Freelancers face very different financial circumstances than salaried employees do. There is no guaranteed regular paycheck that comes every two weeks. Instead, the payments you receive depend on how much work you did and when you finished it. And despite all the advantages of being a freelancer, these erratic pay schedules can make it difficult to follow a consistent investment program.
Lifecycle Funds: The 80% Solution
In his book I Will Teach You To Be Rich, Ramit Sethi explains that most people are so distracted by minutiae (interest rates, stocks vs. bonds, inflation, etc.) that they never actually take the first step and invest in something. As a result, all of their preoccupation with little details generates no action whatsoever. Freelancers are no exception – when you’re always up against a deadline, you may not have time to become an investment expert.
The good news: you don’t have to be. Instead, you can invest in what’s called a lifecycle fund. Very simply, a lifecycle fund automatically spreads your money across various investments according to specific goals you specify in the beginning: for example, when you plan to retire, how old you are and how comfortable you are with risk.
Ramit calls this “the 80% solution” because in a single step, you get 80% of the way toward the “perfect” investment plan other people spend their whole lives chasing.
Freelancers can also get an investing edge by using a Solo 401(k) account for retirement. Standard employees cannot use these, but you can, and here’s why you should. According to the Wall Street Journal:
“…with a solo 401(k) or solo Roth 401(k), for 2009 and 2010 you can put into the plan 100% of your first $16,500 in income from the business (or $22,000, if 50 or older), plus 20% of net profit, until you max out contributions at $49,000 (or $54,500, if you are 50 or older).”
Compare that to a typical 401(k) account offered by a corporate employer (or Roth IRA) which restricts you to putting away around $5,000. Also keep in mind that you are not limited to just putting money away – you can actually invest through your Solo 401(k) in just about anything, making it an even sweeter deal for freelancers to consider.
Want to add even more fuel to your lifecycle fund? Use automation. Rather than relying on your own willpower to put money into your investments each month, just set up a quick monthly transfer. Alternatively, save a percentage of each payment you receive as they come in as. After all, not all freelancers can count on a guaranteed check coming in each month.
Simple. While you don’t have an exact assured minimum, you probably do have a six months to a year or more of previous income history. Look at how much you’ve made for each of the last six months. Then, just set your monthly investment transfer to the lowest amount that you A) are comfortable putting aside, and B) could easily pay no matter how low your monthly income is. Your income history should tell you quite clearly what this amount should be.
Invest Tax Payments
As a freelancer, you are most likely what the IRS defines as an “independent contractor.” In a nutshell, this means that you are not an employee of your clients, not one of their employees. As such, you are responsible for providing your own work space, tools, health insurance and, of course, tax payments. And it is here that being a freelancer provides you with a potential financial advantage.
This means that taxes are not withheld from your pay and sent straight to the IRS. Instead, you are responsible for setting that money aside and paying it either quarterly or at the end of the year. That means, in theory, that nothing stops you from putting the cash into investments while you’re still holding it. (Of course, keep in mind that if you lose that money, you still owe it to the IRS.)
“Aggressive” Tax Avoidance
Another way freelancers can maximize their investment portfolio is by practicing “aggressive” tax avoidance. Don’t worry, the name is just a hook – by “aggressive”, we don’t mean illegal, stupid or foolish. Instead, it simply means structuring your finances so that you do not pay one extra cent in taxes than the law says you have to. And then, for our purposes, re-allocating that money to investments.
For freelancers, this mainly comes down to maximizing their deductions. Because you are an independent contractor, you are eligible to write off anything that is a “reasonable business expense” including office supplies, work-related travel, inventory, advertising, etc. That means keeping all your receipts. For minimum hassle, gather up all your receipts into an envelope and send them to a service like Shoeboxed.com that will automatically scan and organize them for you at tax time.