This post will review the key stepping stones on the path to financial security and independence. Whether you start off with a negative net worth due to debt, or simply don’t have a plan, these are the steps that anyone can incorporate into their lives so they can begin building wealth.
Too often I hear how amazing the FIRE (financial independence, retire early) community is and how everyone should strive to achieve this lofty goal of financial freedom. But what does it really mean and how can you or I really go about changing financial habits enough to even attempt it. Unless you are ready to commit 100% and dive down the rabbit hole of FIRE blogs and information scattered across the internet, it’s too overwhelming and time consuming to even contemplate with any seriousness.
This is why I have written this article highlighting the main steps which are consistent and necessary to anyone’s journey to FI. Regardless of where you are on your personal journey, these steps provide guidance on the general direction the path needs to take. Learn them all, but focus on one at a time and spend as long as you need to along the way. Your journey is unique.
Just remember, we only live once, let’s make the most of it and live our very best life. FI is simply the tool we can use to do just that.
Contents and Quick Links
- 1 What is Financial Independence?
- 2 Why Financial Independence?
- 3 What are the Stepping Stones to Financial Independence?
- 4 Step 1: Money mindset
- 5 Step 2: Goal set for success
- 6 Step 3: Follow the money (track your spending and adhere to a budget)
- 7 Step 4: Own your money (payoff debt)
- 8 Step 5: Save your money
- 9 Step 6: Earn your money
- 10 Step 7: Put your money to work
- 11 Recap
- 12 Helpful resources
What is Financial Independence?
The definition of financial independence will vary widely depending on whom you ask. Like personal finance, it’s just that. Personal. For me, financial independence, or FI, is the freedom to work because you want to, not because you have to. It is a comfortable step up from financial security.
In other words, it means I have the freedom to leave my W2 job, either temporarily, or permanently.
It means the freedom of opportunity. Opportunity that would otherwise pass me by while I’m too wrapped up in the daily grind of just making ends meet.
And financial independence means the flexibility to pursue a variety of lifestyle and income earning opportunities.
Here is a very incomplete sample of how other bloggers and writers define financial independence.
“Financial Freedom means you can make your own choices.” – Retire by 40
“Research has shown time and time again that seeking happiness doesn’t make us happier, but living with purpose does. And when work becomes optional for you, you can devote yourself entirely to living a purpose-filled life that you’ll be proud to look back on.” – Our Next Life
“For me, financial independence is simple: it means that you are not beholden to a job to provide for your livelihood. Instead, your wealth – acquired through a high level of income or aggressive savings plan, supports your lifestyle. While you may still work, you don’t need to. You work because you enjoy it.
To my wife, financial independence is a choice. It refers to the ability to choose the life that we all desire and live it as the person that we all choose to be.” – Think Save Retire
“The key part is to turn that idea of financial independence that you have in your head and in your heart into a long term goal, one that you’re planning on reaching in the future. What can you do today to move towards that definition of financial independence?” – Trent Hamm, The Simple Dollar
But what does it actually mean to achieve FI? What does FI look like? Here are a few different definitions of FI:
FI definition #1: Achieve the 4% rule
The well respected and trusted Trinity Study demonstrates that once invested assets (such as a combination of stocks and bonds managed within investment accounts) reaches a total value of 25 times your annual living expenses, you can safely withdraw 4% every year without depleting the original value.
In other words, if you spend $40,000 every year, and you have $1 million saved across your work 401(k), Vanguard personal IRA and your after-tax ROTH IRA and standard investment account, you can safely withdraw 4% of your investment every year ($40,00) and still maintain your $1 million principal over time.
This means that you could simply save a large percentage of your income in both pre and post taxable investment accounts, and once you reach that target amount of $1 million, you can leave your job, retire early, and live off of the interest earned from your savings.
However, there are some inherent problems with this strategy. The 4% rule assumes you don’t start withdrawing until later in life (it is sustainable for only so many years) so if you begin at the age of 40 and live into your 80’s, the chances of having enough to support a 4% withdrawal rate is less reliable.
It also assumes that your living expenses will remain constant. This is rarely the case with rising healthcare expenses, failing health and the desire to live a more comfortable life further into retirement. Assuming a 3% withdrawal rate, or saving 33 times your annual expenses, is likely a safer rule to follow for those retiring early.
Tanja from Our Next Life and author of Work Optional: Retire Early the Non-Penny-Pinching Way, brings up many relevant points.
“But here’s the thing about the whole discussion: Debating whether it should be the 4% rule, the 3.5% rule, the 3 percent rule — heck, the 1 % rule — all of it misses the point.
It especially misses the point for early retirees, who have much more than a 30-year horizon, if we’re all lucky — perhaps several decades more.
The fundamental problem with any “safe” withdrawal rate is the underlying assumption of level spending over time.”
No one can truly predict what the future holds, but we can aim to be over-prepared.
FI definition #2: Passive income surpasses monthly expenses
Another option is to create passive income through various investments. This could be collecting royalties on a patent or intellectual property like a novel. Or it could mean starting a business that can later be managed passively without your involvement. It could be in the form of owning real estate and collecting rent and building wealth through increasing equity.
Once your passive income surpasses your monthly expenses, you no longer need rely on a paycheck and are financially independent.
FI definition #3: Passion income
Personally, I define financial independence as the ability to create income through work you love. There are so many possible ways to earn a living, but very rarely do we have the freedom to explore these more creative options.
I can’t leave my current career in order to build a real estate business or work on this blog full time, I still need to save more money and invest to build my net worth. But the goal is to save enough money that I can support myself on savings and investments for an extended period of time, then have the financial cushion to grow my passion project into a full time income.
You could argue that I’d still be working and therefore this isn’t true financial independence. But what would I do without any work at all? I’d go crazy!
I still need a purpose and I still want to be occupied. I still want to add value to both my life and the lives of others.
I don’t want to retire early and sit on the porch all day long. I want the freedom to spend my hours how I choose, working for myself or on something that I love.
FI definition #4: A combination of each
Who says you can’t have all three? Here’s where the personal comes into the definition of financial independence. You can use a combination of the three definitions to pave the path that works for you.
Why Financial Independence?
Financial independence is not difficult to achieve for most people. But it does take time and it requires a willingness to accept change. Your habits and financial outlook will change and as you save more money, you will find yourself going against the consumerist grain of our society. And that isn’t always easy.
So why bother?
Why not just keep to the traditional path, save a percentage of each paycheck in the employer sponsored retirement account, retire at 65 and collect social security? This is the normal path to retirement.
If you love your job and this is all you want, this is perfectly fine.
But if you want the freedom to explore other work opportunities, such as entrepreneurship or a passion project that might not pay as well, or simply desire the freedom to walk away from work for a period of time, the traditional retirement plan won’t work.
If you want the freedom to explore your interests and find your purpose in this life, be it launching a business or simply being home with your kids, financial independence is key.
What are the Stepping Stones to Financial Independence?
First off, everyone’s steps will be individual. Personal finance is truly personal and your journey will be unique to your life circumstances, preferences and needs. That said, there are some basic and fundamental steps that will help you begin your journey and make progress towards financial independence.
Step 1: Money mindset
Your outlook on money has a huge impact on your ability to save and build wealth.
Understanding your current mindset can be empowering. I began my journey with a very different outlook. If there was money in my account, I was doing okay. If there was a lot of money, then I could splurge a bit more than usual. And if there wasn’t enough to cover my credit card bill, it was time to cut back and be more frugal.
This is how I balanced my finances month to month. Why? Because I didn’t know any different and this was the money mindset I was familiar with. It was also very much aligned with everyone around me.
However, once I started thinking further ahead into my future, and dreaming of a better life with more time with my son and less money anxiety, my mindset began to shift.
I started examining my spending habits and making small changes regardless of my checking account balance. I began to think of long-term goals rather than my present wants. I found ways to work around my deeply ingrained spending habits rather than force an immediate (and unrealistic) shift in behavior. I started automatically “spending” the extra money in my checking account by moving it to a savings account.
Slowly I became better and better at saving and my overall habits and outlook began to shift.
As you begin the journey to financial independence, your own money mindset will also begin to shift and evolve.
If you have a hard time saving money, it could just be your own limiting beliefs, financial background and mindset. I found this book to be insightful and beneficial to helping me understand my own money issues when I started my journey to FI.
The myth of expendable income
Emotional shopping, similar to emotional eating, is the need to reward yourself with something nice because you work so hard during the week. When you have money left over at the end of the month or after a windfall, there is often the urge to spend it right away before it disappears. Without a plan in place, extra money is just that, extra money. This is why it’s called expendable income!
But your money should not be expendable. With a plan in place, and the ultimate reward of FI as your end goal, that extra money has a place to go. It has a defined purpose for paying off debt, building up an emergency fund, or investing for growth in long term ETFs, an IRA or investment account for your side hustle.
Step 2: Goal set for success
If you’ve continued to read this far, you probably have some idea of what your ideal life should look like in the future and why financial independence would be important to you.
One key step to financial independence is clearly defining what makes you happy and determining what it will take to achieve your ideal life. Define what your end result will be, and how you will get there.
The whole point of FI is having the freedom to live your ideal life. But how does one actually break that down into a series of goals and actionable steps to get there? This is where goal setting is so very important.
I started my journey by looking ahead 10 years and envisioning what I wanted my life to look like. I defined a few goals across different areas of my life. Then I broke each one down into the smaller goals I will need to focus on right now, over the next year, and within the next 5 years. If I focus on these small steps, I will be making progress and work my way closer to my ideal life.
You can read more about this process at: How To Define Your 10-Year Goals And Live Your Best Life
If you are curious what my personal 10-year goals are, I’ve published them here: 10-Year Goals: 2019
Not sure how to define what makes you happy and what your ideal life might be? You aren’t alone! This is why I wrote: How To Design a Happier and More Fulfilling Life
Step 3: Follow the money (track your spending and adhere to a budget)
The very first step you can take to map out your overall plan to become financially secure and achieve FI is to uncover where your money goes. This is so important! In order to control your money, you need to understand where every dollar goes.
You can do this by tracking your spending and creating a budget.
You can learn more about tracing your finances at: How To: Track Your Personal Finances
Here’s what I learned about my spending habits when I started tracking my own finances: I Tracked My Finances For One Month: This Is What I Learned
To learn how to get started budgeting, visit: The Beginner’s Guide to Creating a Budget You Can Stick To
Step 4: Own your money (payoff debt)
If you carry debt, you don’t really own your money. It’s quite possible to have a negative net worth. If this is you, it’s time to make debt payoff a priority and be aggressive about paying it off and taking back control of your finances.
To start off, it’s helpful to understand the difference between good debt and bad debt.
Bad debt: This type of debt doesn’t help you. Debt that you have to pay interest on and does not qualify as an investment (does not earn money or gain value) fall under this definition. Credit card debt, car loans and student loans can be considered bad debt.
Good Debt: This type of debt will help you earn more money and increase your net worth. Your mortgage on a house that is appreciating is the perfect example of what can be considered good debt. Of course, if you bought your home at the top of the market with a high interest rate, that’s not helping you.
Note: Some people consider student loans as good debt. Here’s how I would look at this. Did you acquire student loans by going to an out-of-state or private university for an undergraduate in history that you have no way of practically utilizing? Or did you go to a local university or trade school to learn a skill set that will earn you more money than your prior potential?
There are two schools of thought on how to pay off your debt, there’s the Dave Ramsey snowball method, or the avalanche method.
List all your debts in order of smallest to largest, not worrying about interest rates. Each month, pay the minimum balance on all debts. With the money you have remaining, put all of that towards the smallest balance. In other words, attack that smallest debt and knock it out quickly. Once you pay off that debt, move on to the next. Now you have everything you were putting into the small debt payoff to be applied to the next debt. As you go down the line, you see a snowball effect such that your debt gets paid off more quickly.
List all your debts in order of largest to smallest interest rates. Each month, pay the minimum balance on all debts, then throw all your remaining money towards the debt with the highest interest rate. The thought here is that by paying off the high interest debt first, you will decrease the overall amount that you will need to pay.
You get to decide which method works best for you. Sometimes it’s nice to take care of the little debts first so that you can see your overall debts diminish and feel more motivated to keep up the momentum. Or, maybe the larger interest bearing debts need to be addressed first just to minimize the overall amount that you have to pay off.
It could be that the biggest interest bearing debt is the one that takes the longest to pay off and you risk losing motivation or feeling defeated when you don’t see progress. Since it depends on your unique situation and preference, pick a method that will keep you motivated to keep moving forward.
Make a debt payoff plan (And stick to it!)
Once you are tracking your income and expenses, and have a budget to follow, you know how much money you can apply to debt payoff every month. Using this number, you can then calculate how long it will take to reach your payoff goals.
Knowing how long it will take, and setting that date in your mind, or better yet on paper, will provide a lot of motivation to keep you going.
For more detailed steps to payoff debt, visit: How To: Payoff Debt – Like a Boss
Step 5: Save your money
The overall purpose of money awareness through tracking your income/expenses and paying off debt is to save more money. The above steps review how you can shift your money mindset and start spending less, but then what?
When you become serious about saving more money, there are 4 main steps to help you make progress:
- Calculate your personal savings rate so you know where you are right now
- Find ways to increase your savings rate
- Build up your emergency savings fund in a high-interest but accessible account
- Continue to save beyond your emergency fund and create a highly satisfying, opportunity inducing FU fund.
Calculate your personal savings rate
Your savings rate is the amount of money you save every month as a percentage of your total take home income.
Read more about how to determine your savings rate at: How to Calculate Your Savings Rate – And Why You Need To
Increase Your Savings Rate
Knowing your savings rate becomes a powerful tool because it allows you to easily check how small changes in spending habits or income can dramatically improve your progress.
Once you see improvements, and a growing savings account, it’s hard to not feel motivated to keep making those small adjustments and continue making progress.
Build your emergency fund
Recommendations vary based on how much this account should hold, but money should be accessible, not tied up in investments, and should cover 3-6 months worth of expenses. This could be a standard savings account through your bank, but here are some better options:
Standard savings account through the same bank you have your usual checking account.
Pros: Easy to set up (if you haven’t already) and access.
Cons: Very low interest yield, typically around 0.1%, much less than the rate of inflation. You can do better. If you have a large sum of money sitting in an account, it should be earning you interest.
Online high interest earning savings account
Pros: Federally insured up to $250,000, easy to access through withdrawal or funds transfer. Interest rates are typically around 2%, which is more than 10 times that offered from your bank’s savings account. This is possible because there is less overhead for these companies to operate online accounts.
Cons: An online only account can feel risky to some people. While they are insured and easy to set up, some people like to have a brick-and-mortar business to visit.
I currently use a Marcus high yield savings account for my emergency fund. It was easy to set up and easy to transfer funds when you need to access money. With any online account, it can take a few business days to transfer and access money.
I just learned about a new option, a high-interest earning online savings account offered through Personal Capital. While I haven’t tried it myself, they are currently offering interest rate of 2.3%, unlimited transfers, no minimum balance and it’s FDIC insured up to $1.5 million. The benefit here is that Personal Capital is wonderful for tracking finances, creating and monitoring your budget, as well as tracking net worth and investments. It’s a one-stop-shop that I use daily to keep an eye on my entire financial picture.
It’s a little tricky deciding which to do first, pay off debt or establish an emergency fund. The last thing you want is for disaster to strike, illness or loss of job, and not be able to cover your expenses. One way to protect yourself it to initially work on both at the same time. Set aside a certain amount to go toward paying off debt, then keep some extra handy in case you need it. This doesn’t have to be a full 3 months of living expenses, but you want a cushion to help you out if you need it.
Build your FU fund
Those who live paycheck to paycheck are slaves. Those who carry debt are slaves with even stouter shackles. Don’t think for the moment their masters don’t know it. – JL Collins
Not familiar with the term FU Money? AKA: F*@$ You money, F-You savings, you get the idea. Regardless of how you write it, it all means the same thing. It means financial independence for a period of time. You have enough savings to say F-You and walk away from your job.
There is nothing more satisfying than knowing you have enough in savings to simply walk away from a horrible work situation. I can certainly think of a few times where I felt so stressed out and emotionally drained from a toxic or even abusive work situation. Having an emergency fund that will cover 6 months to a year of expenses provides you with the power to simply walk away and find a better opportunity.
While your emergency savings is money that can be accessed quickly, FU money needs to be working harder and earning more money as an investment. But more on that later.
Step 6: Earn your money
Changing your spending habits will only get you so far. Eventually you reach equilibrium and simply can’t simply lower your expenses in order to save more money. This is when it’s time to earn more money instead.
Earn more money
The first step to increasing your income is to optimize your current earning potential. Can you ask for a raise at work? Can you add additional training and take on a new role with your current company?
Do some research and find out exactly what you are worth in your current role, or what you can do to improve your skills for a new role. See what other companies are paying for your position, what new hires are now earning. Talk to job recruiters about your unique skill set and get an idea of what that is worth. Then, you have the information and power to request a salary adjustment.
If you are open to a bigger change, look around for other positions and search for a higher earning job with a different employer. You don’t have to accept a new position, but if find one at a higher rate, you can either take it or use that offer to negotiate a raise.
Start a side hustle to earn more money
Once you have optimized your salary with your current employer, explore ways to earn money on the side. Whether it’s driving for Uber, completing online surveys or freelance writing, there are unlimited ways in which to earn additional income.
Personally, I’ve reached the point in my life where earning minimum wage (or less) on a side hustle is just not worth my time. I’m much more interested in creating something new by starting a new business venture. This can take the form offering consulting services, starting a real estate investing business, creating a blog like this one, offering VA services, etc. When it comes to entrepreneurship, the sky’s the limit, as are the income earning possibilities.
Here’s a fun little book that inspired me to start Stepping Stones to FI!
Step 7: Put your money to work
Let’s do a quick recap. On the path to financial independence, the key steps you need to focus on are adjusting your money mindset, tracking your money, then saving and earning more money. Once you’ve finally accumulated some savings, it’s time for the fun part! Putting that money to work for you.
Savings in excess of your emergency fund can be earning additional money through investing. This is when you can really begin to build your net worth.
For starters, if you aren’t maxing out your employer contributions, do that now. It’s free money!
For further reading on optimizing your employer-sponsored retirement account and the different types of retirement plans, visit:
Low cost index funds
There are limits to how much money can be contributed each year to retirement accounts. Once you reach those limits, you can continue to save and invest in taxable investment accounts. Low cost index funds are a great option for a high rate of return along with a low fee / expense ratio. Meaning, the cost to invest is very low compared to managed investment accounts.
Note: Investing in the stock market can provide returns greater than 20% during a bull market. However, in a market downturn, you also risk losing greater than 20%. You can control the level of risk by adjusting the balance of your portfolio between stocks and bonds. You can also plan for any market condition by saving more than you think you will need. The difference between a 3% withdrawal rate in retirement and a 4% withdrawal rate is simply saving an additional 8x your annual expenses. This may seem like a lot, but if you can save 25x your expenses, you can certainly aim for 33x.
This additional savings will buffer market fluctuations in the event that you need access to your funds in the middle of a downturn, or your living expenses end up being higher than you expected.
The best resource I know of for learning the essentials of investing in low cost index funds is still JL Collins stock series. His book remains my favorite resource on what you need to know to build wealth, in the most simple and straightforward, easy-to-manage-on-your-own way.
Real estate investing (REI)
This is by far my favorite form of investing. With REI, you can:
- Fully control your investment
- Leverage your investment
- Find the form of REI that matches your needs, style and market
- Be as passive or involved as you like
- Be successful in any market and economy
- Take advantage of multiple inherent forms of wealth generation
Read more about real estate investing at: Real Estate Investing: 6 Pivotal Reasons To Get Started Today
While I love REI, I’m also an entrepreneur at heart. I love the concept that you can create something from scratch, touch lives, add value, and grow your ideas into a business with absolutely no limits. Your limits are only confined by your own imagination.
All our dreams can come true, if we have the courage to pursue them. –Walt Disney
It takes courage and vision to start a business. And it takes a whole lot of persistence, consistency and perseverance. But if you are doing what you love, and you learn from your mistakes and keep going, you will get there eventually.
The main thing that prevents people from following their dreams is a lack of confidence and fear of failure. This is where having that emergency fund and F-You money is so important. When you have the savings in place, you have the freedom to pursue other opportunities. It’s these opportunities that add value and purpose to your life and provide true financial independence.
Someone is sitting in the shade today because someone planted a tree a long time ago. –Warren Buffett
As you read through the steps which you will incorporate into your personal journey to financial independence, think about how they fit into your life and what they mean to you. How does each step align with your goals and dreams? How will tackle each one? How will each step get you closer to your overall goal?
Regardless of where you are on your personal journey to financial independence, your money has a purpose. Whether it’s paying off debt, building your emergency fund or going to work for you by building compound interest, that money is yours and it is working hard to get your where you want to be.
Financial independence is not the drive to be rich. And unless it’s fundamentally important and brings you joy, it’s not about buying the most enviable new toy. It’s about the freedom of time and the ability to explore that which brings you fulfillment and joy.
These are the books that have been most relevant and helpful to me as I work on each of these essential steps to FI:
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