Continuing my series on how to structure your finances as a freelancer it is time to look to emergency funds. If you open any book on personal finance you will discover a section, if not most of the book devoted to this topic. Many writers have covered this topic in far greater depth than I could. But still there are several points to make about the role of an emergency fund as it relates to working as a freelancer which are of great import.
Before I get into the specifics of how this relates to freelancing and our unique needs I should probably explain the concept at a basic level. An emergency fund is a savings account wherein you put money that might be needed immediately in the short term. An example might be a car accident, or major medical problem or job loss. The idea is that even though you lose your job or suffer some other major economic calamity, you will still be able to live your life without significant economic disruption or incurring huge amounts of debt. Since the purpose of an emergency fund is dealing with events that might happen now, it is critical that the money be liquid and not tied up in things like stocks.
As freelancers our concern is not “losing our job” per se so much as it is having those gigs slow to a trickle as they inevitably do from time to time. As such I have found having an emergency fund to be invaluable. I break my emergency fund down into two categories, business operations and personal expenses. I have two separate bank accounts for these and I will explain the difference below.
The account for business operations should ideally hold around 4-6 months worth of business expenses. When I wrote that first essay I talked about placing your “extra” income in this account and that is as simple as it gets. If your target budget is $3k a month and you are making $4k, rather than spending $4k a month you should be putting $1000 a month into your emergency fund. For anyone working consistently who has put together a strong and realistic budget, this should not be too difficult.
While the process is easy, getting your account up to the level of being able to pay for four months of business expenses(this includes your salary) may take some time. Not only could it take time, it will not all happen in a linear fashion. There are times, as work is slow, where the account will get below these numbers, but that is exactly what they are for. Your emergency fund keeps you paying yourself and your subcontractors without building up debts.
For those freelancers who have discrete business and personal accounts it is quite useful to maintain two distinct emergency funds. The first is for the business as outlined above. The second is for personal expenses. While they both serve the same function, it can ease the tracking of one’s money to separate the accounts. In this way, the business account would be used to pay subcontractors or broken computers, while the personal account goes towards medical bills, for example. By maintaining a personal emergency fund distinct from your business fund, it allows you to have your personal salary automated and not have to worry about the minutia of money transfers between accounts.
While there are many methods available for building your emergency funds, their very existence is necessary for work. I have seen too many people handed a check for a project they were freelancing on and told to please not cash it for a few days. While every business falls into these troubles from time to time you don’t want yours to be that one.
Rather, you want to be like Norway who had a national emergency fund and thus has been able to navigate this current global climate with not only no severe impact, but has maneuvered to expand and generate wealth when other countries were floundering.
The value of an emergency fund may seem a bit nebulous in the abstract but here is a good primer on the whole thing complete with personal example.
An analogous tip to the emergency fund for freelancers is saving for taxes. Working on a 1099 basis I have seen far too many freelancers spend away their fees not considering taxes until April rolls around when suddenly it’s crisis time. By saving a portion of each fee into an account dedicated to taxes you find yourself with a large cash reserve at the end of the year to pay the government.
While I use a simple online savings account for this, I have a friend who does the whole thing in CDs. He saves a percentage of his income with each check and then in March buys a 12 month CD, in June a 9 month, in September a 6 month and in January a 3 month. Come April all his CDs mature and he has a nice chunk of cash(plus interest) to pay off his taxes.
For those who would be tempted to dip into the fund, CDs are an excellent option for a tax fund or general emergency fund. Using them for a run of the mill emergency fund requires a bit more advance planning as no emergency will be so polite as to wait for a CD to mature. For an emergency fund, creating a CD ladder to always keep some funds liquid is a good strategy.
Obviously your mileage will vary. The strategy that works, is the one that works for you. Setting up your emergency fund in a way that makes you feel secure is of critical importance. Freelancing is always going to be tumultuous. It is the name of the game. Employing this and the other strategies I outlined will keep that tumult from impacting your daily living.
