Starting out as a freelancer, an entrepreneur, or in some other avenue to self-employment is exciting. Youíll get a chance to be your own boss, do the work youíre truly passionate about, and increase your income potential to practically limitless heights.
However, being self-employed isnít a get-rich-quick scheme. In fact, being self-employed comes with even more financial responsibilities, since you wonít have a steady employer to take care of things like taxes or provide a reliable dollar amount each month. Accordingly, most newly self-employed individuals end up making unfortunate and significant financial mistakes.
Biggest Financial Mistakes to Avoid
These are some of the most common mistakes newly self-employed individuals make:
- Neglecting your debts. In the scramble to build wealth for yourself and invest in your business, you might forget about your debts. But if you start missing deadlines, youíll take a hit to your credit, and if you wait too long to start paying off your principal, youíll get wracked with additional interest payments. The best thing you can do is consolidate your debts to a single creditor with a low interest rate, and make a plan to pay back that debt as soon as possible.
- Failing to make a budget. For the most part, you arenít going to have a steady paycheck like you became used to at your previous full-time job. That makes budgeting much more difficult, so many people end up neglecting it when they become self-employed for the first time. Even on an irregular source of income, you should be aware of how much youíre spending on your needs and wants, and limit that amount as much as possible (especially during periods of volatility in your new business).
- Not saving for taxes. For most full-time employees, federal, state, and local taxes are withheld by your employer. That isnít true anymore for the self-employed, but youíre still going to owe taxes on any income you make. In fact, youíre required to make quarterly ďestimated taxĒ payments using form 1040-ES to stay ahead of what you owe. Throughout the year, youíll need to pay attention to how much youíre making and how much you owe–otherwise, youíll get a nasty bill at the end of the year.
- Allowing your revenue to be inconsistent. Your revenue is going to be somewhat inconsistent no matter what you do-all businesses experience some kind of ebb and flow. But you should make an effort to smooth over your revenue stream as much as you can. You can introduce fee structures like retainers, which require consistent monthly payments, or forecast sales so you know what to expect and adjust accordingly.
- Not having a consistent invoicing strategy. You may do lots of work, but you wonít have money coming in until your customers actually pay you. For that, youíll need an invoicing strategy thatís consistent and leads to a follow-up protocol if your customers donít pay on time. Many new business owners and freelancers neglect this potential reality, and donít know what to do when they forget to send an invoice, or when one goes unpaid for too long.
- Forgetting about saving for retirement. You may hope to build enough wealth to last the rest of your life, but youíll need to have a backup plan in place so you can have a decent stream of income for retirement. Employer-sponsored options like 401(k) plans will no longer be available, but there are many retirement options for the self-employed. Invest in a plan like a Roth IRA or SIMPLE IRA, and establish a strategy for regular contributions.
- Investing too much, too fast in your business. You want your business to grow, and youíre excited to grow it as fast as possible. For the most part, thatís a good thingóthe more you put into your business, the more formidable it will become. However, there is such a thing as investing too much in a business too quickly; and if you do, youíll end up spending more money than you can bring in, or expanding so fast that you canít keep up with the new demand. Start with minimalistic investments, and only take major steps like hiring new employees when you have the revenue or forecasts to back it up.
Your finances arenít going to be perfect, and they donít have to be, but remaining aware of the most common pitfalls faced by the self-employed can help you maximize your potential-or at least avoid a few crushing failures on your path to success. Itís a learning process, so donít feel overwhelmed if you donít ďget itĒ right away; youíll have plenty of time to iron out the details of your financial future.