In honor of Independence Day I want to discuss my big dream – financial independence. Most of us depend on someone when it comes to money like your clients, employer, spouse, or parents. There are very few people who are born financially independent and they always have someone else to thank for it. However, everyone can and should take steps towards financial independence. Some experts define financial independence as 25 or 30 times your annual expenses saved. Depending on the size of your bank account this may seem impossible. Don’t let that deter you from trying. Freedom isn’t free – but it is worth it.
First Step to Freedom
To start, you need to assess where you are at financially right now. To find your income you should look at your most recent tax return (or a few tax returns if you have variable income). That is the easy part. Most people do not know their annual expenses. They also tend to underestimate when they guess – often by a lot. If you want to reach financial independence you have to take a look backwards to see what you spend. Some of these expenses might be fixed, like a student loan or a mortgage. To figure out the rest you can look at your credit card or bank account statements. This part can be unpleasant but it is imperative to look at what you use your money for. If you don’t want your lifestyle to change at all you can stick with this number and skip to step three. If you spending seems out of control focus on step two.
Second Step to Freedom
Which part of your spending history makes you cringe the most? Mine is food. I’m not alone either – Americans spend a lot of money on groceries, takeout and convenience in this area. Skipping a latte will not make you a millionaire. However, if you are spending $150 on groceries each week and throw out $75 worth of them because you go out to dinner 3x (at $50 a night) you should make some changes.
No one is going to judge you for not buying a bag of salad if you know you are going throw it away unopened. Start planning your meals – including the ones you will cook AND go out for and shop accordingly.
If shopping is where you overspend, you can trim that budget by thinking about what you need vs. what you want. Also, you can start asking yourself these 3 questions before you shop. It really doesn’t matter what area you decide to reduce. What matters is that you know in your mind what a decent lifestyle looks like and get back to that point. For example, if “extravagant” = golfing twice a week and “depressing” = once a year maybe “decent” = once or twice a month. You still have to live your life but real change requires some sacrifice.
Third Step to Financial Freedom
Your expenses are going to grow over time thanks to inflation. This means your money needs to be working for you as well. Investing your money might seem intimidating but you shouldn’t be afraid of it. If your employer offers a retirement plan that is a good place to start. They will often make a matching contribution on your behalf to your account to encourage you to participate. You don’t want to pass up any money when financial freedom is your goal. Saving here convenient and easy to stick with so if you can max it out – you should. If you don’t have an employer sponsored plan you can look at other low cost investment options to start saving.
Depending on your income a Roth IRA might provide more flexibility for people that might need to take the distributions earlier than age 59 1/2. You pay taxes on your money before you invest it and if you follow the rules you won’t pay taxes on the growth. Also, you are not required to take a minimum distribution (RMD) at age 70 1/2 which gives you more control over your money. A traditional IRA allows you to take a tax deduction on your contribution. You do not pay taxes on the money until you take distributions. If you want to take money out before 59 1/2 you will likely be subject to a 10% penalty and taxes.
Consider your time horizon when you open any sort of investment account. Being consistent and saving a ton is huge when it comes to financial freedom. However, 401k and IRA’s aren’t invested – they hold investments. Do your homework on the investment choices available inside them or ask a professional for help. It may seem overwhelming if there are too many choices. Also, choose something that matches your risk tolerance. The more time you have the more flexible you can be when it comes to risk. You don’t have to (and shouldn’t) treat all of your money the same way. For example, my retirement accounts are much riskier than my emergency fund.
Ready Aim FIRE
FIRE means financially independent retire early and it is exactly what it sounds like. These people are looking to quit working as soon as possible. Often, they have high paying jobs that help them get there but not everyone does. If you plan to FIRE the types of accounts you choose will be important. You wouldn’t want to pay taxes and penalties on your savings if you decide to retire in your 40’s. A different strategy combining these and other vehicles like Health Savings Accounts (more on those here) and taxable accounts will make the most sense. Slashing debt will allow you to keep more of your money so you will need a plan to pay back debt aggressively. That and a frugal lifestyle can make it possible for you to quit your day job way before your Social Security retirement age.
Personally, I would rather have work that I love and do it for as long as possible so FIRE isn’t for me. Financial independence and a side income stream on the other hand sounds perfect. I’ve never been good with too much “free” time. Also, I think people who just want to retire because they hate their job would be better off finding a new job. You should have a dream that goes along with the goal or it’s a tough road. I respect the hell out of the people who can do the tiny house living and measure their shampoo and toilet paper use to cut costs. It’s just not for me!
Financial independence should be on everyone’s to do list. Keeping more of your money can be the difference between staying in a bad job or relationship or walking away. Money gives you options and choices so feel good about making choices that will give you power in the future to choose your path. Do you FIRE or save for the future now? Let me know how you save in the comments!