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What exactly is financial independence?
The simplest explanation is that it is the point at which your income from assets is able to cover all your expenses. Financial independence is being able to not work another day in your life and still be financially solvent.
Sounds great you say. But also, completely unrealistic to the average person.
While that is technically true, it’s not true for the reasons you think. The average person doesn’t think it is possible and therefore lives and spends as if it will never happen for them. Once you give yourself the hope that it is possible to reach a point of financial independence, you start to look for how to get there.
Breaking It Down
Financial Independence or FI is easiest to reach if you break it down into stages. I was first introduced to this way of thinking by JD Roth of Get Rich Slowly and his Six Stages of Financial Freedom. In his article, he describes six different levels of financial freedom started at Stage 0 (Dependence) all the way up to Stage 6 (Abundance).
Inspired by this I set out to create a (basic) guide map of how to reach that end goal of Financial Independence, with all of the little steps in between.
The Steps to Reach Financial Independence
Step 1: Self-Reliance
Find a way to pay all your bills yourself without relying on credit cards or personal loans (from institutions or family/friends)
The most common ways of doing this are:
- Taking a hard look at your expenses and reducing them where you can
- Pursue a raise at your job
- Get a second job or start a side hustle
Right now, I’m here. It’s been a struggle (yay cost of living!) but every journey starts somewhere. For me, this meant moving out of a house with 3 of my close friends, and into a travel trailer located on my family’s property. Although it was a sacrifice in both space and sociability, it also saved me quite a lot that I can now put towards my emergency fund and my debt repayments (hello student loans!)
Step 2: Start to Save
Being able to pay all your bills each month is a great starting place. All it could take is one emergency (a visit to the ER, a car accident, a cut back at work) to send you right back to zero though. Because of this, once you’ve reached self-reliance it is important to start contributing to an emergency fund. An emergency fund will help cover you if an unexpected expense pops up, without you having to resort to high-interest credit cards or payday loans.
Step 2 is to open a savings account and save between 1 and 6 months of your expenses. I would suggest saving aggressively until you have at least 1 month of expenses in savings before moving on to step 3 but continuing to put some in savings each month until you reach between 3-6 months of expenses depending on your risk tolerance.
Step 3: Pay Off Your Bad Debt
In this step, you will begin the road to paying off your “bad” debt. Here “bad” debt is defined as credit cards, personal loans, and anything else with an interest rate over 10%. The main reason this debt is prioritized and is considered bad is that it is both a financial and emotional drain. The longer you keep it, the more of a drain it becomes due to the power of compounding interest. Additionally, most of this type of debt comes from either emergency or impulse spending. Neither of which pushes your life forward like “good” debt (mortgages, student loans, and to a point, car loans) can.
As stated before, continue to put a little into your savings each month as well until you reach your emergency fund goal of 3-6 months of expenses so that you don’t end up wiping out all of your debt reduction progress with the next emergency that comes around. I would suggest between 10-50% of the amount you put towards your debt should be put into your emergency fund until it reaches the 3- 6-month point.
Step 4: Build Your Nest Egg
Now that all your “bad debt” is paid off and you have a good cushion for any emergencies, it’s time to start building up those assets that eventually will provide the entirety of your income.
It’s that this point that you should consider working with an accountant or financial planner. These professionals will be able to steer you towards sound investments that will propel forward fast while limiting your tax burden. If you go the financial planner route just make sure that you do your research and get a fiduciary (meaning that they only make recommendations that are in your best interests rather than what gets them the highest commission) and are fee-only (meaning that they only charge you a set amount for services rendered rather than a percentage of your assets that they manage)
In the meantime, put as much as you can towards these easy investment vehicles of your choice.
- Max out your 401k, your IRA, your HAS and any other tax-advantaged account you might have access to, and
- Put the rest in the Vanguard Total Stock Market ETF (VTI)
For Step 4 you will be investing until you have enough investment income to cover your basic expenses. These are the bare necessities you need to cover to survive like shelter, food, and transportation. This is the first level of financial independence. With this level of investment income, you could conceivably lose your job at any point and still be okay with a minimum of worry.
Step 5: Become Completely Debt Free
Once you reach that basic income threshold, your next step is to pay down your remaining debt obligations (mortgage, etc.) more aggressively until they are completely gone. This will not only give you peace of mind but will also reduce your monthly expenses and give you more each month to put towards your investments.
Step 6: Invest Until You Cover Your Current Expenses
Now that you have your basic expenses covered and all of your debt paid off, all that is left is to continue investing until you have your current lifestyle covered by your investment income.
Once you hit this, CONGRATULATIONS! You’ve hit full Financial Independence!
(Optional) Step 7: Invest Until You Cover Your Ideal Life
An optional 7th step is to continue investing after you’ve reached your current level of expenses until you hit whatever income level you would like to live at. In the finance community, this is called FatFIRE, which essentially means that you want and even more luxurious lifestyle after retirement than you are capable of with your current budget.
And that’s it! You’re financially independent!
Whether you decide to stop at step 6 or 7, (or even 5!) know that you’ve accomplished something amazing. Financial independence is not impossible. It all starts with a single step.
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