- Personal Finance
5 Steps for How to Achieve Financial Freedom and Independence
Financial freedom means having sufficient personal wealth to cover your living expenses from sources other than employment. The allure of financial freedom is obvious. It means freedom from the daily grind and the ability to spend more time doing the things you enjoy such as spending time with loved ones or pursuing a hobby. Many people spend their lives stuck in a cycle of work more, spend more. As soon as they get a pay raise, they buy a bigger house or a nicer car. Then when the next pay raise arrives, they move up again. In this situation, it's impossible to achieve financial independence because you'll never create enough wealth or live small enough to make it a reality. By following the steps below, financial freedom is possible, even for those with modest incomes.
Step 1: Pay Off Debt
If you have debt, paying it off should should be your biggest priority over and above saving. This is especially true for credit card debt because of the high interest rates charged. Debt increases your monthly living expenses and makes it very difficult to achieve financial independence, not only because you have to make a payment every month but also because you're paying interest for the privilege of carrying the debt. In other words, that $3000 vacation that you put on your credit card will quickly become a $5000 vacation if you don't pay it off right away.
After you're done paying off your debt, don't take on new debt. Pay for purchases in cash, or think twice about making the purchase.
2. Reduce Your Living Expenses
It's easier to become financially independent when your living expenses are low. At first, this will allow you to live below your income level so that you can pay off your debt. Over time, it will allow you to build up your savings which will then be invested to generate income. In order to reduce your living expenses, you first have to know how much you spend. Take a few months to record every purchase you make and categorize them into buckets such as Rent/Mortgage, Groceries, Utilities, etc. Then compare what you spend to what you take home in income. You should have a surplus after expenses that you can use to pay down debt and then save. The biggest expenditures for most people are housing, transportation, and food so concentrate on those areas for savings opportunities. You can still have a latte every now and then if you save a lot of money on the big things.
Living small has an additional benefit. As you'll see after reading the next few steps, when your living expenses are low, you'll need to save a lot less to generate the income you'll need to maintain your lifestyle.
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3. Build Up Your Savings
Once your debt has been paid down and you have your expenses under control, it's time to start building up your savings. This savings will become your capital that will be used to generate income to replace your income from paid employment. Most experts say that paying yourself first is the best way to ensure that you save. If you don't see the money, it's likely that you won't spend it. So set up a budget with your new, lower expenses and your expected monthly savings. Then, arrange for the savings amount to be transferred directly to a separate investment account each month.
4. Invest Your Savings for Income
In today's interest rate environment, it's very challenging to invest for income. Banks pay less than 1% interest and CD's aren't much better. It's time to look elsewhere if you want to achieve financial independence. There are several investments that can generate higher returns. The first is U.S. Treasury Bonds or corporate bonds. For example, thirty year Treasury bonds are currently paying about 4.6% interest, which means you'd need to have approximately $200,000 in capital to produce income of $10,000 per year. The second investment option is dividend paying stocks. Some, like Real Estate Investment Trusts (REIT's) pay large dividends because they're required to by law but are more risky. Others, like McDonald's or AT&T pay smaller dividends but are more stable. It's possible to put together a portfolio of dividend paying stocks that pays an average dividend of 6% - 8% per year. Before investing, do your research. Know the company you're investing in. All investments carry risks so it's important to understand them before you buy.
5. Quit Working
When your investment income exceeds your income from employment, you get to quit working! An added benefit is that your living expenses will probably decline after you quit your job. You'll no longer have a long commute to pay for and you may not need to spend money on suits and nicer clothes. You'll also probably cook more at home, reducing what you spend on food. Finally, if you hired people to do your yard work or clean your house, you'll now have time to do that yourself, eliminating another expense.
Achieving financial independence is possible if you pay attention to the details of your finances and take a disciplined approach to reducing expenses, saving, and investing for income. Even those with a modest income can accomplish this. The beauty is that if you're already used to living small, you'll need to save far less to generate the income required to maintain your lifestyle.