Like with any life changing decision, there are pros and cons to the decision to work for yourself. One such con is the responsibility to handle your retirement by yourself. If you aren’t careful as a freelancer you could be setting yourself up for financial ruin later on down the road. The burden of establishing your retirement fund rests entirely on your shoulders. In this post I hope to offer insight into different retirement planning options that can establish a safe financial future for freelancers in any industry.
1. Save Early
The most important thing to keep in mind when planning for retirement is that the earlier you start saving money, the more comfortable your retirement will be. You should begin making contributions to your retirement as soon as possible so more interest can accrue. In order for me to illustrate the importance of starting early let me give an example:
Freelancer A and Freelancer B are both 20 years old and make $55,000 per year. Freelancer A read this article and decided to start making contributions of $5,000 per year to his retirement fund starting that year. Freelancer B unfortunately did not read this article and bought a car instead. Five years later, B decides he should probably start contributing to retirement, at $6,500 per year. They both want to retire at age 65, and can both secure interest rates of 5%. By age 65, A has $798,500.78 saved up, whereas B only has $785,198.53. Notice how Freelancer B tried to compensate for missing those five years of saving by increasing his annual contribution by $1,500 each year and still came up short compared to A? Interest adds up fast.
2. Save and Don’t Spend
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The next tip may seem obvious, but watch your spending. Mint.com has received a lot of good press, and that’s for a reason. Seeing how you are spending your money graphically can really help you see just how much money you are wasting. I was taking a look at where I was spending money, and I used to spend way too much money on coffee and restaurants. It’s incredible how much money you can add to your retirement fund if you cut out impulse buys and other unnecessary spending. Let me provide an example:
If a freelancer really likes Subway and eats a $5.00 sandwich there three times a week and also loves Starbucks and gets a $4.00 cup of coffee there three times a week , that adds up to $27.00 per week, or $1404.00 per year. Now imagine if this hardworking freelancer only ate out and had coffee once per week instead; the freelancer only spends $468.00 for an annual saving of $936.00. Again, with a 5% interest rate over 45 years, if that $936.00 is put to your retirement fund each year it comes out to $149,479.35 by retirement age, and that is no chump change.
Ultimately, there’s two ways to spend money. Investing it or wasting it. Live within your means, and invest in your future. Don’t waste money on things you don’t need, except for on occasion. That said, be sure to reward yourself a little bit if you land a huge contract or accomplish something big; it’s good for morale.
3. Choose Investments Wisely
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In order to actually accumulate interest on the money you put aside for retirement, you will need to invest it. There are a wide variety of investment opportunities available to freelancers, and they can be as conservative or risky as you’d like. As with anything else in life, higher risk investments have potential to yield much greater returns in comparison to conservative investments, but are you willing to stake your retirement on an investment? I’m not the person to answer that. The decision is yours. Here are some options you have for retirement investing:
IRAs (Individual Retirement Accounts) are often misunderstood. IRAs should be thought of as a collective investment account for retirement. Essentially once your money is in your IRA, you can invest it however you’d like. This includes stocks, mutual funds, CDs, annuities, and bonds among others. The IRA is basically an umbrella account that decides how your investments will be taxed. There are different types of IRAs available, and it is up to each individual to decide the best option for their circumstances. Here are a few options:
The Traditional IRA:
The Traditional IRA allows you to defer taxes on payments made into the IRA until you withdraw the money when you retire.
The Roth IRA:
The Roth IRA is another type of retirement account, but instead of paying taxes upon withdrawal, you pay taxes on your contribution.
The SEP (Simplified Employee Pension) IRA:
The SEP IRA is great for freelancers, because it is a retirement plan that works for self-employed people. It allows your business accounts to make pre-tax contributions to your personal retirement account. You as an individual cannot make contributions personally, however. Of course, taxes will have to be paid upon withdrawal. These accounts are often used to supplement either a Roth or Traditional IRA.
Now that I’ve covered three of the main types of IRAs that might interest a freelancer, I will discuss some investment options within the IRAs. Keep in mind; you will want to diversify your investment portfolio to minimize risk. Make different types of investments. Own some long-term stocks, some microcap stocks, and a few CDs (Certificate of Deposits) instead of just a lot of long-term stock investments for example. Don’t put all of your eggs in one basket, because if that basket drops you will have a hard time retiring.
Personal Stock Investing
Stock investing can be very risky if you’re not very familiar with the stock market and how trading works, but don’t let that scare you away. It is worth learning about. Generally, if you decide to invest in mature companies that send shareholders nice dividends, your risk will be significantly lower than if you were to invest in a microcap company in hopes that it will be the next Apple or Google. Whichever route you take, cut losses before they get too big and take profits when you can. Be disciplined and don’t “marry” a stock, or you will lose a lot of money.
One thing I want to caution readers on is a common stock manipulation scheme called a “pump and dump”. Promotion companies are paid by sleazy companies to tout their stock ticker through emails, phone calls, and mailers in order to create more demand. As any economics course will teach you, where there’s more demand and less supply, prices increase. As the prices increase in what is known as the “pump”, insiders and more experienced sell shares as the price per share reaches a peak. With big time selling, the supply goes up and the demand goes down. This is known as the “dump”, and it in turn decreases the share price significantly; sometimes even in a matter of minutes. This causes inexperienced investors to lose all of their initial investment, and leaves them confused. Please do not buy a stock that you read about in an email unless you know exactly what you are doing, even if it looks really appealing. It is almost definitely a scam.
Certificates of Deposit (CDs)
CDs are generally a safe investment to make because they are FDIC insured up to $250,000. With CDs, you put a principal payment down, and a bank offers you a fixed interest rate until the maturity date. At the maturity date you get your initial investment back plus interest. You get to decide when the maturity date is when you make the initial deposit. The longer the term length of the CD you pick, the higher the APY (Annual Percentage Yield) will be. You can withdraw your principal at any time, but you will lose accumulated interest. If you can avoid touching your money, CDs will offer better returns than savings accounts in the long run.
Bonds offer many options, from treasury bonds to corporate bonds; it’s wise you do a lot of research to fully understand the different possibilities. Essentially, a bond is an offering from a company or entity that allows investors to finance a project. It’s like a loan from an investor to a company or entity. Rating agencies help individual investors to decide if a bond investment fits within their risk tolerance. Investors require a higher return for riskier bond purchases, so the riskiest bonds will have the highest yields, but also the highest chance of defaulting.
A mutual fund is a large pool of money collected from many individual investors and managed by professional money managers. The nice thing about mutual funds is that they allow individual investors to gain access to a highly diversified portfolio that is managed by a financial professional, so it can be fairly safe. There are different mutual funds with varying levels of risk, so again, it comes down to how much risk you are willing to take on. There are many funds out there. Some of the more popular ones imitate the major stock indexes, like the Dow Jones Industrial Average, the S&P 500, and NASDAQ. Stock indexes give a close representation of the movement of the entire stock market. Research any mutual fund you are thinking of investing in very carefully, and decide if it fits within your risk tolerance level.
ETFs (Exchange-Traded Funds)
ETFs are securities that are designed to follow an index, but are tradable like a regular stock. ETFs offer great diversification, but they also allow you to short sale, which is essentially betting that a stock will decrease in price instead of increase. Be careful with short sales, as they are very risky. I recommend doing a lot of research on short sales and practicing them with virtual money before actually taking a short position with real money.
4. Establish Goals and Meet Them
Retirement starts with planning. Your first step is to establish how much money you will need to survive after you retire, and then you have to figure out how much money you will need to save each year to reach these goals. Retirement is not something you should procrastinate on. Get on the ball. Plan and contribute early, or you will not have a smooth retirement. Here are some tools I recommend to help plan for retirement and keep track of goals:
Mint.com – Mint is a powerful tool that provides graphs of how your money is spent. It will help you monitor and reduce unnecessary buying. It will also allow you to easily track the balance of your retirement accounts at all times.
– Google Advisor is a nice little page that Google set up to help users easily find the highest interest rates available on CDs and other accounts.
Bankrate.com – Bankrate has calculators to help you decide the amount per year you should contribute to your retirement funds in order to retire with the amount of money you want to have. It would be easier to use the calculators on this site than to try to figure the calculations out by yourself, because Bankrate’s calculators use the most recent rates for its numbers.
Disclaimer: The author is not a financial professional, and you should do your own due diligence while looking into retirement options. Be sure to talk to a professional financial advisor to help plan your retirement. This is not something that should be taken lightly.