What is financial freedom?
Ask a room of people to define financial freedom, and you’re likely to get a dozen answers.
“We all have different relationships with our money,” notes Shelly-Ann Eweka, director of central advice for financial firm TIAA.
For some, financial freedom means being able to pay the bills with money left over each month or having a fully funded emergency account. Others may want to retire early and travel extensively.
Regardless of how you define financial freedom, the following 15 steps will help you achieve your vision for the future.
Determine your financial goals.
It will be hard to achieve financial freedom if you don’t first define what that means for you personally. “Start by setting goals and thinking about what those goals require financially,” says Liz Ewing, CFO at Marcus by Goldman Sachs.
Goals can include short-term plans, such as going on vacation or buying a new vehicle, as well as long-term objectives like retirement. It may also be helpful for people to analyze their beliefs about money and examine their relationship with it. Rather than assuming wealth is something attainable only by those with high incomes, recognize that even middle-class families can move from living paycheck to paycheck to a financially comfortable lifestyle so long as they spend less than they earn.
“Writing your goals down can help improve your chances of achieving them by allowing you to visualize what’s ahead for you financially and set deadlines to achieve milestones,” Ewing says.
Know your current financial situation.
Regardless of whether you are just out of college or getting ready to retire, it’s essential to understand where you stand financially right now.
“Pull together a net worth statement,” says John Pelletier, director of the Center for Financial Literacy at Champlain College in Burlington, Vermont. “Understand what you owe and the interest rates that are attached to (debts).”
Beyond adding up debt, calculate expected income and identify holes in your financial picture, such as a lack of insurance or emergency savings. Consulting with a professional may be helpful in this process, particularly if you have complex finances or are approaching retirement.
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 are usually best kept in a 529 plan. Those with high-deductible health insurance plans can open health savings accounts to pay for medical expenses.
Meanwhile, you’ll want your emergency fund separate from your other savings to avoid dipping into it unnecessarily. High-yield savings account are usually offered by online institutions such as Marcus by Goldman Sachs and Discover Bank, and these can ensure money earns some interest. However, the most important consideration for an emergency fund is that it is liquid and insulated from market losses.
Set up a deposit schedule.
Once you have your accounts set up, create a system for ensuring they are fully funded. 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% of your income for emergencies or other goals and another 10% for retirement.
“Automating your savings ensures you pay yourself first and can help you stay on track with your savings goals,” Ewing says.
Track your spending.
If you’re currently living paycheck to paycheck, setting aside money for emergency and retirement savings can seem daunting. To find out exactly how much you can save, you first need to understand how much you spend.
“You have to start writing things down,” says Kelly LaVigne, vice president of advanced markets an solutions for Allianz Life Insurance Company.
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 Marcus Insights can make it easy to collect and categorize spending data. These apps can also help you pinpoint hidden expenses.
“(You) have to go into this knowing it’s really hard,” LaVigne says. Tracking expenses requires diligence and will require a significant shift in behavior for some people. But being able to see where your money goes over time is a crucial step, according to LaVigne.
Write a budget or spending plan.
More commonly known as a budget, a spending plan outlines how you expect to use your money each month. As you create this document, consider whether the items you list will bring you closer to your financial goals.
“Do an inventory of what you need and don’t need,” says Renora Nelson, wealth manager with Merit Financial Advisors in Alpharetta, Georgia.
In the past, people were limited to using a pencil and paper or perhaps a spreadsheet, but now there are numerous options that make budgeting easier. The same apps you use to track expenses can also often be used to create suggested budgets based on spending. Using an app can turn what might have been a long process into something that is quick and easy.
“It takes less than 30 minutes, and it can change your life,” Eweka says.
Trim your budget.
Between creating a budget and tracking expenses, it should quickly become apparent if you have enough money to sustain your current level of spending. If not, you’ll need to trim expenses, and the obvious place to start is with unused or duplicative services.
During the pandemic, many people signed up for multiple subscriptions and now is a good time to evaluate whether they are still needed. LaVigne says people should ask themselves, “Do I really need four streaming services?”
Trimming expenses doesn’t necessarily just mean cutting your morning latte or gym membership. Instead, people should think beyond the small expenses and consider major lifestyle changes to make a considerable change in their financial situation.
Selling your house or buying a cheap, used car may seem like a significant sacrifice. However, it can be worthwhile if it helps achieve your ultimate goal of lifelong financial independence.
Prepare for ‘surprise’ expenses.
It’s a mistake to think about budgeting in terms of monthly expenses only. Throughout the year, every household will encounter irregular bills, ranging from expected insurance premiums to unexpected vehicle repairs.
Planning for these expenses is not impossible, Nelson says. She looks ahead and marks on her calendar when irregular expenses are likely to occur. That way when, for instance, a child graduates from high school, there is money set aside to cover senior-year purchases.
Even unexpected expenses such as car repairs and broken appliances can be anticipated since all mechanical items have a limited lifespan. By setting aside a small amount each month, families can be prepared for these “surprises.” Using direct transfers to a separate account is an efficient way to accomplish this.
“I would highly suggest people automate savings,” Nelson says.
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.
“If you have a huge debt burden, I do think it’s important for you to have a psychological win (to stay motivated),” Pelletier says. Usually, the best way to achieve that is 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, paying off the debt with the smallest balance first can build momentum. 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 an emergency fund, you risk going into high-interest credit card debt should an unexpected expense occur. Instead of prioritizing debt over savings, or vice versa, direct a portion of your available cash to each priority every month.
While conventional wisdom is to save enough money for expenses for three to six months, Eweka advises people to start smaller if that amount is overwhelming. “Don’t think about the six months,” she says. “(Your) first goal is replacing one paycheck.”
After saving enough to replace one paycheck, gradually add to the emergency fund until it can pay for several months’ worth of expenses should you find yourself unable to work for any reason. Once that savings account is fully funded, money can be diverted to other needs such as retirement and college savings.
Monitor your credit.
“Your credit score will play an important role in your journey toward financial freedom,” Ewing says.
A person’s credit score can determine whether they have access to loans and what interest rate they receive. In some states, employers can review a job applicant’s credit history when making hiring decisions, and insurance companies in certain areas may use credit to set policy premiums. Reducing debt and paying bills on time are two ways to boost a sagging credit score.
Federal law allows consumers to request a free copy of their credit report once each year using the website AnnualCreditReport.com. During the pandemic, credit reporting companies Equifax, Experian and TransUnion began voluntarily offering free weekly reports as well. Credit scores can be accessed for free through a variety of credit card issuers and finance websites such as Credit Sesame and Credit Karma.
Evaluate your career options.
Don’t overlook the importance of your job when it comes to how to achieve financial freedom. While income is obviously important, there is more to a job than the money you bring home each week.
People should be talking to employers about various benefits that may be offered, Eweka says. Some of these can help workers in ways they may not expect.
Employers may match contributions to retirement funds, provide access to a variety of insurance products and even connect workers with financial advice and money management tools. Just as importantly, the right job may provide options such as flexible scheduling and remote work that can support overall wellness and personal goals. That, in turn, can alleviate stress and may make it easier to stick to financial plans.
Invest for the future.
Many people assume they need a large income to achieve financial freedom, but that isn’t necessarily true. Some households with high incomes may carry substantial debt, ensuring they will never be wealthy. Meanwhile, other wealthy families may have modest incomes. Rather than amassing wealth through their income or an inheritance, many people become wealthy because they save and invest money consistently throughout their lives.
“We have to fatten our 401(k) contributions,” Nelson says. “That’s going to be our pension when we retire.”
While a 401(k) is ideal for retirement savings, other accounts, such as 529 plans and health savings accounts, may be better for other expenses such as college and medical bills. The variety of investment options available can be confusing, though. A financial advisor can help you select the right investments, or online advisory firms can simplify the process for those without access to an advisor.
Prepare your legacy.
This 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 certified public accountant 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.
It’s important that you continually update your financial and estate plans too. Throughout the years, your life will change, and tax laws will change. Your financial plans need to change along with them.
Find a trusted financial advisor.
Some people are comfortable managing their own money and investments, but this final step will be important to others.
“We all need to see specialists for certain things,” LaVigne says. Once you have the basics in place, such as a budget, a financial professional can help with more complex needs such as retirement planning.
Meeting with a financial planner or tax advisor once a year can be helpful to evaluate your current situation and map out strategies for the future. These individuals aren’t emotionally invested in your money decisions, and a trusted professional can provide objective advice and tips you might overlook if you try to go at it alone.
Follow these 15 steps to financial freedom:
1. Determine your financial goals.
2. Know your current financial situation.
3. Open the right accounts.
4. Set up a deposit schedule.
5. Track your spending.
6. Write a spending plan.
7. Trim your budget.
8. Prepare for “surprise” expenses.
9. Create a debt payoff plan.
10. Build an adequate emergency fund.
11. Monitor your credit.
12. Evaluate your career options.
13. Invest for the future.
14. Prepare your legacy.
15. Find a trusted financial advisor.
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15 Steps to Achieve Financial Freedom originally appeared on usnews.com
Update 04/07/22: This story was published at an earlier date and has been updated with new information.