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CHAPTER 4


CREATING YOUR SAFETY NET

Career changes can be challenging enough without added financial pressures. Becoming a parttime or full-time solopreneur may require you to rethink your personal finances.


While some entrepreneurs might encourage you just to quit your day job and start working from a beach or while traveling the globe, that’s not a successful strategy for most. The more you can shore up your finances ahead of a career move, the more options you’ll have for building your business.

Even if you have steady income from a day job, you may have substantial expenses getting your venture off the ground. You may also have clients who turn around invoices more slowly than you’d like. You may bill with net 30 terms—which means payment is due on or before the 30th calendar day (including weekends and holidays) of receiving your goods or services—but clients may take much longer than that to pay.

You may also have seasonal opportunities that cause your business revenue to fluctuate. For instance, a swimming pool cleaning service may have less business during the winter months in many states. To avoid scraping by during the off-season or when clients are late paying you, you need to build a foolproof financial foundation.

A big part of creating healthy business and personal finances is building strong safety nets that protect you and help reduce stress. Life and money are both unpredictable. Just as a smart acrobat would never cross a high wire without a balancing stick and a big, strong net stretched out below, you should never go without a financial safety net.

In this chapter, we’ll cover the importance of having a cash reserve and offer realistic tips on how to build one as quickly as possible. I’ll review ways to make thoughtful cuts to your expenses and debts, including ratios to use as guidelines for your numbers. Use the strategies and formulas in this chapter to take a deliberate approach to managing your money so you have plenty of options and are never backed into a corner, financially speaking, as you build and grow your solo business.

Build a Cash Reserve

If you don’t have any savings, take advantage of your day job’s steady paycheck to build a cash reserve now. Without money in the bank, it can be challenging to be creative or feel justified spending time on your business.

Having as much financial resilience as possible will allow you to leave your day job sooner or increase investments in your business. Consider the worst-case scenario: You believe your side gig is profitable enough to quit your day job, but for whatever reason, your revenue then quickly dries up. The importance of having enough financial cushion to support you during your business’s ups and downs can’t be overstated.

I recommend that you maintain a minimum amount of extra cash in the bank. Whether you call it emergency savings, an emergency fund, a financial freedom fund, a safety net fund, or a cash reserve, the idea is that we all need extra money set aside for the unexpected.

A cash reserve keeps you safe and prevents you from going into debt during a rough financial patch in your personal or business life. If you don’t have savings, a sudden large expense or drop in income might take you years or decades to recover from.

Not having enough money on hand to pay for an emergency is how many people get into credit card debt. If you make card charges that you can’t afford to pay off quickly, interest on the balance grows every month, and you could end up owing two to three times the amount you initially charged.

So do what you can to make sure you’re prepared for the unexpected. Having enough money on hand for emergencies is never a luxury. Building up a reserve should be one of your top financial priorities as you plan and build your business.

Not only does having a safety net protect your finances, but it also gives you incredible peace of mind and eliminates stress. You’ll feel empowered knowing that you’ll never be trapped in a job because you can’t afford to leave it. And having a cash reserve becomes even more critical if you plan to quit your day job and rely entirely on your business income.

How Much Cash Do You Need?

You might be wondering exactly how much emergency money you need to protect yourself. While no one can predict the future, I recommend having enough to cover your living expenses for at least three months. By that I mean just the basics—housing, utilities, groceries, insurance, and loan payments—and not a full replacement of your income.

But having a six-month or more cash reserve is even better. Replacing your job income or managing a downturn in your business could certainly take at least six months, depending on your industry. It’s a good idea to periodically evaluate your needs and adjust your emergency fund goal as your life, business, and employment situation changes.

One way to decide whether you have a sufficient emergency fund is to calculate your cash reserve ratio, which tells you how long your cash would last if your income dried up. This ratio equals your total cash on hand divided by your monthly living expenses:

Cash Reserve Ratio = Cash on Hand / Monthly Living Expenses

Let’s say you typically spend $3,000 per month on essential living expenses. If you have $6,000 in liquid emergency savings, then your cash reserve ratio is $6,000 divided by $3,000, or 2. So you’d have two months of financial leeway in this example.

As I mentioned above, a good rule of thumb is to have a cash ratio of at least three. In other words, make sure you could survive with no income for a minimum of three months. But if you have a large family, high debt payments, or work in an unstable industry, you might need a 12-month cash reserve. Look at your financial situation and consider how long you could stay afloat if you lost your job or business income today.

Where Should You Keep a Cash Reserve?

The purpose of having a cash reserve is to keep it safe and risk-free so that you’ll have it for emergencies and planned short-term purchases. Since you don’t know whether you’ll need it next week, next year, or in three years, I recommend that you keep it in an FDIC-insured bank savings account.

A common question I get from Money Girl podcast listeners is whether you should invest your emergency money. Unless you have an unusually large amount of emergency savings, such as more than a year’s worth of living expenses, the answer is an emphatic “no.”

Even though people tend to use the terms saving and investing interchangeably, they’re not the same thing at all. The difference has to do with risk. There’s always a tradeoff between financial risk and return. Investing your money means you could enjoy relatively high returns, but you could also risk losing some or all of it.

With FDIC-insured bank savings, you won’t earn much interest in return, but you won’t risk losing it either, regardless of what happens in the financial markets. Even though a savings account pays a low interest rate that may not even keep up with the inflation rate, that’s OK. Remember, the purpose of your cash reserve isn’t to make money, but to save you from potential financial hardship.

Make a goal always to have enough money saved to protect yourself in an emergency. If you invest it and expose it to market volatility, it could vanish when you desperately need it.

How to Build a Cash Reserve Automatically

If you haven’t started saving emergency money yet, the prospect can seem daunting. Don’t worry; just get started by taking small steps every month. Make a plan to accumulate $100, then $500, and then $1,000, as quickly as you can.

Depending on your income and financial situation, building a large enough cash reserve could take years. A smart tip that will help even the most undisciplined saver is to automate it.

For example, if you have a day job, ask your employer to split your paycheck between your regular checking and your emergency savings account. If you’re already fully self-employed, set up an automatic weekly or monthly transfer from your checking account into your cash reserve account.

Putting your savings goals on autopilot is a great way to stay on track and avoid the temptation to spend the money. You’ll build security without having to think about it. Even if you can only set aside $50 a month, you’ll be surprised by how quickly your account balance can grow over time.

Think of your cash reserve as a non-negotiable, mandatory bill. It may take a little juggling with your other expenses, but in time, you won’t even miss the money. Plus, having a plan in place to achieve your goals can help alleviate your money stress and increase your happiness. Once you have this safety net in place, you’ll feel more secure knowing that whatever happens with your business or personal finances, you’re prepared to handle it.

Cash Reserve Mistakes to Avoid

A useful cash reserve fund should be large enough to get you through a financial crisis and easily accessible, because you need to move fast in an emergency. But that liquidity can make it tempting to spend on nonemergencies. To keep from cleaning out your cash reserve, avoid these three mistakes:

1. Not setting emergency savings rules. Create clear guidelines for yourself and your spouse or partner about what qualifies as a real emergency and what doesn’t. Tap your cash reserve only in a true emergency situation. For example, if your car breaks down and you need it to get to your day job or to run your business, repairing it is an emergency. Or if your refrigerator stops working, you need to have it fixed or buy a new one so you can have fresh food. But something that you want but don’t truly need, such as a vacation or a new set of golf clubs, is never an emergency.

2. Investing your emergency savings. As tempting as it may be to invest your cash reserve, it’s typically a bad idea. Money you invest is always subject to some amount of volatility and risk. In general, investing is suitable only for your long-term financial goals (such as retirement, which we’ll cover in Chapter 18). However, if you’re a good saver and have a cash reserve ratio in the range of 6 to 12, investing the excess portion may make sense. For example, let’s say you need a 10-month reserve and you have the equivalent of 12 months in savings. In that case, investing the excess two-month reserve (instead of keeping it in a savings account) might be a good idea, depending on your work and family situation.

3. Keeping your emergency savings too handy. Don’t take the opposite approach and tuck your cash under the mattress. While you may want to keep some money at home in a fireproof safe, consider putting most of it in a different bank from your other accounts. Using another local or online institution for your emergency savings creates a small but additional barrier to accessing it. You’ll have to initiate a bank transfer, which could help curb any impulsive spending.

Radically Cut Living Expenses

In addition to building a cash reserve, another safety net you can create is to radically minimize your living expenses and lifestyle. Maintaining high fixed costs might be sustainable when you have a steady salary or a secure job. But if you plan to become fully self-employed, expect your income to vary. To manage the ups and downs, you’ll need to find ways to be as financially flexible as possible.

While you’re building your emergency fund, consider lowering your expenses at the same time. If you’re like most people, you can probably stand to cut some or many smaller expenses, such as dinners out and impulse purchases.

However, I recommend that you focus on reducing your largest expenses first. That’s how you can truly transform your financial life. Housing and vehicles are the typical big-ticket items that suck up most of your income. By reducing or eliminating them, you can free up the most money.

How can you slash your housing costs? It can be challenging, but it is a wise place to start because it is probably the largest portion of your expenses. Housing costs vary dramatically depending on where you live, but a good rule of thumb is that your basic mortgage or rent payment should be no more than 25 percent of your gross income.

You can use the housing expense ratio to evaluate how much you spend on your rent or mortgage compared with how much you earn. It’s calculated by dividing your housing expense by your gross income over a set period, such as monthly or annually:

Housing Ratio = Housing Expense / Gross Income

For example, say your rent is $1,500 per month, or $18,000 per year. If you earn $80,000 a year, your housing ratio is $18,000 divided by $80,000, which is 0.23 or 23 percent.

Paying no more than 25 percent of your monthly gross income for your rent or mortgage principal and interest is ideal. If you can keep it under 20 percent, that’s even better.

Also consider the total housing expense ratio, which includes rent, mortgage principal, interest, property taxes, insurance, and homeowner’s association fees. Keeping this ratio under 30 percent of your gross income is wise.

If you’re in the market to buy a home, another good rule of thumb is to limit the amount you borrow to three times your gross annual income. For instance, if you make $80,000 per year, don’t take out a mortgage that’s more than $240,000. If you make a 20 percent down payment, that would allow you to buy a home worth $300,000 ($240,000 mortgage plus $60,000 down). Again, shooting for a smaller amount, such as 2.5 times your gross annual income, would give you more financial breathing room.

If your housing expense is a source of financial stress, take a hard look at downsizing or relocating to a different neighborhood or town. Taking a similar or better job in a less expensive area could also help you get ahead financially as you build your solo business.

It’s possible to turn your finances around by creating a realistic household spending plan, aggressively cutting your expenses, and sticking to the guidelines you set. Using your money to create a secure financial future, instead of spending it on material possessions, can give you a feeling of freedom that expensive toys never deliver. But you have to decide what’s truly important to you. We’ll cover much more about managing your money in Part III.

Ditch Your Debt

Another important financial safety net for many solopreneurs is to reduce what you owe. Having fewer debts can take the pressure off if your pay gets cut, your business income drops, or you lose your job. It can also be the key to living within your means if you tend to overspend.

If your finances go in the red every month, or if you live paycheck to paycheck, you can’t get ahead and build wealth for the future. Knowing that you’re going backward financially or even just treading water can cause a lot of stress.

For some people, owing any amount of money can be a source of anxiety—even if you’re meeting your expenses and diligently saving for the future. In some cases, additional income from a side business may be the answer to paying down debt or saving more. But if working a W-2 job and simultaneously building your business on the side isn’t sustainable, it’s time to reevaluate your debt load.

If you’re using credit cards and loans to finance a lifestyle you can’t truly afford, consider the consequences. Having little or no discretionary income can hold you back from building the business and life you want in the future.

One way to analyze and monitor your debt level is to calculate your debt-to-income (DTI) ratio, which is how much you’re paying for debt, such as minimum credit card payments, student loans, auto loans, and mortgages, compared with how much you earn:

DTI Ratio = Debt Payments / Gross Income

A healthy DTI ratio is less than 35 to 40 percent. For example, let’s say the total of your mortgage payment, car loan, student loan, and minimum credit card payment is $2,500 per month, or $30,000 per year. If you earn $80,000 a year, your DTI is $30,000 divided by $80,000, which is 0.38 or 38 percent.

It shouldn’t surprise you that the lower your DTI ratio, the better. Paying less for debt means you can increase your cash reserve and fund other savings goals. If debt is stressing you out, get serious about reducing your living expenses so you can pay it off as quickly as possible.

You can reduce your debt faster by tackling your highest-interest debts first, so you can whittle down your loan balances more quickly. Also consider refinancing or changing payment plans on student loans to make debt more manageable.

If you’re young or just starting your career, you may have more debt and fewer assets than older people. The real value of the financial ratios in this chapter is that you can use them to analyze your finances over time, so you can spot trends. Pat yourself on the back when your DTI ratio goes down and your cash reserve ratio goes up!

Stay Focused on the Positive

If you don’t currently have any safety nets in place, don’t beat yourself up about it. Instead of dwelling on what’s wrong with your finances, think about what’s going right that you can be grateful for. I promise that whatever your situation may be, many people would love to switch places with you. Here are some ways to stay focused on what is positive in your financial life:

$ Thoughts and beliefs always precede actions, so reframe how you think and speak about your finances. Never say that you can’t increase your income or that you should cut your spending. Instead, say “I want to increase my income,” or “I will cut my spending.” A shift in your language is the first step toward changing your mental attitude.

$ Never believe that a financial challenge is a sign of personal failure or weakness. Whatever your situation, millions of people have struggled with the same thing.

$ Taking some small steps to create more financial safety nets will give you peace of mind and put you in a better position to deal with any unexpected hardships.

$ Try keeping a gratitude journal as both an outlet for negative thoughts and a place to write down at least three things you’re thankful for each day. The Five-Minute Journal (available as a book or a mobile app at Intelligentchange.com) is a perfect tool for daily gratitude practice.

$ If you have persistent financial challenges or can’t seem to get ahead enough to create safety nets, talk to a wise friend, family member, or financial professional. They may be able to see options and solutions to your challenges that you’re overlooking.

Gather Your Data Exercise

Audit your savings and spending by gathering financial data from the past few months from wherever you track it (such as a software dashboard, bank statements, credit card statements, or a manual checkbook). Answer the following questions:

$ How much liquid savings do I have in nonretirement accounts?

$ What is the total of my essential monthly living expenses?

$ Do I have enough savings to cover a period of unemployment or low business income?

$ What are my three biggest monthly financial obligations?

$ What lifestyle changes can I make now to reduce expenses?

$ Do I have a plan to pay off expensive debt sooner rather than later?

$ Does my spending reflect my priorities and values?

$ What changes am I willing to make that better align with my personal and professional goals?


While money stress or anxiety may never completely disappear from your life, using safety nets to reduce it as much as possible can improve not only your business, but also your relationships, health, and sense of well-being.

Next in Part II, you’ll learn critical aspects of organizing your business. We’ll cover what you should know about choosing the best business entity type and naming your venture properly. Plus we’ll review licensing, insurance, and banking rules that may affect your solo business.

Money-Smart Solopreneur

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