The 7 Steps to Financial Freedom

What are the steps to financial freedom? How do you achieve that seemingly impossible goal of financial independence?

First, let’s get clear on what financial independence means. You are financially free and independent when you have sufficient passive income streams that you no longer need to work because your assets consistently generate more income than your expenses. At this point, you can consider yourself financially independent –hooray! Many people in the F.I.R.E. community (financial independence, retire early) focus almost entirely on accumulating paper assets (stocks and bonds) to reach this goal, not realizing that it is often easier and faster to reach financial freedom through business or rental real-estate. The wealthy usually get rich through business and/or property and then park their profits in stocks and bonds. For this blog, I’ll focus on the paper asset path to financial freedom and assume you are starting from the beginning so skip the steps you have already mastered.

Step 1. Set up automatic savings.

You need to make the switch from being a spender to a saver and the easiest way to do that is set up this up to happen automatically from your paycheck before you get your hands on it. Most people naturally adjust their spending when they see they don’t have any money left in their checking account. It never works to save what’s left over at the end of the month. You must pay yourself first, then pay your bills and you can safely spend the leftovers.

The quickest and easiest way to double your savings is to make sure you are contributing the amount required to get your full company 401K matching contribution. If your company matches your contribution, you are instantly doubling your money, getting 100% return on your investment. This is worth doing as you aren’t likely to get that kind of return as quickly and easily anywhere else! Yes, do this before you pay off your debts. The sooner you get your money doubling, the richer you’ll become.

Once you’ve gotten your full company 401K match set up (see Human Resources for the forms), your next savings goal is $1000 into a money market or savings account. If you are tempted to spend your savings, don’t connect it to your ATM debit card or open this account at a different bank. This is your emergency cash reserve fund and will serve as a money magnet, helping you get into the savings habit and enabling you to break the cycle of using your credit cards or overdraft to cover unexpected emergency expenses. This savings will provide you with a nice little cash cushion to soften the inevitable road bumps in life. Once you have this cash reserve in place, you are ready to take the next step.

Step 2. Get out of debt as fast as you can.

Dave Ramsey is a big proponent of the Debt Snowball method in which you list your credit cards and loans from smallest balance to biggest balance and pay them off in that order. The idea is to create some quick wins to create momentum by paying off your cards quickly. This provides a nice psychological benefit –it feels good to pay off and close your credit cards.

If you want to get out of debt faster, use the Debt Avalanche Method. Pay your highest interest rate debts first, regardless of the size of the balance and work down the list to your lowest interest rate. Of course, you’ll have to make the minimum payment on all your debts, but apply any extra money to the debt that is costing you the most. Always negotiate with the credit card company for the lowest possible rate and consider getting a debt consolidation loan to reduce your interest rate.

In practice, I did a combination of the above, paying off and closing cards that had a small balance of under $100 just to clear the decks, then tackling the debts in order from highest interest rate to lowest. It makes no financial sense to pay off a lower rate student loan or car loan before you pay off a higher interest rate credit card.

Life hack: Take your credit cards and freeze them in water and keep them in the freezer. This makes it harder to spend without really thinking about it first as you’ll have to wait until they defrost. Remember, if there is a true emergency such as a lat tire that needs replacing, you have your $1000 emergency fund to tap first from Step 1. The key here is that you’ll break the habit of relying on credit cards.

Consider the source of your debt. Most Americans get into debt because of uninsured medical expenses. Make sure your health insurance coverage is appropriate so this doesn’t happen to you! On the other hand, if you are racking up credit card debt due to overspending and buying stuff, then it is worth taking a close look at your personal and emotional needs. Unmet needs can create an overwhelming desire to spend (yes, I’m speaking from personal experience). Overspending is often an unconscious attempt to feel better about ourselves, a way to reward ourselves to compensate for a job we don’t like, a way to boost an ego, or simply a form of entertainment (yes, shopping can be fun!). Relentless and omnipresent media and advertising continually fuel the consumerist lifestyle.

Unfortunately, you can never get enough of what you don’t really need and no number of new shoes will compensate for feeling unloved, stressed or unappreciated at work. Instead, focus on getting your real emotional needs satisfied in healthy and appropriate ways and you’ll find your desire to shop disappears, handily saving you a bundle in the process. You can take the free Emotional Index Quiz here to discover your top four personal and emotional needs. Creating the right relationship with your money is critical to your financial freedom and as a bonus, once you satisfy your emotional needs, you’ll also be more attractive to love and relationships. Learn more about your personal and emotional needs here.

 Step 3. Boost your emergency fund.

The goal of your emergency fund to help you reach financial freedom is to have three to six months of living expenses in a savings or money market account. This will provide a bigger cushion for the unexpected shocks such as losing your job or having an illness or injury. You want to make sure you can cover your rent and mortgage and living expenses until your insurance kicks in. If you have dependents or a family to look after, are self-employed or in a tenuous career, you might want to increase that emergency fund to one to two years of living expenses.

Step 4. Increase your savings rate.

Now that your high interest rate debts are paid off (except your mortgage), you can afford to ramp up your retirement savings, redirecting all debt payoff monies towards your financial freedom and retirement accounts. Set a minimum of 20% of your income with a goal to contribute the maximum allowed to your company 401K (you can get a solo 401K if you own your own business). Fully fund your traditional IRA or Roth IRA with automatic investing. Your investment house will help you set up automatic contributions. If you can’t invest 20%, then start with 10% and gradually increase the amount until you’ve achieved your desired savings rate. Once you’ve filled your tax-deferred accounts to the maximum allowed, you can increase saving in your taxable accounts.

If you want to retire early, before you can access your retirement accounts, you can do so by increasing your savings rate in non-retirement or taxable accounts. Amazingly, you can set your own retirement date by choosing your optimal savings rate. Again, automate your retirement savings with automatic contributions. Increase your contributions to investments as your salary increases. If you get a bonus or inheritance, the hard data is clear: invest it all in a lump sum and you are likely to do better than drip-feeding over time via dollar-cost averaging.

What if the thought of saving more sounds painful? Don’t worry, it doesn’t have to be. Yes, frugality can be a powerful tool for speeding your way to an earlier retirement, but it isn’t the only way. Read more here to learn how you can save money without struggling or sacrificing the quality of your life.

Step 5. Use compounding and leverage to your advantage.

A key fact to keep in mind: at a 7% rate of return (the average rate of return you are likely to get in a 60/40 stock/bond balanced fund over time), your money will double about every 10 years, even if you don’t add any extra money – the incredible power of compound interest! Obviously, you want to maximize the number of doublings and the easiest way to do that is to get a decent chunk (think $50K to $100K) invested as soon as possible – before you turn 30 ideally.

If you start in your 20’s, you will have four possible doublings before you retire in your 60’s and five possible doublings if you wait until your 70’s to retire. However, if you wait until your 30’s to start investing for your retirement, you’ll only have 3 doublings before 60. And if you wait until your 40’s you’ll only have 2 doublings before 60. Every year you procrastinate, you make it even harder to reach your financial freedom goals and harder to retire.

Ah, but if only the stock market were that predictable and delivered a nice steady return. There is no guarantee that you’ll double your money bang on time every ten years because the stock market can go down as well as up and sometimes it goes sideways for a long time, which makes it even more essential that you start early because over a longer time frame, your likelihood of getting a good return increases while the risk of loss decreases. In fact, the longer your money is invested in the stock market, the less risk you’ll have a negative return, which is another reason why you are better off starting to invest as young as possible, before you think you can afford to, but not before you’ve paid off those high interest rate cards! Don’t wait, get going now. The sooner the better.

If you don’t know where to start or what to do, just go to Vanguard.com (overall the lowest cost investment company) and ask them what to do. By funding your retirement account before paying off your mortgage, you are using leverage to your advantage. Getting a higher return on your investments and taking advantage of low interest rates. Leverage can cut both ways so use it cautiously.

Step 6. Increase your income.

Start that sideline gig or hobby business. Invest in additional training or develop special skills that will enable you to command a higher salary in the workplace. Work hard and ask for raises and promotions regularly. Read this article on how to ask for a raise. Invest in coaching and personal and professional development courses so that you get the competitive edge at work. You can make yourself a better, more valued employee. If you’ve always wanted to start your own business, a coach can make the jump into self-employment easier. When I started my coaching company years ago, my coach saved me loads of money by preventing me from making mistakes. Leverage the experience and knowledge of others to speed up your own results.

Here is a fun fact: for every $10,000 you earn in a lifestyle or hobby business that you’d continue doing in retirement, you’ll need $250,000 less invested in your retirement fund. Wow! That could really speed things up and take you to a much earlier and happier retirement. And, if your hobby business grows, you might be able to quit your day job and retire super early doing what you love for as long as you wish. The real goal after all isn’t to quit work, but to have the freedom to do what you love and enjoy. The latest research on happiness makes it clear that those who are actively engaged and participating in life in retirement are happier and healthier. Our job as life coaches is to help you create such an amazing life, you never want to retire from it!

Step 7. Pay off the mortgage and save for education.

Once you’ve set your savings rate for retirement, you can then look at paying off low-interest rate debt, such as your mortgage and start saving for your children’s education if you want to. Your retirement is far and away the most critical so give it top priority before you start thinking about paying off the mortgage or funding the kid’s education. Remember, your kids can get loans and scholarships, but you can’t get a loan to pay for your retirement.

Most retirees are happy they have a paid for home as it provides a feeling of security and serves as a nice hedge against inflation, but you shouldn’t pay off the mortgage before investing in your retirement fund or you’ll lose that critical doubling time in the stock market. You want to get your retirement pot on the boil as quickly as possible in order to get the power of compound interest working in your favor. Then at some point, you’ll discover that your investments will grow nicely all by themselves and you can enjoy spending on the fun stuff in life. This is the joy of financial freedom! Your money makes money without you lifting a finger.

What are you waiting for? Get on the path to financial freedom today. If you want to learn more, click here for the Financial Freedom, Retire Early video course.

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