I’m Self-Employed. How Do I Start Investing?

September 03, 2019

If you’re self-employed, you’re in charge of building and sustaining your financial independence. Investing can play an important role as you grow your business and plan for your future.

According to a 2019 report on self-employment in America, 24 million Americans want to leave traditional employment to become their own boss by 2021. In that same study, though, 35% said they’re also worried about inconsistent income, and 27% about earning less money.

So, as more of us consider making the leap to self-employment, it’s important to understand how investing can help offset those anxieties and prepare us to pursue our goals.

If you’re self-employed or freelancing, you’re in charge of building and sustaining your financial independence. Investing can play an important role as you grow your business and plan for your future.

In the past, if you worked for an employer, you may have looked to them to provide some sort of financial security for your career and retirement. However, being self-employed, you must provide your own financial buffer. This is where investing may come into play as a helpful way to reach your goals and prepare for the years ahead.

Whether you’re running a side hustle or are already freelancing full-time, investing may make sense for you. Here’s why, and how to get started.

I’m Self-Employed. Why Should I Invest?

Think of a goal, something you’ve been dreaming about for a while. Maybe it’s a personal goal like taking a vacation or owning your own home. Maybe it’s something for your business, like a new office space or equipment. Whatever you’ve been dreaming of having enough money to be able to afford, investing may help you achieve it.

Now, think even further into the future. How do you picture retirement? Investing typically plays a key role in building enough savings to sustain yourself when you stop working.

Why is that? Investing can be more powerful than saving alone. A typical savings account earns around 1% in interest, and even a high-yield savings account usually only earns around 2%. Investing, on the other hand, gives your money the possibility of earning returns based on the performance of the market, which can be much higher over time. While investing involves more risk and returns are never guaranteed, investing is an opportunity to make the most out of your money and help you reach your goals.

Not to mention, you don’t have to be ultra-wealthy to open an investment account. What’s important is to start somewhere.

I’m Self-Employed. How Do I Start Investing?

To start investing is simple, but first things first: Before you open an investment account, you should always make sure to have a fully funded emergency savings account. Typically, it’s recommended to have at least three months’ worth of expenses covered in emergency savings. This ensures you’ll have financial security in case of the unexpected, like a home repair or medical bill. Once you’ve established your emergency fund, you’re ready to invest.

You can open an investment account and start investing with however much you want, whether you have $50, $500, or more! Whatever you start with, look at your savings, income, and expenses to come up with an amount to invest that fits with your budget. Once you’ve funded your account, what’s important going forward is to continue to make regular deposits into your investment account. How much and how often “regular” contributions are will be different for everyone.

For example, if you’re freelancing, your income may vary from month to month. So, because your monthly income can change, investing a specific dollar amount on a regular basis might not work for your situation. Instead, you might want to deposit a specific percentage of your take-home earnings from each contract you sign or job you complete. Just like you looked at your income and expenses when opening your investment account, you should think about your cash flow when establishing what a “regular” investing strategy looks like for you. Having a strategy that’s already factored into your cost of living will help you make investing a smart habit.

If your income is pretty stable, making automated recurring deposits into your account is an easier way to work investing regularly into your budget. It holds you accountable for investing, while also making sure you don’t put away more than what’s within your means.

There are many places you can go to open an account when you’re ready to start investing. You can go directly to a financial institution, you can go online, or you can go to an advisor who will handle the account opening for you. If you’re self-employed, it’s probably safe to assume you lead a busy lifestyle. Depending on how much time you have to do research and how hands-on you want to be with your investments, you may find an online or mobile platform is an ideal option. These types of accounts tend to have streamlined account opening experiences, and many will help select your investments and then automatically manage them for you.

I’m Self-Employed. Which Type of Investment Account is Right for Me?

When it comes to choosing what type of investment account you open, you have a lot of options. Don’t worry! Depending on your goals, there are certain investment accounts that have advantages over others, making it easier to choose which is right for you.

Retirement Accounts

If you’re investing for retirement as a self-employed freelancer, you’ll have a few options. The first is an Individual Retirement Account, better known as an IRA. There are two common types of IRAs, traditional and Roth.

A traditional IRA is what’s called a “pre-tax” account, meaning you contribute pre-tax money into the account and pay ordinary income taxes on it when you withdraw the funds. Because you’re contributing pre-tax, the contributions are tax-deductible.

A Roth IRA is an “after-tax” account, so you contribute after-tax money and then don’t have to pay income tax when you withdraw the funds in retirement. This would be a benefit if you expect to be in a higher tax bracket once you retire.

One possible strategy is to have both traditional and Roth investments, so you have the advantage of your tax payments being varied across your different accounts. Both traditional and Roth IRAs have an annual contribution limit of $6,000 (for 2019) and the benefit of tax-deferred growth, meaning you don’t pay taxes on earnings in your account until you withdraw the funds.

Another investment option for retirement if you’re self-employed or freelancing is a SEP IRA. This works like a traditional IRA and has similar tax benefits, but it allows significantly higher contribution limits. For 2019, the annual contribution limit is the lesser of 25% of your taxable income or $56,000. This higher limit simply gives you the opportunity to have more money in the market to save for your future.

There’s also a retirement account option, unique to those who are self-employed or freelancing, called a solo 401(k) plan, sometimes referred to as an individual 401(k). This is comparable to a 401(k) plan you would have through an employer. It has both traditional and Roth account options and growth is tax-deferred until withdrawal. It also has the same contribution limit as a SEP IRA, the lesser of 25% of your taxable income or $56,000 for 2019. One distinctive benefit of a solo 401(k) plan compared to IRA options is that it allows you to take a loan from the account. Depending on the features of your plan, there may be certain penalties and restrictions to taking out a loan, but if you’re self-employed, the ability to do so may be an advantage.

Having a SEP IRA or solo 401(k) is often used as a supplement to a traditional or Roth IRA because of their higher contribution limits.

Note that all of these retirement accounts have early withdrawal fees and a number of other unique characteristics based on income, age, etc., that will be outlined in the specific account’s fine print. Don’t skip this step! Before choosing your account, it’s important to read all the details and have an in-depth understanding of each account type. When in doubt, consult a trusted financial professional if you’re still unsure which retirement investment account is right for you.

Personal Investment Accounts

If you’re saving for a goal other than retirement, you can open a personal investment account. Anyone can have a personal investment account with no contribution limits, and it can be used for any goal you have, whether it’s future business expenses, a new home, or a dream trip.

While there aren’t any unique tax-advantages of a personal investment account, “you can deduct your short-term losses from your short-term gains and your long-term losses from your long-term gains, to reduce the amount on which potential tax may be due,” says Misty Lynch, CFP®, Head of Financial Planning at John Hancock. “You may be able to deduct up to $3,000 in accumulated losses from your ordinary income and carry forward losses you can’t use in one tax year to deduct in the next tax year.” So, depending on the performance of your investments, your personal investment account may provide a bit of a buffer, tax-wise.

Just like retirement accounts, personal investment accounts have a variety of fine print details and tax considerations you need to look at closely. Whenever you invest, make sure you understand all the tax implications and how your account choice fits into your greater financial plan.

With a personal investment account, you can also opt to invest consciously and align your investments with your values. By investing this way, such as with COIN’s conscious investing platform, your investments go toward companies that are making a difference in the causes you care about, and not the ones that don’t.

I’m Self Employed. How Much Risk Can I Take On?

Just like choosing the type of investment account, you can use your goals to help you decide what to invest in. There are many different investment options and the ones you choose will be based on two key factors: when you want to reach your goals and your risk tolerance.

If you’re investing for a short-term goal, typically you want to hold less-risky investments. This is because you’ll need to access the money sooner, and therefore can’t risk a loss if the stock market takes a downturn. If you’re investing for the long term, you can afford more exposure to risk because you don’t plan on needing to use the funds in your account for a long time and, as a result, will be leaving them in the market.

Simply put, the longer you’re planning to invest, the more risk you may be able take on. You can also adjust the risk levels of your investments as you get closer to your goal and near the date of using your funds.

For example, if you’re saving to move into a new office space in five years, you may start with an investment portfolio that includes more stocks, which are generally considered a riskier investment than bonds. As the date of moving into the new office gets closer, you can adjust your portfolio to include more investments that are considered less risky, such as highly rated corporate or government bonds. What’s important is to always have a diverse portfolio of investments and to re-allocate them when necessary based on changes in the stock market, your goals, and your risk tolerance.

While making an investment and taking on any risk can be intimidating, it’s important to understand the power of investing and in particular, investing early. When you invest, you expose your money to the market and give it the possibility to grow beyond your contributions. The longer it’s invested, the more time it has to take advantage of movement in the market. Investing what you can early and keeping it in the market for years is a slow and steady way to plan for your future.

If you’re considering self-employment, or are already enjoying the freedom, flexibility, and control of being your own boss, consider investing. It can help you reach both your short- and long-term goals, whatever they may be. Additionally, as a self-employed worker, you may find saving and investing provides peace of mind during the years when your income varies.

You’re already doing a lot to build your business. Make your plan even stronger by using investing to build your financial future.