Steps to Financial Independence

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Most Americans consider retirement age to be 65, or somewhere in that ballpark. Early retirement might be considered 55 – 60.

Yet, there are plenty of people in their 30’s and 40’s (and sometimes even younger) who are able to achieve financial independence.

Reaching financial independence doesn’t necessarily mean that these people are completely retired from all work (although that can be the case), but it does mean that they have freedom and flexibility to work on their own terms. That could be a job that they love, even if it doesn’t pay very well. It could be a part-time job rather than a full-time job. It could involve running their own business and having a flexible schedule.

Of course, financial independence or financial freedom sounds good to all of us. Who wouldn’t want it?

Most people would believe that reaching financial independence at a young age is impossible unless you have an extremely high income.

But the truth is, reaching financial freedom is possible even on an average income, and in some cases even below average.

In this article we’ll take a look at the specific steps you can take to work towards financial independence and how to retire early, but first let’s take an introductory look at the topic.

Introduction to Financial Independence

You may have read an article or listened to podcasts that mentioned Financial Independence (FI) or FIRE (Financial Independence, Retire Early). There is a growing community online, and that means even more articles from fire blogs, more resources, and more information available.

The label of financial independence typically applies to anyone whose net worth equals or exceeds 25 times their annual expenses.

Of course, that’s just a definition on paper. In reality, the whole point of financial independence is to have, and feel, freedom. Financial independence can be different from one person to the next.

This definition is based on details from the Trinity Study that indicates 4% is a safe withdrawal rate. This study and the topic of the safe withdrawal rate is too much to get into here, but basically if you have $1,000,000 you could (in theory) withdraw 4% of that amount per year, or $40,000, and have a 95% chance that your money will not be depleted to $0 during your retirement (based on a 30 year period).

The goal of this article is to help you reach financial independence, whatever it means to you, as fast as possible. One of the key terms that is mentioned several times throughout this article is savings rate. Your savings rate is simply the percentage of money that you are saving from your disposable income. According to Investopedia, the savings rate in the U.S. in 2018 is only 3.1%. With stats like that it is no wonder many people will never be able to retire.

→ Related reading: How to Calculate Your Net Worth

Our Fictional Example

Throughout this article, I’ll use sample numbers to explain and demonstrate. To make it easier to follow I’d like to work with one consistent example. Here are the details of this fictional example that I will be using:

  • Family of 3
  • Brian (husband) is 30 years old, Heather (wife) is 30 years old, and they have a one-year old daughter
  • Brian works as a teacher and has an after-tax income of $45,000
  • Heather is currently a stay-at-home mom with no income
  • Their current net worth is $75,000

Brian and Heather are interested in retiring early, but they never thought it was possible. They’ve recently started to look into it and they realize that it is possible with the right approach.

And let’s use this stock photo to represent the fictional family.

Steps to Financial Independence

Key Steps to Reaching Financial Freedom

Now, let’s move on to the details of how you can achieve financial freedom at a young age, even if you don’t have a high income.

Step 1. Understand Your Motivation

The first step towards financial independence is knowing your motivation, or your “why”. Why do you want financial freedom?

It could be that you want to be able to retire young enough to be able to travel and enjoy your retirement. Or maybe your motivation is to spend more time with your family. Or maybe you just really hate your job and can’t imagine spending 40 or more years on your career.

The steps that we’ll be covering in this article are not that complicated. Even though anyone can grasp the concepts, the process of pursuing financial independence will come with some challenges. One of the biggest challenges is simply sticking with it and staying dedicated to saving for the future rather than living in the moment.

When you face challenges, frustrations, and even setbacks, it’s helpful to think about your motivation and why you want to do this in the first place. Putting things into perspective can make all the difference.

So, if you haven’t already, take some time to think about your own motivation to pursue financial freedom and why it’s important to you (and worth the short-term sacrifice). If it’s something you really want to do, commit yourself to making it happen.

Step 2. Track Your Spending

If you don’t already track your spending you might be surprised at how your money is actually being spent. You can’t get the most out of your money without a solid understanding of how you’re currently using it.

You can either start tracking your expenses going forward, or go back and try to see where your money went the past few months. Looking back is a lot easier if you typically pay with credit cards or checks. Cash can be harder to track. You can go through your credit card statements and checkbook, record your expenses, and put the expenses into categories for each month.

If you’re not sure how to track your expenses, you can use a simple spreadsheet (we have a free spending log that can help), Mint, or one of several other budgeting apps.

Categorize your expenses so you know how much you are spending on things like housing, groceries, eating at restaurants, gas, etc.

Step 3. Start Tracking Your Net Worth

Your net worth is one of the most important ways you can know where you stand financially. If you’re not sure of your current net worth, this is an important step.

You should also track your net worth over time so you can gauge the progress that you’re making on your journey towards financial independence.

Calculating your net worth is pretty simple. Essentially, you’ll add up your assets and then subtract your liabilities. The difference is your net worth. To keep things simple, only count assets like equity in your home, investment accounts, savings accounts and other cash, and possibly some other valuable assets if you have them. You don’t need to try to calculate the value of all the “stuff” that you own. If you happen to have something really valuable outside of cash, investments, and real estate (for example, a very valuable car that you own outright), you can add that as well.

Personal Capital is a great free app that makes it very easy to calculate and track your net worth. You can link it to your back accounts, investments, and credit cards and it will provide you with a ton of useful information and data, including your net worth. I started using Personal Capital a few years ago and I love being able to get a high level view of my finances, including my net worth.

Personal Capital - Track Your Net Worth

Knowing your current net worth is important, but you’ll also want to track it over time. You don’t need to spend a lot of time on it, especially if you’re using Personal Capital. Your net worth will serve as a measuring stick to show how close you are getting to financial independence.