bills and expenses for the time that you’ve calculated. This cash needs to be easily accessible in your main bank account. More steps you can take to ensure you never accrue additional expenses include adding overdraft protection to your account or linking it to a savings account at the same institution.
Secondly, your budget has to take into account irregular expenses like taxes and seasonal increases in your costs. This can be accomplished in different ways: you can either have separate accounts for these expenses or overlay a budget program/spreadsheet over your accounts to track monthly contributions for these expenses. And because there is no employer to conveniently deduct part of your paycheck for retirement savings, you have to be more mindful and contribute a percentage of your income to a Roth IRA or another retirement account.
This popular advice is particularly important for freelancers and entrepreneurs. Based on the risks inherent in your industry or line of work, you might need to save 3-6 months of expenses in a high yield savings account. Note that this should be separate from the money in your checking account for your expenses mentioned above. The purpose of having an emergency fund is to protect yourself from periods of decreased revenue and market downturns. Therefore, your emergency fund should never be invested in stocks. Another reason to have an emergency fund is to decrease dependence on credit cards and cut down the dreaded credit card float (when your credit card basically subsidizes your living expenses and you’re always carrying a balance).
As a freelancer or entrepreneur, you are probably no stranger to taking charge of your own life choices. Fortunately, this is a skill that easily transfers over to wealth building. If you’re unsure where to start, look into the 50/30/20 rule as your guideline. Ideally, you should be spending 50% of your income on necessities like rent, transport, health insurance, and food. 30% of your paycheck can go into wants or extras (or back into your business if you’re in the growth phase). 20% of your income should go into savings and investing. As we mentioned earlier, start by opening a tax advantage account for retirement investments. Once you max your contribution for the year, look into other options like SEP IRAs or Solo 401(k)s—you can always work on the more complicated pieces with a trusted tax planner. Another option is to have a personal investment account that gives you more flexibility in terms of withdrawals and investment choices.
You shouldn’t fall into the trap of over complicating your investments, but there are very good reasons to diversify. As we’ve seen from the current pandemic and the resulting market volatility, diversification has real, tangible benefits for investors.
We’ve written extensively about how to diversify as an investor in the past, and most of the investment advice carries over to a freelance or entrepreneur career.
Unless you are already in the real estate space and know exactly what you’re getting into with real estate properties, investing in a property might not be the best diversification tool for you because of the time and effort required to maintain it. Instead, look into REITs to invest in real estate without any hassle.
Working as an entrepreneur or freelancer can often feel very alienating—unlike a corporate or business environment there are no coworkers to brainstorm with or ask for help from. If you feel like you’re in over your head when it comes to saving and investing, it can be a good idea to seek help from online sources (like us, hello!) or professionals like tax attorneys and financial planners.
To find the right finance professional, your first check should be to ask whoever you’re considering working with if they are a fiduciary. A fiduciary’s first and foremost duty is to the client, so you can weed out people who are only trying to make commissions or referral fees from your clientage. Here are some more questions to ask.
Saving and investing can be scary, especially if you’re not sure where to begin and can’t find credible sources to help. We hope this article gets you started on the path to financial freedom as an entrepreneur or freelancer so that you can focus on all the great things that come with taking charge of your own business!