Financial independence (“FI”) means slightly different things to different people, but it usually entails having enough wealth to live off for the rest of your life without having to work to earn money. It’s about having the resources to afford the life and lifestyle that you want without financial restrictions.
Financial independence isn’t a function of how much you earn; it’s all about how much you save. There are stories of high-earning celebrities (and lottery winners) who spend all their wealth and end up with nothing. On the flip side, people who earn a moderate income but save and invest throughout their working lives can amass significant wealth.
It’s not rocket science. Do the math.
A person who earns $40,000/year and saves 10% every year will be much better off in the long run than a person who earns $4 million/year and spends every penny. For example, let’s assume both people earn a fixed salary every year (with no increases) from age 25 through age 65 and invest their savings at an average annual return of 8%. The $40,000/year earner would become a millionaire ($1,163,658), and the $4 million/year earner would be broke ($0 at 8% compounded annually for 40 years = $0).
Otterwize’s goal is to nudge you in the right direction.
In our mind, there are two paths:
- If you spend decades not saving and not investing, you will probably live paycheck-to-paycheck and never reach financial independence.
- If you save and invest wisely, you have a much better chance of reaching financial independence.
Pick one.
ROADMAP TO FI:
1. Spend less than you earn.
- Pay yourself first from each paycheck; your bills can be next in line.
- Figure out how to manage the 3 biggest expenses: housing, transportation, and food:
- Housing: renting; buying a home; getting a mortgage
- Transportation: buying or leasing a car; taking out a car loan
- Food: see Simmering Savings
- Track your spending to help identify areas in which you can cut back.
- Check out these savings apps and other ways to save money.
2. Invest for the long term.
Two prerequisites before you start investing:
- Pay off any non-mortgage debt (credit cards, student loans, other consumer debt).
- Pay off the highest-interest debt first.
- See here for ways to crush debt faster by saving money, refinancing, or taking on a side hustle.
- Learn about credit, credit scores, and the ins and outs of personal loans.
- Depending on your financial situation, you may want to wait to invest until all of your non-mortgage debt is paid off or you may want to wait until all your high-interest non-mortgage debt is paid off. This decision depends upon many factors and is something each person has to decide for him/herself. In either case, you should try to pay off all your non-mortgage debt as soon as possible.
- Save money in an emergency fund.
- Put aside enough to cover at least 6-9+ months of expenses for true emergencies like job loss, health issue, etc.
- Add a $1,000 cushion for one-time unplanned large expenses like broken appliances, car repair, leaking roof, etc.
After those prerequisites have been met, you might want to consider investing to build wealth:
- For retirement:
- If your company offers a 401(k) plan, what are you waiting for? You can also open an IRA in addition to your 401(k).
- If you don’t have access to a 401(k) plan, you can open an IRA.
- Non-retirement
- After you have maxed out your tax-advantaged options (or if you need more flexibility), consider opening a taxable brokerage account (non-retirement). For Investing 101, see here.
- The New 99%
- Investing small amounts every month over time can potentially add up to large amounts down the road.
- Invest the Difference
- Optimize your spending and invest the difference.
- One great way to do this is by cooking more at home instead of eating in a restaurant and investing the savings. See Simmering Savings for ways to turn your cooking into earnings.
- Starting to invest as early as you can (as long as you have an emergency fund set up and have paid off all your [high-interest] consumer debt) will help you take advantage of compounding.
3. Other pit stops along the road to FI.
- Track your net worth so you know where you stand.
- To optimize and protect your earnings:
- Look into ways to manage your career
- Consider taking on a side hustle
- Pay attention to Uncle Sam
- Look into opportunities in “The New Economy“
- Protect yourself with the proper insurance
- To see some interesting rules of thumb like how much to spend on rent, food, a car, an engagement ring (and other useful things like that), check out our Rules of Thumb.
- To read about how to get your personal finances in order, check out our 10-Step Financial Fitness Workout.
- To read some other thoughts on money that only your mother/father/brother/sister/close friend/uncle/aunt/cousin . . . will tell you (over a beer or a nice meal), check out our 10 Personal Finance “Fortune” Cookies. Yes, that’s “Fortune” Cookies, as in making a fortune.
- To see 10 ways (and there are lots of others) that a 25-year-old can potentially become a millionaire by age 65, read “10 Ways a 25-Year-Old Can Reach $1 Million by Age 65.”
