6 Money Moves for the Self-Employed to Achieve Financial Freedom

Financial planning helps design a money management strategy to achieve various financial goals based on your risk appetite, investment horizon, and cash flow.

The income and cash flow dynamics of the self-employed are different from those of employees. The self-employed have lower income certainty than employees. In addition to this, they also have to make their own social security, health and pension arrangements.

Following these financial tips can help self-employed people achieve financial freedom:

1. Establish and maintain an emergency fund sufficient to meet financial demands

Employees are often advised to maintain an emergency fund large enough to meet unavoidable expenses for at least six months. Self-employed people should aim to maintain a relatively larger corpus, at least for nine to twelve months, due to greater income uncertainty. Without an adequate emergency fund in place, any unforeseen financial emergency may force you to resort to more expensive loans or liquidate investments for critical financial purposes.

Park your emergency fund in highly liquid instruments like high-yield savings accounts or high-yield fixed deposit accounts to ensure instant access.

2. Purchase adequate term insurance to serve as replacement income for your dependents

The main purpose of purchasing a life insurance policy is to provide replacement income for your dependents in the event of your unfortunate passing away. You should ideally purchase life insurance coverage equivalent to at least 15 times your annual income. The best instrument to purchase such important coverages at a lower cost is a term insurance plan. A term plan will not only help your family meet day-to-day expenses, but also meet crucial financial goals like your child’s college education or wedding expenses.

3. Buy an adequate health insurance policy to meet rising medical costs

The sharp increase in private sector medical expenditure highlights the importance of purchasing an adequate health insurance policy. Without health insurance coverage, a single incident of hospitalization can jeopardize your life savings. In addition, since the self-employed do not have collective employer health insurance contracts unlike their salaried counterparts, the purchase of adequate health cover becomes all the more important for them. Self-employed people should purchase floating family plans to cover themselves, their parents, spouse and wards at a much lower premium.

4. Create a financial plan to achieve your crucial financial goals

Financial planning helps design a money management strategy to achieve various financial goals based on your risk appetite, investment horizon, and cash flow. In addition to providing direction for your investments, financial planning also helps implement an appropriate asset allocation strategy for your investment.

Self-employed individuals must first estimate the amount needed to achieve each of their crucial financial goals, an assumed rate of return, an assumed rate of inflation, and the remaining investment horizon to achieve those goals. They must then use SIP calculators to estimate the monthly investments needed to meet those financial goals.

5. Start investing early to reach your post-retirement capital

The absence of employee provident funds (EPF) and other retirement benefits makes it important for the self-employed to build their own post-retirement corpus. However, most investors, especially younger ones, generally tend to put off investing for their post-retirement life. Instead, they prioritize more immediate financial goals like accumulating funds for vacations, arranging a down payment for a home loan or auto loan, etc. to build a sufficient corpus in a shorter period of time.

Start the process by using online retirement calculators to determine the monthly contributions needed to build a retirement corpus. Since retirement planning is a long-term financial goal that spans more than a decade, start investing your monthly contribution in equity funds through SIP. Since equities are an asset class, they can significantly beat fixed income instruments and other asset classes over the long term. Once you are 2 or 3 years away from your retirement age, estimate your expected monthly expenses after retirement. Then activate the Systematic Transfer Plan (STP) in the equity funds to automatically transfer the amount into the debt funds at monthly intervals. This will consolidate your capital gains from equity funds and reduce market risk to your retirement corpus while leaving you with enough equity exposure for the future growth and longevity of your retirement corpus.

6. Use a credit card to build your credit score

Those with a credit score of 750 and above are more likely to get approved for a loan and a credit card. Many lenders have also started offering preferential interest rates to those with higher credit scores. Since there can’t be a credit score without having a credit history, self-employed people with no credit history can establish their credit score by using their credit cards in a disciplined manner. Credit card transactions are similar to available loans and are therefore reported to the credit bureaus. The credit bureaus use these transactions to calculate your credit score.

Self-employed people whose credit cards have been declined due to insufficient income, unusable locations, etc. can use secured credit cards to establish their credit score.

(By Gaurav Aggarwal, Senior Manager, Paisabazaar.com)

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Sara R. Cicero