Start living within your means.
You’re in good company if you’re living paycheck to paycheck, says Jon Brodsky, U.S. country manager for personal finance comparison website Finder.com. “It’s common in every single income bracket,” he explains. While Brodsky argues people shouldn’t beat themselves up over their financial situation, they also shouldn’t be content with the status quo. Instead use the following 10 steps to finally break the cycle and begin living comfortably within your means.
Define financial freedom.
Before you can reach financial freedom, you need to define what that means for you. The concept of FIRE — financial independence, retire early — is trendy right now and refers to the ability to stop working a traditional job at an early age. However, there are plenty of other definitions of financial freedom, including being able to pay the bills with money left over or having a fully funded emergency account. “Almost all of them are a variation of this idea that you need enough money to not be stressed about money,” says Divya Sangam, spokesperson for personal finance research website ValuePenguin.
Designate a family financial officer.
If you’re single, you can skip this step, but other households will need to designate someone to fill the role of the chief financial officer. This person isn’t making the financial decisions but rather is the one monitoring progress toward goals and reporting back to the rest of the family. “You have to be a facilitator, not a dictator,” says Kevin Brauer, certified financial officer of Affinity Federal Credit Union. Once you have your financial officer selected, decide when and how information will be relayed. Ideally, there will be weekly or monthly updates in which progress toward goals is updated, major purchases are discussed and any changes in the family financial situation are noted.
Open the right accounts.
There is no one single account that is right for all your money. Cash for retirement should be placed in a tax-favored 401(k) or IRA account, while college savings is usually best kept in a 529 plan. Meanwhile, you’ll want your emergency fund separate from your other savings to avoid dipping into it unnecessarily. “One of the best things you can do with your savings is not hold it in cash,” Brodsky says. Plus, with many traditional banks offering only a fraction of a percent in interest, savings kept there will never keep up with inflation. Instead, look to online institutions such as Vio Bank, where interest was as high as 2.35 percent as of December 2018.
Set up a deposit schedule.
Once you have your accounts set up, you need to create a system for ensuring they are fully funded. “Schedule regular deposits into all your savings accounts,” Sangam says. Many employers will direct deposit paychecks into multiple accounts, so you can divert a portion of your income to checking, regular savings and your emergency fund. You can also contribute directly to your 401(k) through a payroll deduction. For other savings goals, you may be able to set up automatic, regular transfers from your bank account to other financial accounts. Finance experts often recommend saving 10 percent of your income for emergencies or other goals and another 10 percent for retirement.
Track your spending.
If you’re currently living paycheck to paycheck, setting aside 20 percent of your money for emergency and retirement savings can seem daunting. You may have to start with a smaller amount. To find out exactly how much you can save, you first need to understand how much you spend. Take a month to track where your money goes, from major bills to the couple bucks spent on coffee in the morning. Using a free app like Mint or a paid budget service like YNAB can make it easy to collect and categorize spending data.
Trim your budget.
Now that you know how you’re spending your money, it’s time to trim wherever possible. Brodsky says that doesn’t necessarily mean cutting your morning latte or gym membership. “I wouldn’t get rid of the things that keep you sane and happy,” he says. Instead people should think beyond the small expenses and consider making major changes in their lifestyle to make a major change in their financial situation. “You can always sell a house,” Brodsky says. “You can always get a less expensive car.” These may seem like significant sacrifices, but they can be worthwhile if your ultimate goal is lifelong financial independence.
Create a debt payoff plan.
For most people, financial freedom means eliminating debt. While it can be difficult to own a house without a mortgage, getting rid of credit card debt or even car loans can be more achievable. It’s easier if you start by focusing all your extra money on one debt while making minimum payments on the rest. From a mathematical standpoint, it may make the most sense to start with the debt charging the highest interest rate. However, some finance experts suggest paying off the debt with the smallest balance first to build momentum and motivation. When you pay off that debt, don’t let the money you had been paying toward it get absorbed by your budget. Instead take that payment amount and apply it to the next debt on your payoff plan.
Build an adequate emergency fund.
It can be tempting to deplete savings in order to pay off debt more quickly, but that approach can backfire. “Without that emergency fund, you’re probably going to increase the high-interest debt you have,” Brauer says. Instead of prioritizing debt over savings, or vice versa, direct a portion of your available cash to each priority every month.
Focus on financial education.
The more financial knowledge you have, the easier it is to make savvy money management decisions. From finance websites to books to podcasts to in-person seminars, information is readily available today. However, for every website offering solid financial advice, there may be another suggesting dubious investment strategies. To ensure you’re following sound financial principles, check with multiple sources to confirm they share a similar philosophy. “That’s the best way to check the validity of a suggestion,” Brauer says. If one source is an outlier, there is a good chance the advice it provides is problematic.
Prepare your legacy.
This final step isn’t so much about creating your own financial freedom as much as ensuring that of your heirs. After a lifetime of managing money correctly, you don’t want your money to end up in the pockets of relatives you didn’t intend or, worse, Uncle Sam. Create a will, update the beneficiaries on financial accounts and, if your assets are considerable, talk to an attorney or CPA to discuss strategies to minimize estate taxes. Beyond that, regardless of your income, you’ll want to maintain adequate life insurance to support your loved ones in the event you die unexpectedly.
Steps to reach financial independence
Here’s what you must do to break free of your bad money habits and live comfortably:
— Define financial freedom.
— Designate a family financial officer.
— Open the right accounts.
— Set up a deposit schedule.
— Track your spending.
— Trim your budget.
— Create a debt payoff plan.
— Build an adequate emergency fund.
— Focus on financial education.
— Prepare your legacy.
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