Don't worry about volatile, erratic cash flows, freelancers.
Vishal Dhawan explains how you can invest and achieve your financial goals despite irregular income.
Over the past few years, both globally as well as in India, there has been a significant expansion of the gig economy, which refers essentially to the creation of flexible jobs using freelancers, part-time, temporary or short-term contract employees, instead of full-time employees.
Since the cash flows of gig workers tend to be more irregular and lumpy, they need to plan their finances differently from regular, full-time workers.
Employer-employee needs driving the shift
About one third of the US working population today is in some way a part of the gig economy.
India, too, now has among the largest gig economies in the world.
Multiple factors have led to the growth of the gig economy. One is the development of the \Internet that allows people to work remotely.
Workers also desire greater flexibility regarding where they work from, when they work, and whom they work for.
Employers, on their part, increasingly depend on freelancers to deal with temporary increases in workload.
Traffic-related challenges in large cities across the world, low-quality public transportation, and parking woes mean that freelancers can have greater work-life balance, if they manage their freelance assignments in a disciplined manner.
Employers can manage with less office space, a significant cost for most businesses.
For all these reasons, it appears that the gig economy is here to stay, more so as the demands for different types of skills undergo a change in the new economy and learning, unlearning and relearning becomes the norm.
Uncertain cash flow is a challenge
While freelancing has definitely become very popular and very aspirational for many people looking to escape the traditional nine-to-five job, it also poses many challenges.
One of the biggest is finding ongoing sources of professional income.
A large number of assignments are created outside India.
Marketing one's services and expertise is not simple, though there are multiple platforms that one can list on.
Since there is only so much work that an individual can handle at one time, there could be peaks and troughs in work load.
There could be periods when a freelancer must decline work, and other times when work may not be available even though the freelancer is ready for it.
This can result in uncertainty of cash flows in the gig economy as compared to traditional jobs that offer a significant level of fixed compensation which comes on time every month.
A flexible job is, therefore, less of a job in the traditional sense and is more of a solo venture or a small business, with similarity to how professionals like doctors and architects earn.
Since cash flows are likely to be erratic, both financial planning and cash flow planning need to be significantly different for such workers, depending on their family structure and number of financial dependants.
Budget and track expenses closely
Since freelancers enjoy a lot of flexibility regarding time, there is always the risk that the additional free time could result in higher expenses, especially discretionary spends. Expenses could shoot out of control due to this.
Having a fixed budget for discretionary spends is, therefore, very critical.
Such spending should also be monitored very carefully, especially as there could be a tendency to splurge when money comes in as a lump sum for a project, either as advance or after its completion.
Hence, freelancers should create a separate budget for fixed expenses and discretionary spends, and then track both.
One of the simplest ways to do so is to have a separate bank account for expenses, so that any spillover from the budgeted amount becomes evident as one will have to dip into another account, or redeem some investments to cover these expenses.
Build a robust contingency fund
Since cash flows can be rather erratic, freelance workers must have adequate contingency funds to tide over times when cash flows are low or even zero.
Ideally, such workers should keep aside about twelve months of expenses, including EMIs, for emergencies.
This can be halved if there is a spouse with a steady source of income, or if there are no financial dependants.
Adequate insurance is critical
As a freelancer, you can't depend on paid sick leaves, or company health cover.
You should, therefore, buy adequate health insurance and critical illness cover.
You should also buy adequate life cover to help support situations that have not been planned for.
You may also need to enhance the life cover of your spouse, if the latter has a more predictable income.
Buying adequate health insurance for the immediate family as well as other dependants like dependent parents, parents-in-law, siblings, and children will ensure that your finances are less exposed.
Review your financial goals
By being a part of the gig economy, the way you work may change, but many of your financial goals will remain the same.
A good education for your children, whether in India or overseas, will still need to be supported, along with retirement, and asset purchases like house or car (or car replacements).
It is important to ensure that there is continued focus on these financial goals even as a freelancer, and adequate money is set aside for achieving them.
Put in place a flexible investment strategy
Volatile cash flows could mean that a freelance worker may have more frequent need to draw down money from his assets.
Hence, such a worker needs to opt for investments that are more flexible and liquid.
A savings-oriented insurance plan that requires commitment for longer periods of time and offers low liquidity will not be a good option for such workers. Look for investment options where you can stop contributing if needed, and restart when able.
Systematic Investment Plans (SIPs) of mutual funds, for example, may be a good idea, or even Systematic Transfer Plans (STPs) wherein the money is invested in a lump sum and then gets invested into equity or balanced funds.
While freelance workers may invest in equity or balanced funds, they should keep only long-term money in such funds, as equities are not suited for parking money that could be required in the short term.
Instruments like Public Provident Fund (PPF) are good in terms of tax efficiency, but have a lock in that may not work from a liquidity perspective.
Ultimately, flexibility in your job means that you must have a higher level of flexibility in your finances as well.
Vishal Dhawan is founder of Plan Ahead Wealth Advisors, a Sebi-registered investment advisory firm
Photograph: Kind courtesy pixabay.com
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