Financial independence is the ultimate financial goal.
Once you’ve reached financial independence, you shouldn’t have to worry about making money anymore.
You’ll just need to stick to your spending plan.
Don’t want to work a traditional job anymore? You won’t need one.
Here is the journey you will need to take.
How to Achieve Financial Independence
Most people achieve financial independence when they reach 25 times to 33 times their annual spending in investable assets.
Some people want an even higher multiple to feel comfortable they won’t run out of money.
Generally, the younger you are when you reach financial independence, the higher the multiple should be due to the extended time you will need to rely on your investments for income.
Initially, it seems impossible to have 25 times to 33 times your annual spending in investments, so how do you actually achieve financial independence? Here are the steps I suggest following.
It’s completely doable, but it takes serious commitment to your goal.
Track Your Spending
Tracking your spending is the first step on the way to financial independence. You can track spending on the most basic level of total money spent, if you wish, or you can track your spending on a very detailed level and categorize every expense.
What matters most for financial independence is your total expenditures, since they determine the amount of money you’ll need in investments.
However, it is nice to have detailed data because it can give you information that allows you to realize where you may be spending too much money in a particular category. Armed with that knowledge, you can adjust your spending and reach financial independence faster.
The absolute easiest way to track your spending as a whole is use a service that aggregates all of your financial information in one place. I like to use Personal Capital to get a snapshot of my total spending through their cash flow tool.
All you have to do is link your bank, credit card and any other accounts you spend money on and they’ll import all of the data. Then, Personal Capital will make graphs explaining your total cash flows each month.
Action Step: Sign up for Personal Capital today and link your accounts to see how much you’re spending each month.
Spend Less Than You Earn
Now that you have an idea of your cash flow, you can figure out if you’re currently spending less than you earn. If you’re not, you should be in emergency mode!
Spending less than you earn is the biggest key toward achieving financial independence. In fact, you should aim to save as much as possible while living a lifestyle you’d be comfortable living for the rest of your life.
Why? The larger percentage of your total income you save, the earlier you’ll reach financial independence.
It may be tempting to sacrifice some spending today to reach financial independence faster. Just remember, scrimping now to reach financial independence early will not achieve your goal.
Since your financial independence is based on the amount of money you’re spending now, scrimping now will mean you have to scrimp once you hit financial independence, too.
Instead of cutting everything you love in your live to increase your savings rate, you should learn to spend consciously.
Conscious spending is the idea that everything you spend money on was spent for a reason. Today, many Americans simply spend money without thinking about how it will affect them down the road.
People spend thoughtlessly every day on eating lunch out at work or buying gifts that no one will remember a year from now. Instead of wasting money on these things that you probably don’t enjoy, quit spending on them.
Only spend on things that you either truly need or things that you consciously decide you want. It will take some time to get used to, but if you ask “Do I really need or want this?” before every purchase you’ll be shocked how much money you can save.
Pay Down Debt or Invest the Difference
After you start spending less than you earn, you’re going to have a cash surplus each month. There are four things you can do with this cash surplus, three of which I personally recommend. You can:
- pay off debt,
- invest or
- spend (not recommended).
If you’re just getting started on your financial journey, I suggest establishing a small emergency fund in a savings account. Small may be $500 or $1,000 for one person while it could be one month’s worth of expenses for someone else.
If you have a retirement account that matches your contributions, make sure to contribute to the match even while starting your emergency fund. Employer matches are essentially free money and you should never skip free money.
Next, pay off all high interest rate debt. To me, high interest rate debt is anything with an interest rate of 8% or higher.
After the high interest rate debt is paid off, switch back to saving in cash to boost your emergency fund to a comfortable level.
For most families, a fully stocked emergency fund should be anywhere from three to six months of expenses. Rare cases, such as a self employed family, call for as much as twelve months worth of expenses in cash.
Then, pay off any debt that makes it hard to sleep at night. For us, that was my wife’s $80,000 of student loan debt even though most of the interest rates were below 8%. However, we don’t mind having a mortgage so we aren’t paying that off aggressively.
After your high interest rate debt is paid off and you’ve built an emergency fund, it’s time to kick up the speed on investments.
You can invest in retirement accounts, such as 401(k)s, Roth 401(k)s, TSPs, 403(b)s, IRAs or Roth IRAs depending on your preferences.
If you believe you’ll hit financial independence prior to the age in which you can withdraw from retirement accounts, you’ll likely want to set up a taxable investment account and invest there, too.
Finally, spending part of your extra cash flow, which I don’t recommend, should only be done with caution and done consciously.
Any additional spending will delay your financial independence both from an increased expenses and a decreased investments perspective.
Next Up, Earn More Money
Once your consumer debt is gone and you’ve started investing, it’s time to work on earning more money.
Growing your income is a great way to accelerate the timeline to reach financial independence, as long as you don’t spend the extra money you make.
Whether you decide to pursue a big raise and promotion at work or you decide to start a side hustle, you have unlimited potential to earn more money. Figure out how you want to make more money and commit to making it happen.
Every extra dollar you earn can be invested for your future. This essentially increases your savings rate and moves your financial independence date closer to today.
Watch Your Investments Grow
Part of the journey to financial independence will involve checking in on your progress. Personally, I like to keep up with my investments through Personal Capital.
All I had to do was link my accounts once and they pull the data in automatically for me. It’s nice to be able to look at my investments without logging into my brokerage account.
Personal Capital doesn’t have access to perform transactions. They can only view data. That means I won’t be tempted to make any rash decisions such as selling an investment because the markets had a bad day when checking on my progress.
I personally track my net worth monthly, but you can take a look quarterly, twice a year or once a year if you find that works better for you.
Once you link your accounts in Personal Capital, you’ll only have to go one place to check how you’re doing compared to your net worth and financial independence goals.
Action Step: Get started today by opening a Personal Capital account and linking your accounts. Then, commit to check on your progress on a regular basis by setting reminders in your calendar.
Reach Financial Independence & Celebrate
Once you finally reach financial independence, it’s time to celebrate! Now, you can do whatever you want with your time, as long as you stick to your annual expenditures you used to calculate your financial independence number.
Want to volunteer at an animal shelter instead of working a paying day job? You now have that option. Find out you don’t like volunteering at an animal shelter? Do something else! Money will no longer dictate what you do with your time.
Personally, I look forward to my financial independence. While I currently enjoy what I do, I want to have the ability to change my mind at any time without worrying about how it will affect my finances.
The freedom of financial independence is the ultimate financial goal.
Are you ready to start on the path to financial independence today? If not, what’s holding you back? Let me know in the comments below. I’m excited to hear your thoughts, ideas and stories!
Photo by: Christine Rondeau Text added by: Lance Cothern