Transition to self-employment – where is the water?
Life is pleasant. Death is peaceful. It’s the transition that’s troublesome. – Isaac Asimov
The latter days of August are usually a rude awakening for my kids and me. After two luxurious months of sleeping in and goofing off (I call it the season of 85 straight Saturdays), we get down to the business of going to bed earlier, sharpening pencils, and preparing lunches. Anxieties creep in as we face the unknown:
“Who will my teacher be?”
“Are my friends in my class?” and
“Why, as the first bell rings, am I standing in front of this class in only my underpants? Oh no!!!! Why didn’t I put on my pants this morning??!! Wait, am I awake?”
Summer to school is a minor transition in the grand scheme, but a transition nonetheless. And transitions are hard.
This Fall, our family’s transition looms more momentous than normal. I am hanging up my teacher hat after 17 years in the classroom, and launching full-time into self-employment. I’ve actually been testing the waters for the last few years – in 2016, we took half a year off to travel through Asia as a family, and last year I worked half-time as a teacher, half-time in financial planner. But this year, it’s the full plunge. I feel as though I am setting forth on an adventure – a trip down a river that I’ve not journeyed before. The exciting side of this transition is the time and mind space I get to dedicate to serving my clients and building Trail Financial Planning. But there is a scary side, a problematic side. I am also leaving the safe shores of being taken care of by others: our family’s health insurance, retirement savings, and tax payments used to be managed by a human resources department. Now, each of those areas is a new challenge, a rapid we must navigate.
As a planner, I often get questions considering self-employment. The financial question is usually “Is it a good idea?” Like most answers in financial planning, the answer is likely “it depends.” In this post, I am going to document some of my experiences, and explore the associated financial planning issues that I must navigate as we transition from pay receiver to pay creator. I imagine it may turn into a bit of a serial blog – a bit like a journal. The first step is to create a paycheck.
What is a paycheck?
This is not complicated. I work. I receive(d) a paycheck. Strangely though, after several years of teaching, my paycheck started to feel disassociated from my work. I did my teaching thing. Behind the scenes and before I saw any money, some money was sent to pay for my family’s health insurance, income taxes, and retirement savings. At the end of every month, the remaining income landed in my bank account, just in time to pay for the mortgage, a student loan payment (yes, I still owe student loans, grrr…), extra savings towards college and retirement, pay off a credit card, etc. There was equilibrium, our financial house was on autopilot. I spent very little time on the day-to-day inflows and outflows (apart from balancing the checkbook and paying bills). Once a year, as my paycheck changed, I adjusted the automatic withdrawals. My paycheck made our current lifestyle possible; it allowed us to focus on other important matters like what should we make for dinner, or the emotional health of our dog.
But self-employment is a different boat, on a wilder river. Last year, when my September paycheck became half the amount from the month before, I sort of freaked out. The autopilot system was broken. With a 50% cut to our monthly income, I found myself scrambling to bail water as leaks sprouted from unforeseen spots and waves crashed over the sides. Captaining the boat, while also keeping it afloat, turned out to be difficult. Struggle, however, can be a powerful motivator for innovation.
Step 1. Change the metaphor
Our family usually runs rivers in the summer, when it is hot and dry. Even though we are swimming, floating, and getting drenched by waves, we also must tend to what water goes into our bodies. We must stay hydrated. We ingest water, and water leaves our system in several ways (breath, sweat, urine, etc.). There is a parallel to our financial life. It’s called cash flow. Cash flow is similar: money comes in, and money goes out. Without proper cash flow, the household will wither.
Step 2. Figure out our blood, sweat and tears
Before overcoming a challenge, I needed to understand it. The question was: “How much money do we spend?” To answer, I ended up tumbling, then scratching and clawing my way, through a nine-month rabbit hole. There are two pieces to this puzzle – tracking/categorizing all spending, followed by summarizing/reporting what I tracked. The first step creates awareness, the second understanding.
Tracking and categorize all spending and saving
I tried all sorts of tracking systems, from hand-crafted spreadsheets to packaged solutions like Mint, Quicken, YNAB (You Need a Budget), GoodBudget, Quickbooks, Tiller and Right Capital (the financial planning software I use for long-term planning). I settled (for now) on three different systems:
- Tiller for my wife’s business
- Quickbooks Online for Trail Financial’s business, and
- Tiller/Right Capital for our personal spending
I find the time and effort I spend regularly categorizing each and every expense to be incredibly valuable. For me, it is a comfortable, weekly financial routine. I like the discipline. Every week, on the same day (Saturday mornings with coffee and NPR’s Scott Simon as my co-pilots), I categorize every business and personal expense. After a couple months, it now costs me about 10-15 minutes per week and $20/month in subscription costs.
The second piece is the summarizing/reporting bit. Tiller and Quickbooks do a great job reporting our business cash flows. But, I have yet to find a good personal side solution. For now, I still rely on a hand-crafted spreadsheet. What I discovered was shocking to a 47 year old dad who still basically thinks of himself as a low-bagger mountain and river guide. The monthly cost to live our life was way higher than my initial guess. I was thinking we spent in the $6,000 – $7,000/month range. Nope. $10,000/month seems to be more accurate. WTF??!! That is more than we earned just a few short years ago. And it is about twice what we spent while travelling in Asia (if you want a breakdown, I wrote about it here – How a teacher and small business went with their 2 kids to Asia for 4 months.). Why? Inflation, lifestyle creep, raising involved teenagers are all culprits – not in a crime, but in a story of a good life lived in Bellingham, WA.
This last statement is crucial to addressing cash flows. We live a good life. A good life costs money. It’s ok. When I bring up cash flows with my clients, they either get excited to talk about it (because they are very good at tracking their cash flows already), or they say something teetering on the edge of self-shame, like
“Ohh, all I know about my cash flows is that we spend too much. I mean, we could definitely spend less.”
Maybe, but it is important to remember that a good life costs money. As a friend of mine often says, “you’ve got to pay to play.” Spending money, just like breathing out, is vital, it is not inherently bad. It just is. The question I like to explore with people is: does your spending match your values and bring happiness? But that question is fit for a totally different blog post.
Categorization/tracking give me clarity, summarizing/reporting help me build insight. The next step was to take action.
Step 3. Engineer the flow
I knew that monthly expenses were essentially consistent, but cash inflows were not. There were months when I felt thirsty, but the fountain was dry. For a Northwest boy, that is unsettling. I am accustomed to readily available clean water! I needed to do a little bit of hydraulic engineering. I needed to build some infrastructure to store, and moderate the flow of money. For years, my wife had been depositing business income and paying for business expenses from our personal checking. Her business is a sole proprietorship, the accounting was fairly simple, so it was relatively easy to just track and separate business income and expenses for taxes at the end of each year. But, now that both of our incomes are intermittent, and they are needed to very consistent monthly bills, we needed a new system.
So, we set up dedicated business accounts to contain all business income and spending in one place. In business school, this step is probably remedial learning, the kindergarten class of entrepreneurship. But, my wife and I are reluctant entrepreneurs. Starting businesses allows us to live a life we want, serve people we love, and do the work we enjoy. We didn’t go to business school. We’ve had to learn on the job.
Step 4. Set the paycheck amount
Understanding our “monthly outflow” gave me a target. The next step would be automate monthly disbursements, just like paychecks. Although this step sounds easy, I had to answer some seemingly simple questions:
- What about the hidden payments in a paycheck like insurance, retirement and taxes?
- Does the business have enough cash to pay out a paycheck?
- Does the business have consistent enough revenue to support a monthly paycheck?
I decided to skip the first question for now (covering taxes, retirement and insurance). I will write about that puzzle in a future post. I first just wanted to set a consistent paycheck that covers the monthly spigot. Thanks to good tracking systems, I knew what we needed, and what the businesses could support. I set up paychecks that were just enough to cover the monthly outflows, but less than the business net income. The transfers occur on the same day of the month, just before the mortgage and bills are due.
Step 4. Return to the river
My wife and I have now been operating on this system for about six months. Our business account balances are growing, which means that the regular payments are sustainable. We both keep at least two month’s of expenses as a floor in our business accounts. We have steady flows into our family personal accounts. We have a family emergency fund to cover the unexpected (why an emergency fund?) But, this September is a new transition, as I go to full-time self employment. I will need to increase the flows to make up for a lost half-paycheck, and there is a new expense that we must fully pay for – health insurance. The latter is a fresh cost, about $1,600/month will hurt! But, it is just a challenge, one rapid on a river that we chose to ride. I have a system in place, and I’ve been planning for the transition. I am confident that I can twist some nozzles to keep all the flows working. Certainly, the river has not become any more tranquil. But, the float is looking a lot more doable. I feel confident to have found the oars again. Maybe sometime soon I’ll even be able to drink in the views.
You’ve reached the end!
Thanks for reading. If you would like to read more about my thoughts on personal finance, you can check out our main blog page at Trail Financial main blog page. If you’d like to talk to one of us about your own transition into self-employment, you can schedule a free consultation here.