Financial independence is defined as being comfortable with your financial situation, not necessarily have enough money to retire early.
Thus financial independence can be a goal for a middle-aged person, as well as someone who is starting off. No matter where you are, achieving financial independence can be a matter of months to a couple of years.
And it is worth it, since you will feel so much in control and at the same time, excited about building your net worth. As you get more towards Financial Independence, you will thank yourself for starting somewhere.
The following six steps are the stepping stone to the world of financial independence.
The net worth
No matter at what stage you are or how bad or good your finances are in, there is a number which gives the accurate picture. Simply listing all that you have as assets and all that you owe, and a simple arithmetic can provide this very important number.
Net worth = Assets – Liabilities
It’s that simple. However it tells you if you are positively wealthy or negatively broke.
Five metrics of personal finance
Pay off debt and find surplus money
Now that you know where you stand, you want to increase your Net worth.
If the Net worth is negative due to high debt, then of course you want to pay off debt.
This strategy of paying off debt will require discipline and sticking to a budget.
The budgeting in turn has a snowballing effect. The more months pass while you stick to a budget, the easier it becomes to pay off debt.
And as debts get paid off, the earlier payments now become available as surplus money.
Build an emergency fund
What to do with the newfound money as you pay off debt or stick to a budget?
Yes build your emergency fund, because emergencies do not wait for anyone.
Thus this has to be your highest priority as soon as you start getting control over your finances.
There are typical thumb rules of 3-6 months of expenses to be saved as emergency fund.
While it is a good rule, the actual amount depends on your own situation and how much security you need.
Of course, in the beginning you will not have 3 months saved up, not even one full month’s expenses.
So the idea is keep building this as long as you can. No amount of emergency fund can be too much, until you realize you have enough liquidity. People pursuing financial freedom even have 2 years worth of expenses saved up, they just call it Freedom Money or something similar.
Fund your short and medium term goals
As you get more control of your finances, you will see that you no longer think about dreams and obligations as not-achievable. In fact, you will now start planning for new goals like a house, vacation or higher education.
This is like another emergency fund, except that it will have a longer time horizon when you will need the money. This means in some cases for goals 3-5 years away, you may be able to invest the money to grow and not just save it in a savings account.
It is better to create separate bucket for each goal and in fact open new savings/brokerage accounts (or sub-accounts) for each.
Bucketing your money for different goals also has the advantage that one expense will not eat into the other one. For example, you may not buy that extra-bedroom house if your house bucket does not allow enough down-payment or affordability.
Invest for the long term
You don’t have to wait for all prior steps before doing this. This can go in parallel to the funding of your short and medium term goals.
The investment and the short term savings are budgeted for in the monthly savings plan.
They should in fact be setup as “pay. yourself first” and the long term investment ideally should be in tax-advantaged or tax-deferred accounts.
It is good to start investing as soon as a decent emergency fund is ready. This gives the investment time for compounding over the long term.
The 3 dimensions of investment planning
The steps we discussed above do not happen overnight or in bursts. They are built over time through a series of monthly actions. This is cash flow management and building assets slowly, the right way.
It is not humanely possible to repeat the same steps or manually budget every month.
Thus it makes sense to automate the steps through auto-debit and auto-transfers.
Everything from paying off debt to saving for emergency fund, short term goals and investments should be automated.
FinTech – can you be immune to it?
The SAFE plan – Simple, Automated, Flexible and Efficient
Here in this blog, we presented 6 steps to achieve financial independence.
The simplicity of the steps may make you wonder whether it will work.
There is no complex mathematical and financial calculations, no talk of IRR, DCF and investment types.
You do not need a complicated method to start or dig yourself out of a debt hole to a life of Financial Independence. This is the Tortoise way.
If you want to read about setting a minimalistic system for your finances, read the below post.