3 Financial Planning Lessons for Freelancers
Thanks to the feast-or-famine nature of their income, freelancers really need to be smarter savers than the average working Malaysian. So, what are the 3 financial planning mistakes freelancers commonly make that affect their retirement nest egg?
1. Thinking that it is still early, therefore they can do it later.
In fact, everyone should start saving as soon as possible; the earlier the better to take advantage of the power of compound interest.
If person (A), who is 30 years old, contributes RM 15,979 a year (RM 1,332) a month to an investment that is able to generate a net yield of 8% p.a, 10 years later A would have accumulated a retirement principal of about RM 250,000. By letting the same principal stay invested and assuming the same yield to the portfolio, by the time this person is 60 years old, A would have a retirement fund about RM 1,165,239.
Compare this to person (B) who decided that 30 years is too early to start saving but chose to do it at age 40. So B would have a retirement principal of zero at 40 years, as opposed to A who has RM 250,000. By investing the same amount of money in the same investment vehicle as A, by the time B is 60 years old, he will only have about RM789,729. This has a difference of about RM 375, 510. Including the additional contribution of 10 years, the total additional capital is RM 159,790, and this means the total cost of delay is RM 375,510 + RM 159,790 = RM 535,300, about RM 53,530 for each year of delay!
2. Thinking that they can start to save after their income becomes more stable or higher.
The fact is, no matter how much a freelancer earns in a particular month, she should practice paying a fixed salary to herself, and practice to automate the effort to save regularly via standing instructions to transfer the savings amount to another bank account that is not being used for daily expenses. When we pay a fixed salary to ourselves, the additional income that flows in at that particular month will serve as a surplus to the business so that you can utilise it to expand the business or keep it for a rainy day. This will also help to build a habit to live based on a fixed ‘salary’, and help contain your cash flow situation.
3. Spending Based On Your Best Month
As your freelance business becomes more established, you'll start spending more to match your higher income. This can become a real problem as it's always easier to upscale your lifestyle rather than the opposite. To prevent spending based on your best month or year's earnings, have a look at the past two years and pinpoint your worst month. This should be the month to base your average spending on so that you won't go into debt should your income suffer a dip. If your earning are more, keep it in your emergency fund to tide you over lesser income months.
Working with inconsistent income can be a blessing or it can also be a recipe for financial disaster. It can allow you to have good months where you can up your spending and follow your heart to buy the things you'd like to have, or even to clear your debt, or to put down the down payment you need for your dream house. However, there are months that your income may even go below the line (your lifestyle and financial commitment line). When this happen, it can cause you to be troubled by emotion, taking away your best creativity.
Through out my experience working with people who have inconsistent income or who are self-employed, we have managed to help them get over this bump, and on their way to build their dreams the way they'd like it to be, and live their best life.
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