How to invest if you are self-employed

Working for yourself can make financial planning more challenging. Your income often fluctuates from one month to the next so your tax bills are not as predictable, but your expenses don't necessarily reduce. Not surprisingly, sticking to an investment plan isn’t the easiest thing to do. But with some discipline and forward thinking, you can still take a strategic approach to your investment strategy and grow your portfolio effectively.

You might be tempted just to invest a lump sum at the end of the tax year when you know exactly how much you have earned and how much your tax bill is likely to be. But James Norton, head of financial planners at Vanguard, says that doing this could mean missing out on valuable time in the market. Instead, he suggests making smaller monthly contributions and topping these up with any extra cash at the end of the year.

If you have cash available, consider investing your annual individual savings account (Isa) allowance, which is currently £20,000, at the beginning of the tax year. For example, with a 5 per cent annual rate of return after costs, a contribution of £20,000 a year would grow to roughly £694,000 if you made it at the beginning of the year, £661,000 if you made it at the end of the year or £679,000 if you made monthly contributions of £1,666.66.

However, in real life, market movements make things more complicated. So if you have a sizable amount of cash ready to deploy, for example because an important client settled an invoice, consider whether it is better to invest it all straight away or drip-feed it into investments gradually.

Because markets tend to rise over time, investing as soon as possible has probably been more profitable over the long term. Nonetheless, drip feeding money in gradually is a way of guarding against market timing risks.

How you feel about it also matters. Uday Tuladhar, paraplanner at JM Finn, says that investing a large lump sum in one go can feel even more daunting than usual during times of high volatility. So what you do ultimately depends on your approach. “Regular investing tends to suit more risk-averse investors due to the effects of pound/cost averaging, which aims to smooth out the ups and downs of the market, and is a less emotional and time-consuming approach,” he explains. “Then again, there is the potential for greater returns with lump sum investing, depending on the markets.”

Alice Haine, personal finance analyst at Bestinvest, suggests a middle ground via ‘ad hoc’ investing, whereby you invest a percentage of your income or a set sum during the year, adding money whenever you can, regardless of market movements. By doing this even just two or three times a year, you can reduce the risk of investing all in one go while taking into account the nature of your income streams and benefiting from compounding.

Another consideration when deciding whether to invest regularly or via a lump sum is your platform’s fees. Many platforms, including Interactive Investor and Hargreaves Lansdown (HL.), offer free regular investing while on others it may be cheaper to invest less often. It also depends on whether you invest in open-ended funds or listed securities such as investment trusts and direct shareholdings, as various platforms don’t charge for buying and selling open-ended funds.

Put your cash to work

If you’re self-employed another big question is how much cash you should hold. Everybody needs an emergency fund; financial planners usually advocate having at least three to six months’ worth of your expenses in easily accessible cash, and ideally up to a year’s worth. If your income is irregular, it could be a good idea to err on the higher side of that range.

“Investing money that might be needed to cover everyday expenses is pointless as your portfolio may have fallen in value if you withdraw funds too soon,” argues Haine. Your income can become even more irregular during an economic downturn when struggling markets are more likely to be down, so having cash to draw on instead means that you can avoid selling investments whose value has gone down. 

But make sure that your cash earns as much as possible. An easy-access savings account is the obvious choice and currently some of these offer attractive rates, albeit they don't keeo up with inflation. Use comparison websites such as moneyfactscompare.co.uk to find the best rates available.

Also consider short-term bonds. Capital gains on directly held UK government bonds (gilts) are exempt from tax. Alternatively you can gain exposure to them via an exchange traded fund (ETF) or active fund. For example, the IC Top 50 ETFs list includes Lyxor Smart Overnight Return UCITS ETF (CSH2), which aims to generate a return linked to money market rates. It is benchmarked against the Sterling Overnight Index Average (SONIA) compounded rate, an interest rate computed as a weighted average of all overnight unsecured lending transactions in the interbank market in pounds. Or for a focus on US Treasuries, iShares $ Treasury Bond 0-1yr UCITS ETF (IB01) is also a straightforward option. If you hold these funds within an Isa, they are exempt from capital gains and income tax.

Don't neglect your pension

Depending on your goals and circumstances, you will also need to decide whether to prioritise saving and investing in your Isa or pension. If your income fluctuates, and you are still far from the age at which you can access private pensions, which rises to 57 in 2028, there is much to be said for an Isa. In most cases you have access to your investments, and withdrawals from them are tax-free. If, for example, you only work part-time but have a sizable portfolio, you could draw some income from investments within Isas, holding a combination of fixed-income assets and dividend-paying stocks to generate regular income. Generally, high-yielding assets are the first that should go into tax-efficient wrappers because income tax rates are higher than capital gains tax rates.

And thanks to tax relief you receive on contributions, pensions beat most types of Isas when it comes to growing your pot. Tax relief at your marginal rate boosts the value of your assets and, due to compounding, the longer-time horizon typically involved means a bigger boost to asset values. If you’re self-employed or a business owner, because of all the other things you have to think about it can be easy to neglect your pension. But doing this can result in you having less to live on in retirement and you miss out on tax relief.

Pension contributions can also be timed to reduce your tax liability and tailored to your income pattern. “Most private pension providers allow savers to stop and start contributions whenever they want, and alter the contribution level, so the flexibility needed by the self-employed is available,” says Haine. If you are concerned about committing to a monthly pension contribution, you could use a provider that accepts ad hoc contributions or invest a low monthly sum and top it up whenever you have funds available. But you should increase your contribution levels every year as your income grows to keep up with inflation.