Self-employed individuals lack uniform cash inflows unlike their salaried counterparts. This often leads them to park substantial amount of surplus for meeting their expenditures during lean periods or investing in their business/profession for future growth. Moreover, being devoid of Employee Provident Fund (EPF) and other employment-linked pension benefits, they are completely on their own to ensure their post-retirement financial security. Hence, financial planning becomes even more vital for self-employed individuals.
Here are some smart financial moves for ensuring the financial fitness of those with irregular income:
Maintain adequate emergency fund
An emergency fund of at least six months of monthly expenses is advised for salaried individuals. But for self-employed individuals earning irregular income, the fund must be on the higher end of this range. Try to maintain a contingency fund covering at least nine to 12 months of your mandatory monthly expenses. This should also include your existing EMIs, insurance premiums and monthly SIP. Without adequate emergency fund, you may end up using your investments to deal with unforeseen financial crisis arising out of severe illness, accident, etc., and hence, thus compromise on your long term financial goals. As the name suggests, you might need to make instant withdrawals from the fund. Hence, park your contributions for this fund in high yield savings account and ultra-short duration debt funds. These instruments generate higher returns than regular savings account while offering higher level of liquidity and capital protection features than other debt funds.
Purchase adequate term and health insurance
The next step after the creation of emergency fund is to purchase adequate term and health insurance. Buy a term insurance amounting to at least 15 times your average annual income. Doing this will secure your family financially by providing them a replacement income in your absence. The proceeds of your term insurance plan can help your family in repaying your existing loans and meeting important life goals like meeting your child’s higher education or wedding expenses.
Apart from this, progressive rise in medical cost has created the need to buy a health insurance for covering the medical expenses of you and your family. Moreover, having adequate health insurance for self-employed is even more crucial as they are not covered by employer’s group health policy. In the absence of a health policy, a single incident of hospitalisation can eradicate your lifelong investments and savings. Married individuals should opt for a family floater plan as that can get their parents, children and spouse covered at much lower costs.
Create a financial plan
Financial planning is comprehensive money management strategy created for achieving your financial goals based on your risk appetite, investment horizon and cash flows. Apart from providing a proper direction to your investments, it also ensures an appropriate asset allocation for attaining your life goals. Begin by estimating the amount required to meet each of your financial goals, the time horizon left to attain them and an assumed inflation rate. Once you have calculated the size of your financial goal, take the assistance of SIP calculators to know the monthly contributions required to attain the financial corpus.
Consider appropriate asset allocation strategy
Asset allocation is the process of diversifying your investments across various asset classes, such as equities, debt, gold, cash equivalents, fixed income securities etc. The objective is to balance your portfolio’s risk and rewards according to the risk appetite and investment horizon of your financial goals. For instance, as equities can be highly volatile in medium and short term, investors should invest in short term debt funds and high yield fixed deposits for financial goals maturing within three years because of their higher income certainty and capital protection features.
For medium term goals maturing between three and five years, investors can consider hybrid funds. Similarly, investment for long term goals (five years and above) should be invested in equities as they outperform other asset classes and inflation by a wide margin over long term.
Use credit card to build your credit score
A good credit score is considered an essential financial asset today. Lenders not only consider your credit score when approving your loan and credit card applications, they also offer lower rate of interest to those with higher credit scores. Thus, those without credit history have lower chances of loan approval. However, taking a loan to just build your credit history is also not advisable as that would include paying interest cost and processing fee. Instead, opt for credit card to build your credit score. Transactions made through credit cards are reported to the credit bureaus, which factor them in to calculate your credit score. Additionally, choosing the right credit card will also save you money in the form of cashbacks, discounts, reward points, joining benefits, etc.
If you are denied credit cards due to lack of credit history, insufficient income, unserviceable locations, etc, opt for secured credit cards to build your credit history. These cards have similar features as regular credit cards except for the fact that they are sanctioned against the collateral fixed deposits. Transactions made through secured credit cards are also reported to the credit bureaus, which are then used to calculate your credit score.
Naveen Kukreja is CEO and co-founder, Paisabazaar.com.