The Freelancer’s Survival Guide: Money, Part Four
Kristine Kathryn Rusch
First, thanks to everyone who responded last week. I very much appreciate the fact that we’re talking again. Since I mentioned that the money topic silenced everyone, I received a lot of comments (see the extended comment section on the post, Money Part 3) and several donations. Much appreciated. The e-mail is still relatively silent, but I think those questions are waiting until I’m done with the money topic. I hope anyway. Either that or I’ve scared you so badly that you’re not willing to ask any questions for fear of the answers I’m going to give.
Second, Rick Dickson brought up the topic of credit cards in the comment section. I answered, and he clarified his point, which is a good one. Look at those comments if you don’t look at anything else.
But the reason I mention Rick’s credit card comment is because of the week I had. This past week is the reason freelancers have credit cards. Last Wednesday, moments after I finished writing Money Part 3, I logged onto the internet to download a few songs from iTunes. It had been nearly a year since I downloaded songs—I still have dozens of CDs to put into my iTunes files—but there were a few songs that I’d heard and wanted on my iPod.
I couldn’t download any songs without upgrading iTunes. Which I tried, but the system wouldn’t let me do so without a security patch. You can see where this is going. After getting the patch, iTunes still didn’t work and I had to download a few more things, then a few more things—and because I was tired and not thinking and just wanting my songs, dammit, I forgot I was working on an already precariously overstuffed laptop, which finally gave up. Right then and there.
(This lovely computer meltdown is the reason I’ve been relatively silent during the week. I have a number of posts I need to make, including recommended reading, recent publications, and more, but my backup computer is so old that it would shut down my web browser every time I approved a comment on the website. So…I’ve got a lot of catching up to do.)
Fixing the poor old laptop is relatively easy, although it doesn’t solve the iTunes problem or any other upgrade problem. But…we’d been planning to get a new laptop for four years now, and we figured this was the time. We had money budgeted, but not entirely saved for it. Still, we would be right near the computer store on Monday, so we decided to buy.
With a credit card—which will be paid off in its entirety in about three days, when the rest of the budgeted money arrives in the mail.
But there are times—and we’ve had maybe a dozen in the past few years—when the money’s not quite there as the emergency happens. Credit cards cover the problem until the money arrives.
Here’s the key point about credit cards. It’s the same point Rick makes: Do not use them unless you can pay them off in full. Otherwise, find another way to deal with the problem.
Sometimes there is no other way, and you can’t pay off the card immediately. Go over your budget, add credit card payments in excess of the minimum to your monthly expenses, and try to pay the damn thing off as fast as you can.
Another key to credit cards: Make sure your credit limit is low. Also make sure that you have only one or two cards. With only one or two cards and a low credit limit, you can’t get yourself into deep financial trouble in the face of a true emergency (like spiraling medical bills). You won’t be tempted to pay with the card, and you’ll save yourself a huge disaster.
If most Americans use their available credit, they’ll owe more than their car is worth on credit cards alone. The payments for those credit cards will exceed the mortgage payment. You don’t want to be in that situation, so cut up cards 3-10, keep the two with the lowest credit limits, and pay them in full when you do use them.
Okay, there. That’s the credit card lecture, which I am going to follow myself on Friday or Monday when the already mailed check will arrive.
Finally, a number of you have asked me how you learn this financial on your own—without making the mistakes—when there are very few books published about freelancing and money. I’ll try to recommend some books as time goes on. Most that I know of are out of date, thanks to the so-called New Economy. I’m reading one right now that looks promising. If I like it, I’ll recommend it here.
However, most of my information that hasn’t come from personal experience has come from observation. Not just observation of my friends and business associates, but observation of others as well.
And this week provided yet another opportunity for that kind of observation.
Mixed into the increasingly lurid coverage of Michael Jackson’s death is the coverage of his finances and his estate. Read all of that. Listen to whatever you can. Because you can learn from celebrities, who are mostly freelancers. Michael Jackson certainly was.
Estimates put him at $400 to $500 million in debt at the time of his death, yet he has an estate that will increase in value over the years—and has increased in value just since his death. Artists, writers, musicians, take heart from this and keep your copyrights, get royalties, and make sure you’re paid for your work without losing rights to any of it. Those rights are what will make Jackson’s debt vanish in no time, and leave his heirs with a large fortune.
Jackson mismanaged his money horribly. I wouldn’t be surprised if we soon learn of embezzlements and other problems in the estate itself. I’m following this financial stuff as closely as I can, because there are always lessons to be learned—good and bad. If nothing else, it helps with estate planning.
But the state of Jackson’s finances reminds me of the state of another entertainer’s finances at the time of his death. Elvis Presley had spent every dime of his fortune and then some at the time of his death. Like Jackson, he sometimes spent more than he had. Yet now the Presley estate is one of the largest entertainment estates in the world. What happened? Priscilla Presley took over and managed the money properly.
You can read about the changes, the legal fights, and the money management in an out of print book called Elvis Inc. Find this book. It’ll make fascinating reading while you listen to the financial coverage of the Jackson estate.
And as you’re reading about Elvis and learning about the Jackson estate, realize that these two men made money outside of the mainstream. They were entertainers, not brokers or money managers. They made money from their art, and their estates continue to make money from the work that these people produced in their lifetime.
Which brings us to…
Remember my initial freelancer’s equation?
Gross income – cost of doing business = net income
We discussed expenses for the past two posts. This time, I’ll actually discuss net income.
First, a reminder: Gross income is all of the income that arrives at your business, from the smallest pennies to the largest checks. All of the income without exception. If you earned the money through your freelance labor, then it gets counted as part of the business’s gross income.
Net income is the money left over after you pay the expenses. All of the expenses, including a salary to yourself and your employees. (Note that I didn’t do much on employees in the expenses posts. Never fear, I’m going to give employees a post all their own sometime in the future.) Sometimes that net income is tiny and sometimes it’s very, very large.
Because freelancing is often so unpredictable, you may not know on January 1 that you will make a large net profit by December 31. Most freelancers plan for the bad times, but they have no idea how to plan for the good times.
In some ways, that’s what happens to millionaire lottery winners and others, like artists/entertainers/athletes, who can make six to seven figures more than they expected in a single year. Even contractors can do that, by getting plum project in an upscale housing development—although that’s less likely these days than it was in 2005.
Before you get into the enviable position of making a large net income (and you will, if you’re good at what you do, you work hard at what you love, and you keep your expenses under control), you must learn how to handle large sums of money.
How do you do that without the large sum of money? Easy. You follow what others have done. I read a lot of celebrity and sports news because mixed in with the gossip is valuable information about failed investments, horrible risks, and terrible tax problems. Those are all relevant to you now.
In addition, I read the financial press. The business section of my newspaper, the Wall Street Journal, and a lot of financial magazines. As I do this, I remember that I used to be a business reporter, and I had only a marginal understanding of what I’m writing about. So I take everything I read with a grain of salt. If I don’t understand what the article said, I look for some other way of gleaning the same information, and I try to figure out if the reporter filter is inaccurate (often it is).
Reporters, even business reporters, rarely specialize in high finance. The people who claim to do well in high finance don’t always do well either. The financial gurus on the business channels like CNBC missed the upcoming housing bust, which I find laughable. My business-oriented friends and I all saw it coming. It was obvious—the elephant in the room, if you will. Yet the so-called experts missed it and the inevitable economic downturn.
Read books about the history of finance. Books about the Great Depression, about stock swindles, about banking schemes, about times of great worldwide financial success and great worldwide financial loss. Start with John Kenneth Galbraith’s tidy little book on the crash of 1929, The Great Crash of 1929. History really does repeat itself. We just witnessed it.
Finally, read books by self-made millionaires. Folks like Warren Buffet are willing to share their insights. You don’t have to do what Buffet does—and probably shouldn’t—but you should learn his attitudes about money. He’s extremely good at handling it, and he understands what it can and cannot do for you.
The problem most people have with a sudden net profit is that they see it as a windfall. They don’t see it as something that needs to be managed, just as something that can be spent.
I mentioned the millionaire lottery winners who go broke within a few years. Everyone wonders how they do that, but it’s really very simple. They spend every single dime, save nothing, invest nothing, incur great expenses, and fail to understand that money—even a great deal of money—is finite.
Michael Jackson died $400-500 million dollars in debt. Figure out how he did that. It wasn’t all amusement parks and facial reconstructive surgery. He lost more than he made year after year after year—and he made more per year than most people ever make in their lifetimes.
Here’s what you don’t do when you have a large net income—which I’m going to call a net profit from now on, because that’s the correct business term.
You do not go on a mega-spending spree.
You can go on a small spending spree. Buy your wife an expensive pair of earrings. Buy your kids some great new toy. Buy yourself something small that you’ve always wanted, but see as an indulgence.
There. Now you’re done spending. You’ve rewarded yourself and your family, but not in a great big way.
Because—here’s the raw truth of it, folks—that small spending spree is a taxable event. The money you just spent is money you’ll have to pay taxes on. It’s not a business expense. It’s a bonus, and if any of you have ever gotten a bonus at your day job, you know that the bookkeeper already took payroll taxes out of the bonus before giving it to you.
How do all these lottery millionaires and first-time celebrities get in tax trouble? Simple. They forget that they must pay taxes on their net profit (which they saw as a windfall). They spent all the money, and then the tax bill occurred.
If you figure federal taxes at one-third of your net income (which is how the IRS does it [roughly]), then you would owe over $33,000 on a net income of $100,000. See how quickly that adds up? And how difficult it is to catch up, particularly if your net profits don’t happen year after year after year?
So…you have a net profit. You rewarded yourself with a tiny spending spree. Or not. Preferably not. But people do like celebrating when they come into money, so if you’re one of those folks, then celebrate by spending a teeny tiny amount of money.
After your itty bitty spending spree, set aside one-third to one-half of the net profit to pay the taxman. The IRS wants you to pay for large tax bills quarterly, and that’s a good idea.
Net profits aren’t always predictable, as I noted above. Most people underestimate how much they’ll earn once the profits start rolling in. So if you set aside one-third of the money you got on the first quarter’s net profit, then forgot to do so for the second quarter, received a bigger-than-expected net profit in the third quarter, and no net profit in the fourth, you could easily be behind on your tax bill. That one-third of the first quarter’s profits won’t be enough to cover the entire year.
Better to pay that one-third in at the end of that quarter. That’s called an estimated tax payment. You don’t get penalized for estimating wrong, unless you continually underestimate and underpay, year after year after year.
Remember, I am not a tax attorney nor am I qualified to give tax and legal advice. I’m just giving you my opinion here.
And my opinion is to pay those estimated payments to the best of your ability. If, at the end of the year, you discover that you overpaid your estimated tax, you can get a refund, just like you did when you overestimated your withholding payments from your day job.
If you underestimated, you need to make that payment in full when you file your taxes. And if you seriously underestimated, you can make payments, but you have to pay interest and/or penalties.
Don’t underestimate. Set aside more money than you need for taxes, and pay your quarterly tax bills from that. Keep that money in a liquid account like a money market savings account or a one- to three-month certificate of deposit especially earmarked for taxes.
At the end of the year, do your taxes and make your payments. If you have money left over, great. Set it aside for next year’s taxes, or invest it like you’re going to invest the rest of the your net profits.
So you’ve had your insy weensy spending spree and you’ve paid your taxes, and you still have money left over. You can do a lot of different things with it.
You can pay yourself a large bonus, taking all of the leftover money—after you’ve taken tax payments out of that. If you do so, realize that you’re going to pay taxes twice on that money—once on the business receipt of the money and once on your personal use of that money. In other words, that’s probably not the best use of your money.
First, I would reinvest in the company. I would upgrade something like a bit of machinery or something to a better product. I would not incur monthly expenses doing so—which means I wouldn’t get an office outside the home or hire an employee.
I might simply park that money in some kind of savings account as an emergency fund. Over time, you’ll get a large emergency fund and you’ll need to diversify. But if it looks like the large net profit is not going to be a recurring event, then save as much of that money as you possible can—in low-risk savings.
Be smart about it. Don’t put all of your money in the same institution. As people learned this past year, banks do fail, and even though the FDIC insures them, sometimes it takes weeks to get all the money that you’re owed. Spread your liquid savings around various banks.
Watch your level of risk. Here’s my theory of investing. My job—my writing career—is high risk. I do not have a day job and a salary paid by someone outside. I’m dependent on myself to make money.
So I keep my net profits in low-risk investments. I plow a lot of money back into my business. I have much more liquidity than the “experts” say a person should have. And I have no stocks. I never have. They’re too high risk—and were even in the tech bubble of the 1990s.
I invest in real estate—and that took a hit in this recession—but I’ll continue to do so as time goes on. Why? Real estate isn’t as high risk for me as it is for most people. I used to work in real estate. I handled rentals. I’ve never expected property values to rise continually. I’ve always expected—and planned for—the ups and downs.
I’m sure each and every one of you has expertise in an area outside of your freelance business. You might consider your secondary investments there. But again, watch your risk.
For example, between us, Dean and I have run or been involved in at least ten different bar and restaurant businesses. We would never own one. Running a restaurant takes diligence that we would not have as investors—and we don’t want to run the business ourselves.
Dean recently started a retail business to sell collectibles, which he knows quite a bit about. We invested heavily in that business and sold it for a profit as the recession was getting deeper. We always planned to sell the business. We knew how much money we could make. (We actually made more.) But again, we both knew retail and we knew our limits.
Those are not traditional investments—stocks, bonds, etc—but we don’t live a traditional life.
So…to put it all in a nutshell:
If you have what you believe to be a short-term net profit:
1. set aside your taxes
2. save for future emergencies
3. reinvest in your business
4. stash the remaining money in a low-risk investment, maybe even something liquid.
If you know that your net profit will continue and might even grow over the next few years:
1. set aside your taxes each time you register that net profit
2. save for future emergencies. Set a limit on that savings account.
3. reinvest in your business
4. Diversify. Keep some money liquid. Then invest in something quite different from the business you’re working in. Again, keep your investments as low risk as possible.
Let me define risk:
Risk comes in many forms. Not just in the possible financial loss that can occur when your investment goes south, but also in the possible loss of time. I wouldn’t own a restaurant not just because the financial risk is great (it is) but also because a restaurant needs hands-on management to make sure it maintains its profit margin. I don’t have that kind of time.
Dean was willing to invest a great deal of time for his collectibles store, knowing that investment of time was limited to 12 to 18 months. It paid off, even as the economic downturn started, because he knows the collectibles business and the local business environment very well, and because he has run other profitable retail businesses in the past.
It was a nice break from his writing, and he used it as such. He does that now and then, which makes me, the financial conservative, very, very happy.
When you invest—in anything—research that investment first. Know your level of risk. Know the possible downside to the investment and monitor that investment closely.
I can’t tell you how many people I’ve talked to who never once looked at their 401K until stocks fell dramatically last September. These people let other people invest for them, had no idea how their money was being used, and believed those “estimated rate of return” figures some broker spouted off when they joined the 401K. Some people I talked to last fall had thought that the stock market was a risk-free investment. I still shake my head over that.
Managing money takes a lot of time and effort. The more money you have, the more effort it takes.
The people who lose their wealth do so because they let someone else manage their money. Those managers embezzle (Bernie Madoff and all the lower level pond scum that are filling the news these days) or mismanage the money. If the managers were wealthy, for the most part, they wouldn’t be doing the day job of managing other people’s money. It’s that simple.
That doesn’t mean that financial managers are worthless. But most people use them incorrectly.
Never lose control of your money. Keep track of every single dime. If you made a risky investment, fine—as long as you know the risks going in. The last thing you want to do is be surprised, as so many Madoff investors were last fall. One day those sad people were comfortable or even rich. The next, they were broke. All because they forgot the basic rules of investing: Keep an eye on your money, ask questions, and diversify.
I can’t be much more specific than this because everyone’s risk tolerance varies. Everyone’s knowledge of money management varies. Everyone’s expertise varies.
But if, with this post, I’ve gotten you to be conservative with your profits, I’ve done my job. Don’t hide your money under the mattress. But it’s okay to park the money in a low-yield money market account (or several accounts) while you’re deciding what to do with it. Research everything and go into each investment with your eyes wide open.
The best thing you can do is start researching how you want to invest before you ever have a net profit. If it’s too late for you and you’ve been running profits for years, then start your research now.
Yes, managing your money takes time. But that’s one of the problems you trade up for. You want to spend time allocating your profits. It’s a much better way to spend your days then trying to keep yourself from sinking in too much debt.
You can now order either an e-book copy of the Guide or a trade paper copy of the Guide. It’s in slightly different format and has been organized, so that related topics are in an easily accessible place.
You can get the print version here.
For those of you who’d like to buy an ebook, here’s the Amazon link as well as the Barnes & Noble link. The e-book will also be available on all the other e-book sites. If you want it in your favorite format, and the book hasn’t yet been uploaded to your favorite site, try Smashwords. You’ll be able to download in a variety of e-book formats.