The income and cash flow dynamics of self-employed individuals are different from those of salaried individuals. Self-employed individuals have lower income certainty than salaried employees. In addition to this, they also have to make arrangements for social, health and retirement security on their own.
Following these financial tips can help self-employed individuals achieve financial freedom:
1. Build and maintain sufficient emergency fund to cope up with financial exigencies
Salaried individuals are often advised to maintain an emergency fund large enough to meet unavoidable expenses for at least six months. Self-employed individuals should aim at maintaining comparatively larger corpus, at least for nine to twelve months, due to higher income uncertainty. Without an adequate emergency fund in place, any unforeseen financial emergency may force you to avail costlier loans or liquidate investments earmarked for crucial financial goals.
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 act as replacement income for your dependents
The primary purpose of purchasing a life insurance policy is to provide a replacement income to your dependents in the situation of your unfortunate demise. You should ideally purchase a life insurance cover equalling at least 15 times your annual income. The best instrument to purchase such large life covers at lower premium is a term insurance plan. A term plan will not only help your family meet their regular living expenses, but also achieve crucial financial goals like your child’s higher education or marriage expenses.
3. Purchase adequate health insurance policy to meet rising medical costs
Steep rise in private sector medical expenses highlights the importance of purchasing an adequate health insurance policy. Without a health insurance cover, a single incident of hospitalization can risk your life-long savings. Moreover, as the self-employed are devoid of employer group health policies unlike their salaried counterparts, buying an adequate health cover becomes even more important for them. Self-employed individuals should purchase family floater plans to cover themselves, parents, spouse and wards at a much lower premium.
4. Create a financial plan to attain your crucial financial goals
Financial planning helps devise money management strategy for achieving various financial goals depending on your risk appetite, investment horizon and cash flow. Apart from providing a direction to your investments, financial planning also helps in implementing an appropriate asset allocation strategy for your investment.
Self-employed individuals should first estimate the amount required to fulfil each of their crucial financial goals, a presumed rate of returns, an assumed inflation rate and investment horizon left to attain such goals. They should then use SIP calculators for estimating monthly investments required for attaining those financial goals.
5. Start investing early to achieve your post-retirement corpus
Absence of employee provident fund (EPF) and other pension benefits make it important for self-employed individuals to form their own post-retirement corpus. However, most investors, especially the younger ones, usually tend to procrastinate investments for their post-retirement life. Instead, they prioritise more immediate financial goals like accumulating funds for vacations, arranging down payment for home loan or car loan, etc. Avoiding early investment for building retirement corpus would either result in an insufficient corpus or lead to excessive financial strain during later life phase for building sufficient corpus within a shorter time span.
Begin the process by using online retirement calculators to figure out monthly contributions needed for building retirement corpus. As retirement planning is a long-term financial goal that spans over a decade, begin investing your monthly contribution in equity funds through SIPs. Equity being an asset class can beat fixed income instruments and other asset classes by a wide margin over the long term. Once you are 2 to 3 years away from your retirement age, estimate your expected monthly expenditures post-retirement. Then, activate Systematic Transfer Plan (STP) in equity funds to automatically transfer the amount to debt funds at monthly intervals. Doing so will consolidate your capital gains from equity funds and reduce the market risk to your retirement corpus while leaving you with enough equity exposure for future growth and longevity of your retirement corpus.
6. Use credit card to form your credit score
Those having a credit score of 750 and above have higher chances of loan and credit card approval. Many lenders also started offering preferential interest rate to those having a higher credit score. As there cannot be a credit score without having a credit history, self-employed individuals without any credit history can build their credit score by using their credit cards in a disciplined manner. Transactions made through credit cards are similar to availing loans and thus, are reported to the credit bureaus. Credit bureaus use these transactions to calculate your credit score.
Self-employed individuals denied credit cards due to inadequate income, unserviceable locations, etc can avail secured credit cards to build credit score.
(By Gaurav Aggarwal, Senior Director, Paisabazaar.com)