Did you know that the word “freelance” was coined by the writer Sir Walter Scott to refer to the knights who used to roam the countryside in the Middle Ages?
They owed no allegiance to any particular lord, but were free to wield their
lance for whoever paid the most gold.
I think it’s appropriate. Today’s freelancers enjoy similar freedom, and similar insecurity. It’s unlikely that we’ll ever get impaled on someone else’s lance, but there are plenty of other risks that can knock us off course, from bad clients to a bad economy to an unexpected medical bill.
In a previous tutorial I showed you how to budget effectively in this precarious freelance existence. But to have financial freedom and security, you need to do more than just keep track of your spending. You need to save for the future, building up enough of a nest egg to cover major expenses, living costs, and your eventual retirement.
So today you’ll learn how to save and invest for the future. You’ll learn what to do first—save or pay down debt—and how to prioritize different saving goals after that. I’ll also talk about investing for the long term and building a balanced portfolio of investments.
I’ll start with the most immediate, urgent priorities, and move to more long-term investment later on. So if you’ve already got the basics covered, feel free to skip ahead. But if you’re struggling to keep your head above water, start with step 1.
1. Build Up an Emergency Fund
If you’ve followed the steps from the budgeting tutorial, you should have trimmed your expenses down to the point where you have a small surplus each month. So how do you allocate that?
The very first thing to do is to build up an emergency fund. I’m talking a lot about planning and predicting in these tutorials, but unexpected stuff always happens. You’ve prepared your budget carefully and stuck to it rigidly, but then the car needs repairing, or you lose your biggest client and can’t find new assignments.
The danger is that these unexpected things knock you off course, blow your budget, and you rely on that popular 21st-century safety net: the credit card. You figure you’ll pay it off when you get the chance, but the chance never comes, and soon you’re paying 20% interest on a balance that never seems to get smaller. Not smart. (If you’re in this situation, there’s more on debt in the next section.)
The purpose of the emergency fund is to save you from using the credit card for anything other than regular purchases that are within your budget, so that you can pay off the balance each month.
How Much of an Emergency Fund Do You Need?
The general advice is six months of basic living expenses, but that’s just a rule of thumb, and you need to consider your own personal situation. Freelance income is often less secure than salaried employment, so you may need more.
Ask yourself: How secure do you feel about your income? How likely is it that you’ll go for a few months without being able to get work?
If you’re relying on one-off freelance gigs, or dependent on one big client for the majority of your work, then your income is pretty unstable and you’ll probably need a bigger than average emergency fund—up to a year of basic expenses.
But if you have a diversified set of six or more regular clients, you could even be better off than your salaried friends. If you lose one client, you’ve still got five more to pick up the slack. So your emergency fund could be smaller—perhaps three months.
Also consider other aspects of your life. Can you rely on a spouse, parents or anyone else to help you out if things go south? Or might they be relying on you? Do you have good insurance for sickness, property damage and the like, or could those major expenses derail you? Do you have an old car that may need replacing, or a house that needs repairs and maintenance? All those things and more can affect how much you need to save.
How to Set It Up
It’s good to open a separate account for this money, so that it’s separate from your day-to-day spending. Try to find an account that pays interest, giving a little boost to your savings, but make sure that it allows instant withdrawals with no penalty. This is money you may need to access immediately.
Choose an amount you can afford, and set up an automatic transfer from your checking account each month, so that you commit to saving that amount each month, and build up the habit of saving.
If you’re struggling to get by from job to job, building up the kind of emergency fund I’m talking about may seem impossible. But keep in mind that we’re only talking about basic living expenses here. In a true emergency, you’d cut back on a lot of the things you currently spend money on. So just calculate how much you’d need to keep food on the table, a roof over your head, and the creditors and tax authorities from your door.
And don’t feel you have to reach your goal immediately. If you’ve decided you need a $5,000 emergency fund, for example, but can only save a couple of hundred bucks each month, that’s fine. Just start paying in the money each month, and in about two years (barring emergencies) you’ll have reached your goal.
2. Pay Off High-Interest Debt
If your “emergency fund” up to now has been your credit card, it’s important to deal with that as soon as possible. I’ve put it second on the list, but if you have large amounts of credit-card debt or other loans on which you’re paying more than 10% interest, you could do it at the same time as building up an emergency fund.
For example, if your budget allows you a $200 surplus each month, you could allocate $100 to building up your emergency fund and $100 to paying down debt. Pick the amounts that make sense for you. And keep in mind that paying down debt will only work if you address the behavior that built up those balances in the first place. Read the budgeting tutorial if you haven’t already.
If you have several different cards or loans, don’t pay them all off at the same rate. Instead, rank them in order of the interest rate you’re paying. You should be able to find the interest rate or APR on your statements, but call your loan provider if you’re not sure.
Start with the loan with the highest interest rate, and attack that one, while just paying the minimum amount on all the others. When you’ve got that first balance paid off, move to the next one on the list, and keep moving down through the list, from the highest interest rates to the lowest.
One final point: this section was called “Pay Off High-Interest Debt” for a reason. It really is the high-interest debt that’s the priority here: the credit cards or payday loans or other balances on which you’re paying 10% or more.
If you have loans on which you’re paying a low interest rate, such as a mortgage or student loan at 3% or 4% interest, don’t allocate extra money to paying them off right now—just pay the minimum amount. Of course you want to pay off all your debts, but you have bigger priorities first.
3. Plan for Retirement
If you’re in your twenties or thirties, retirement is a long way away, and probably doesn’t seem like a priority.
But here’s the thing: retirement is really expensive.
Think about how difficult it was to build up that emergency fund with six months of basic living expenses. Now think about building up a fund that will allow you to live for perhaps 20 or 30 years, or even more, without working. And consider that now we’re not talking about basic living expenses—we’re talking about living a good, full life. And in that time you may have severe health problems or need constant care. And in many countries, governments are cutting back on state pension provision.
Get the picture? If you don’t start early, you simply won’t have time to build up the kind of money you need.
Set Up Regular Contributions
So as soon as you’ve got your emergency fund built up to a point where you feel comfortable and have paid down those high-interest debts, start allocating money to a retirement plan. Depending on your situation, you may even want to start retirement saving in parallel with steps 1 and 2.
Many countries have special accounts you can open to save for retirement, allowing you to access tax breaks and other incentives. These can have a powerful effect on your savings, because you’re saving for the long term so the benefits are compounded for decades. The details vary widely, so research the options in your country, and make sure you’re taking full advantage of all the tax incentives on offer.
There are lots of online calculators you can use to check whether you’re on track to survive retirement. Here’s one from MarketWatch, for example. Just input all your data and see if you’re saving enough, or if your money will run out at some point. Keep upping your retirement contributions until you’re confident that you’re on track.
Allocate Your Investments
You may find yourself with lots of choices of how to invest your money. How do you do that? We can start to take a different approach now.
With the emergency fund, we stuck to a safe, instant-access bank account, because it was money we needed to access immediately. But when you’re saving for longer-term goals, you can afford to take more risks in an attempt to boost your returns and reach those goals more quickly.
For example, if you’re 35 right now, you’re saving for a goal that's 30 years in the future. So it makes sense to allocate some of your money to stocks and bonds. Yes, there’s a risk of losing money in the short term, but you’ve got plenty of time to make it back. Stocks and bonds have beaten the returns of bank accounts in most periods of ten years or more.
In general, stocks (also known as “equity” or “shares”) have provided the best long-term performance, but are the most risky. Check out this page from Vanguard. It shows you different mixes of stocks and bonds, and how they would have performed in the U.S. for the period from 1926 to 2014.
As you can see, a portfolio of 100% bonds provided the lowest average annual return (5.5%), but had fewer and smaller losses. Adding more stocks boosts the annual return, but also increases the risk. Investing everything in stocks provides the highest return (10.2%), but you’d have had to stomach losses in 25 of the 89 years.
So keep that in mind as you allocate your money. More stocks are generally good for long-term returns, but can lead to severe short-term losses. The most important thing is to diversify, using broad funds rather than individual stocks or bonds, and investing in funds that cover different parts of the world as well.
4. Take Advantage of Tax Incentives
I mentioned tax incentives in the section on retirement, but there are often other tax breaks available when it comes to saving and investing. Your next step, after getting your retirement sorted out, is to research these.
In the UK, for example, an Individual Savings Account (ISA) allows you to save up to £15,240 a year completely tax-free. And you also get to choose whether to allocate that money to a simple savings account or to invest it in the stock market.
I won’t say too much about these tax breaks because they’re so country-specific. But the point is that it’s a no-brainer to let the government boost your savings, especially when you have a wide range of savings and investments at your disposal.
So this step is simple: research any tax-advantaged accounts you can access, and make sure you’re not letting any opportunities slip by.
5. Save for Specific Goals
Once you’ve taken care of basic survival, paid off debts and started saving for retirement, it’s time to set some other goals.
These are big-ticket items, too big for your emergency fund to cope with. Maybe you want to buy a new house, for example, or save for your kids’ college education. A major trip could also fall into this category—not a regular vacation, but a big, expensive, once-in-a-lifetime kind of journey.
Make a list, estimate the amount you’ll need, and set a target date for accumulating the money. Then start allocating money each month to meet that goal.
As with the retirement, we can afford to take a little risk with these longer-term goals. But they’re not so far away as retirement, so keep the possibility of losses in mind.
For example, if you’re planning that big round-the-world trip ten years from now, you can probably afford to allocate some of that money to stocks and bonds. But as you get closer to the end date, be sure to shift that money back into safer investments, like a simple bank account. You don’t want to be packing your bags for the trip, only for a stock market crash to wipe out half your funds. If you’ll need the money in the next year or two, stay away from anything risky.
If you’ve completed all the steps so far, congratulations! You’re in a better position than most freelancers.
You’ve started to build a solid emergency fund to keep you afloat through periods of no work, late-paying clients and other disasters. You’ve paid off debt, or are in the process of doing so.
You’ve started saving for retirement, and understand some basic principles of asset allocation and diversification. And if you have money left over, you’ve taken advantage of any tax-free savings vehicles available in your country, and have begun saving for specific medium and long-term goals.
All that remains now is to keep updating your goals and monitoring your progress. Make sure that you understand the risks you’re taking in all your investments, and that your asset allocation (the mix of stocks, bonds and other investments) is appropriate for your goals, your timeframe and the amount of risk you’re comfortable with.
And whatever you do, don’t follow the latest investment fad. Keep it simple, keep it well-diversified, keep your fees low, and now that everything is under control, allow yourself to stop worrying about money and get back to doing what you enjoy.