Personal Finance for Freelancers

Planning for retirement just isn’t what it used to be! Gone are the days of 40-year careers with a single employer—and the generous pension plans that often came with them. Also gone is the assumption that we can count on state-funded pensions to keep us afloat in our golden years. Life expectancies—and thus the length of retirements—are on the increase and doubts about the future viability of state-sponsored retirement funds are growing as the population continues to age in a number of countries.

While retirement is an issue that affects everyone, freelance professionals are particularly vulnerable for a number of reasons: We have no employer-sponsored retirement funds (and the lucrative matching funds that often come with them—if you have a spouse who is an employee, make sure that they have their employer-sponsored plan maxed out!); we tend to be multicultural by nature and this makes us likely to move from country to country, thus decreasing or eliminating future benefits from state systems; and, finally, our income can be somewhat irregular from month to month, making it difficult to budget effectively and plan for our futures.

However, the best way to face an uncertain retirement scenario is to plan and prepare, which is something that everybody can do. It is never to late—or too early—to start getting your financial house in order. Don’t run the risk of “outliving” your assets in retirement. Think of saving as a way of “buying your future”—especially the next time you hear a pair of shoes or a new tennis racket (or other impulse purchase that you can’t afford) calling your name!

Key points covered by this article:

• Pay yourself first
• Put compounding to work for you
• People first, then money, then things
• Set up an emergency fund for “rainy days”
• Save 15% to 20% of your income for medium-term goals and retirement
• Invest regularly
• Overcome financial setbacks by revising your plan

Three Basic Concepts

Before we get into the nuts and bolts of personal finance and retirement planning, there are three basic concepts that should apply regardless of where you live.

1. Pay yourself first. This is the golden rule of personal finance. Whatever your current goals are (building up your emergency fund, saving for a medium-term goal, or growing your retirement nest egg), paying yourself first means setting aside a given percentage of your income and putting it away where you can’t get at it before you even start to budget for other living expenses. The opposite of this is waiting until the end of the month to see what, if anything, is “left over” and then saving (sound familiar?).

Automatic transfers or direct debit from your checking or current account are great tools for achieving the goal of paying yourself first. Of course, as freelancers, we don’t have a weekly/bi-weekly/monthly paycheck like employees do. I used to take money from my business account on a very irregular basis “as needed.” This made it impossible to stick to any kind of a savings plan. Now that my business has been up and running for a few years, I pay myself a regular monthly “salary” based on the previous year’s business income. Because my income has gone up steadily, this has two benefits. I have a steady “salary” to facilitate budgeting and savings and, if my income is higher than last year, I end up with a “surplus” at the end of the year that goes to my emergency fund, medium-term savings, or retirement savings. Estimating how much your “salary” should be will depend on the tax and social welfare systems in your country. In France, contributions to social welfare programs are high, as are income taxes. I base my monthly “salary” on 50% of the previous year’s total income divided by 12. This leaves me with more than enough to pay my social contributions and income tax. If your income drops from one year to the next…well, that’s what your emergency fund is for (see below)!

2. The magic of compounding. For the mathematically inclined, this is rate of return x time. For the rest of us, the earlier you start saving, the longer your money—and the returns on your money—will work for you (rather than you working to save money). If you are under 30, this is excellent news (even if you feel that you are too “broke” to start saving). Here’s a good example of compounding from the Morningstar Investing Classroom:

When compounding, the earlier you start, the better off you’ll be. Let’s consider the case of two investors, Joe and Sam. Say that Joe put $1,000 into the market at age 25 and earned a 10% after tax return. Sam also put in $1,000 and earned the same return, but waited until he was 35 to do so. When both were nearing retirement at age 60, Joe ended up with $28,102, while Sam only has $10,834 from his investment.

For a fun illustrated (Flash) example of compounding, visit Vanguard’s Investor Education Center.

3. People first, then money, then things. This is Suze Orman’s “First Law of Money” as explained in her book The Courage to Be Rich.

People first. Those things that are created by and kept with love must always come before anything else. Family, friends, your partner, your children, yourself […]
Then money. Can you imagine going to someone’s house and having them proudly show you a room filled with thousands of dollar bills and telling you the history of how all that money came to be? You would be appalled at the vulgarity. At the same time, you would think nothing of it if you were to go to someone’s house and be given a tour of a room they had just redecorated. What did it take to redecorate that room? Money. [...] In either case you are being shown a room full of money. The difference in your perception was the value system that you applied—a room full of things is okay, whereas a room full of money is not. That is because you value things more than you value money.
Then things. When your financial priorities are in order, things come last.

If you are feeling overwhelmed by debt or are just disorganized and don’t know where to start, I would recommend reading The Courage to Be Rich as the first step to planning for your future. While the investment advice is geared to US investors, there are a number of universal life lessons in this book that can help anybody to face their financial future more effectively.

If, on the other hand, you feel that you are ready to take the plunge, the following three guidelines are the foundation of any personal financial plan and will help you get started. I will try to keep these guidelines as general as possible, but I encourage budding investors to seek tax and investment advice from qualified professionals in their country to see what options are available locally.

1. Emergency cash reserves. Most financial advisors recommend saving enough to cover six months’ living expenses (rent, food, utilities, etc.). This emergency or “rainy day” fund should be in an account that is risk-free or low-risk, accessible, that charges no penalties for withdrawing funds (such as a money market account or a savings account) but that is ideally separate from your checking or current account (the account you use for your month-to-month living expenses). If you do not have an emergency cash reserve, this should be your first savings priority. It will cover unexpected medical expenses, car repairs, and living expenses if you suddenly lose work or are too sick to work (you might also look into the option of a private insurance policy to cover long absences from work due to illness). Once you have built up your emergency fund, you can get started on the next two savings goals (medium-term savings and retirement savings). Again, pay yourself first. Set a goal for building your emergency fund (aim for 15% to 20% of your income each month), open an account to hold this money for you, and automatically transfer the funds to this new account each month until you reach your goal.

2. Medium-term reserves. This is money you have earmarked for goals such as vacations, a down payment on a home or home renovations, a new car, or a career change. It may be placed in term accounts, CDs, or other low-risk investments that will enable you to withdraw the money when needed (but not before, or at least not without dissuasive penalties). You can work on this while you build your retirement nest egg.

3. Retirement savings. These are long-term savings that you will not withdraw until retirement. Right now, even if you do not know where or how to invest, do not have the time to get started, or are simply afraid to invest, the important thing is to save regularly every month, even if you are just putting the money into a savings account until you can figure out what to do with it (although a savings account is not a good long-term solution as inflation will erode any earnings). Once you do figure out how to invest your savings, investing regularly is important as it will “smooth out” the effects of market fluctuations over time (for instance, it is better to invest $100 per month than $1,200 all at once each year). This is also known as “dollar cost averaging.” In some countries, there are tax considerations to factor in when saving for retirement. See a professional in your country for tax-related investment information. Saving for retirement may be a way to significantly reduce your taxable income. So, by saving, you are doing yourself a favor now that will also pay off in the future (unfortunately this is not the case in France where I live, where such tax breaks are limited!).

Most financial advisors suggest saving 10% to 15% of your income for retirement. This estimate is often geared towards employees and takes into account employer-sponsored pensions and state pensions. For freelance professionals, I am afraid that this is not enough. To secure a comfortable future, 15% to 20% of your income is a good starting point. Remember, pay yourself first and then base your monthly budget on what is left. If you don’t feel that you can live on the remaining 80% to 85% of your income, then it is time to take a look at how you can cut spending or increase your income. Learning to live within your means and within a budget is a whole topic unto itself, and I would encourage you to read Suze Orman for more on how to achieve this.

Now, the 15% to 20% figure can vary depending on a number of factors. I consider this a minimum. The closer you are to retirement, the higher the percentage will be. In order to refine your investment plan, you will have to assess your retirement needs in greater detail and get to know yourself a bit better (your investor profile).

Assess Need, Know Yourself, and Allocate Assets Accordingly

Assessing retirement needs may seem complicated, but it is really just based on your current income, current retirement savings, years until retirement, anticipated length of retirement, estimated pension or other benefits, the standard of living you wish to maintain in retirement (as a percentage of your current income), and inflation. There are a number of online calculators that can help you with this. Again, they are geared towards employees and I feel that the answers they spit out are not enough for freelance professionals, but they will at least give you a basic idea of the bare minimum that you should be saving.

Again, I would encourage you to see a qualified financial advisor in your country (an independent advisor, accountant, or contact one through your bank) for a detailed assessment of your current situation.

You will also need to get to know yourself a bit better as a potential investor. This means determining the level of involvement you are willing to take on in terms of managing your portfolio (if you want low involvement, a mutual fund might be better than trading stocks directly yourself, for instance) as well as the level of risk you can tolerate (this depends on your personality as well as other factors such as the number of years until retirement). This will determine the asset classes and types of investment products that are right for you. Here is an extremely simple interactive investor profile tool that will give you sample asset allocations for different levels of tolerance for risk.

All of the major investment firms (Fidelity, Vanguard, etc.) have online tools and more extensive questionnaires designed to help you determine your profile and allocate your assets accordingly. As a general rule, diversifying your portfolio is the key. You must also re-allocate your assets to more secure investments as retirement approaches. It is a good idea to review your allocation every year.

Investing Basics: Types of Assets and Investing vs. Speculating

Stocks, bonds, and short-term or cash reserves are the three main asset classes (I am not going to talk about real estate here). Fidelity provides a clear explanation of the different asset classes and possible asset allocations.
If you are still afraid to invest, it is probably because you are confusing investing with speculating, which is something you should be afraid of (according to Vanguard, speculating is akin to gambling). Investing is something you simply cannot afford not to do. Merely saving (in bank accounts, for example) is safe (especially in countries where the government insures regular bank accounts) but it is not enough to ensure a comfortable future as inflation will eat away at any returns you make. Historically, investing (meaning adopting a long-term strategy and sticking with it) in the stock market outperforms most other forms of investment, with average returns of around 8% per year, and is an important part of any long-term personal financial strategy.

So, after reading this, you probably think I have it all figured out. Well, you’re right, but not entirely! In addition to the basic concepts listed at the top of this page, if there is one thing I would like you to take away from this article, it is that planning for your financial future is an ongoing process and it does have its ups and downs. The important thing is to never throw the baby out with the bath water. Life is unpredictable. If you get off track, simply revise your plan and make the necessary adjustments. Never lose sight of your end goals, even when you experience financial setbacks.

My own story

My own story started around ten years ago. I was just out of grad school, flat broke (I had about $300 in cash to my name) and up to my ears in student loan and credit card debt (around $30K). When I got married in 1998, my husband was just out of the army and was unemployed and I was working as a teacher. We had a potluck wedding and took a bus to our honeymoon destination! Things have turned around quite a bit since then. Through careful planning, we were able to pay off my debt, set up an emergency fund, and start saving for retirement. We were also able to buy our own home and invest in a second rental property. But today it is time to reassess. After some unexpected expenses this year, our emergency fund is practically at zero. Most of our savings are now tied up in high-risk investments made on the spur of the moment for immediate tax relief (Oops, I hadn’t anticipated the whopping income tax payments in France...time to revise my plan) or other investments that are locked in for ten years with huge penalties for early withdrawal. Right now I find myself coming up short at the end of the month without a lot of maneuvering room. So, it is time to get back to basics, rebuild our emergency fund, start living within a budget again, and start putting money aside on a regular basis rather than throwing huge chunks into risky investments on a whim. In short, it is time to re-deversify my investments. These days I am not feeling very good about my financial situation, and, like many people, when I am feeling stressed about money, I have to resist the urge to spend even more (that faulty logic that a new pair of shoes or that new set of golf clubs—or whatever it is that men buy on impulse—will somehow make me feel better…many of us have been there before!).

If this story has a moral, then it is if I can do it, then anyone can. It is just a matter of getting informed, getting started, and sticking with your plan—or revising it after a setback.

If you would like to give me feedback—positive or negative—on this article or share your own financial challenges or success stories, please respond in the associated thread (discuss) or contact me through my profile on Proz.com.