Financial freedom. To me, this means having enough money to do what YOU want to do — enough money to live the life you choose, rather than a life of “working for the man” because you have no other options.
Financial freedom, or financial independence, opens up your world to anything. It doesn’t mean you HAVE to quit your job — it just gives you the OPTION to quit if it stops being enjoyable. Financial freedom also gives you the opportunity to pursue a job that may not pay very well but that you truly enjoy.
Want to travel the world for six months or six years? Your job is no longer a limiting factor. Ditto taking time off to spend with your children or using time you would otherwise be spending at work to help out in your community.
Those are the good options, but what about the BAD options? Protecting yourself from the unexpected is another benefit of financial independence.
Remember Enron? Tyco? MCI Worldcom? These companies crashed in spectacular fashion in the early 2000s, costing their employees their jobs — and in many cases, their retirement funds, too. We’ll talk about portfolio diversification a little later, but these companies left their employees out in the cold. Sure, some of the higher level executives went to jail, but having your former CEO behind bars doesn’t put food in your mouth.
If you aren’t financially free, what happens to you if a family member has a prolonged illness and you’re their caregiver? Imagine a scenario where you’re the breadwinner, and you suddenly get very sick. What would happen to your quality of life if your boss told you your job was over?
Financial freedom can provide many great things, but it can also help shield you against the unexpected circumstances — those curveballs life throws at you.
Achieving financial freedom doesn’t mean you just save up a giant pile of cash. Obviously, you’ll need to save up a fairly large amount, but pulling an arbitrary number out of thin air can leave you with too little down the road or working for the man for far too long.
Here are 14 steps to take to gain your financial freedom.
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Financial Freedom: 14 Steps to Stop Relying on Your 9-5 Job’s Income
Step #1: Get Your Family On Board
The very first step to ensuring your success is to get everyone on board with your plan. Money is the #1 thing couples fight about and one of the top reasons a marriage falls apart.
Last year for April’s Fools Day, we “introduced” BiggerPockets Love, a dating site to help real estate investors avoid the cash-flow negative spouse and find someone who spends money on what matters — cash-flowing investments instead of depreciating assets!
Now, while this was a joke, there’s some truth in there. Having your spouse be on the same page as you can mean the difference between success and failure.
But if you have kids too and are making a change from spending freely to saving fiercely, your kids aren’t going to understand what’s going on when you start your question towards financial freedom — and might give you a lot of pushback.
Make it fun for your kids to participate in your goal. The main thing children want is your time, which just so happens to fit perfectly into your new spend-less philosophy.
Start a family game night, make weekends the time to go to the park, local pool, or on a long bike ride. Go for a walk with them and talk. Go hiking, camping, or even just invite some of their friends over for a playdate.
As you fill up their time, they won’t miss the “stuff” so much. But also explain to them what you are doing and why. Financial education in America is so lacking; most people graduate from high school without even knowing the basic essentials like budgeting and living within their means.
Step #2: Figure Out Your Financial Freedom Number
Knowing how much money you need to save up shouldn’t be guesswork — what if you guess wrong? Do you know how much you spend on groceries every month? What about gas? Utilities? Clothes?
Step #3: Track Your Spending
The first step to knowing how much you need for financial freedom is knowing how much you spend. Start tracking your spending — any dollar, any dime that goes out of your pocket needs to be accounted for.
Tracking your spending can be as general or as detailed as you would like, but it’s far easier to make changes and cuts when you get more detailed.
When I first started tracking my spending, I was astonished to see that I went to the grocery store about five days a week. I drove past it on my way home from the gym, and I would always remember something I needed, so I would just stop in for “a few things.”
But every day, I was stopping in and grabbing the “few things” I needed, plus a few more items that were on clearance or on sale or just looked interesting.
I ended up spending hundreds of extra dollars every month without even knowing it. Once I started tracking my spending, I was able to exercise more discipline and make shopping lists and stick to them.
Step #4: Review Your Expenses
Track your spending for a month, and then review each individual category. Do you see anything you could reduce or remove completely? Another thing we discovered when we tracked our spending to help achieve financial freedom is that we were going out to restaurants three times a week. We cut back to once a week and don’t really miss it.
After you know how much is going out and you have reviewed your categories for easy cuts, take a deeper look at items that may seem fixed. Your mortgage or rent isn’t going to be reduced easily, but is there any way to reduce your utilities?
The general consensus is that you can save about 3% off your heating bill for every degree you turn your thermostat down. A programmable thermostat pays dividends almost instantly because you set it once, then go about your life. No more forgetting to turn the heat down before you go to work and heating the space unnecessarily all day. It doesn’t take long before you are used to the lower temperature.
Do you live where water is expensive? My dad made us take “military showers” when we were kids. Turn on the water enough to get yourself wet, then turn off and wash your hair and body. Turn back on to rinse. I didn’t like them, but they saved a ton of water. And it benefits the earth, so green bonus points, too!
Step #5: Ask for Discounts
Contacting your current vendors and suppliers and asking for discounts can give you some pretty sweet returns. I was listening to the Clark Howard show on the radio a few months back, and a man called up to tell his story. He received an increase on his car insurance premium and decided it was just too expensive. He called the company and asked for a discount, and they gave him a 40% discount off his new premium, just for asking — 40%!
When was the last time you shopped around for insurance? Have you asked your cable company if there is a less expensive plan available? If these companies tell you no, maybe it’s time to start shopping around for new ones.
Step #6: Challenge Everything
My friend J. Money over at Budgets Are Sexy performed an experiment to see just how much money he could save by requesting discounts. He called it Challenge Everything, and it spanned an entire year. He challenged his bills to see how low he could make them, while not sacrificing his quality of life. He ended up saving more than $5,400 over the course of the year, including more than $1,300 just on cell phone service.
Best of all, he didn’t feel deprived because he made sure he wasn’t changing his quality of life during the process. He made that a top goal so it didn’t seem like a sacrifice at all.
Step #7: Make a Budget
Your next step in achieving financial freedom is to make a budget based on your income — not your expenses. Your brand new budget is a work in progress; very few people can make a budget and get it right the first time. Try to stick to it for a few months, but if you find yourself consistently going over in a few categories and under in others, simply make adjustments.
Things to include in your budget are the recurring monthly expenses like rent or mortgage payment, utilities, gasoline, food, etc. But also plan for those expenses that only come up once or twice a year, like car insurance and registration, club or membership dues, professional licensing dues, etc. Some credit card rewards programs are worth the annual fee for the card, so if your card has one, budget that, too.
Do you enjoy giving gifts? Make sure to earmark a few dollars every month for your gift fund — birthday, holiday, anniversary, etc. Don’t find yourself scrambling at the end of the year or worse, putting all your gift purchases on credit cards because you don’t have enough money to pay for them.
Include line items in your budget for investing and for saving. Trying to achieve financial freedom without properly investing and saving just won’t happen.
And last but most definitely not least, put money away each month into an emergency fund. Most experts recommend having a fund equal to three to six months of expenses.
All of this information combined will show you how much you need to live comfortably on a monthly basis. But what do you do with this information?
The 4% Rule
In 1994, William Bengen released a study that had some pretty astonishing revelations. If you withdraw 4% or less from your retirement account during your first year of retirement, then re-adjust your withdrawals for inflation, you have a 96%-100% chance of having enough money to last you 30 years or more.
Bengen took historical data from the stock markets and ran his theory in varying amounts, from 3% to 6%. He found that withdrawal rates of 3.5% or less returned a 100% chance of having enough money, while withdrawal rates of 6% only had a success rate of 40%.
He also came up with the ideal mix of investments as 50-75% stocks and the remainder in bonds. But here’s one interesting fact: Bengen’s study assumes zero additional income once you retire. His study was meant for the traditional retire-at-65 crowd. What do you think would happen to your investment account if you included the income from even one rental?
Let’s do some easy math. Let’s say you need $50,000 a year to live comfortably.
$50,000 x 25 = $1,250,000
According to Bengen’s study, which was tested to basically the same conclusion in 1998 by The Trinity Group (they used a different bond type and concluded only a 95% success rate versus Bengen’s 96% rate), you can comfortably live for at least 30 years by saving and investing $1.25 million.
That’s really not a lot of money. Remember when Dr. Evil demanded $1 million in Austin Powers? He was laughed at by the entire world.
Bengen’s study shows a significant percentage of accounts end up lasting far longer than 30 years — with many scenarios ending the 30 years with a balance larger than what they started out with.
Let’s go back to your $50,000 annual withdrawals. Let’s say you have a rental property that brings in $12,000 a year. It’s paid off, and you have a healthy capex reserve fund. Now you only need to withdraw $38,000 a year. That’s a 3% withdrawal, and Bengen put a 100% success rate at 3.5%.
Bengen’s study did use historical stock market data, and past performance is not indicative of future gains. So while this isn’t a guarantee, it’s still a great place to start.
Related: How Much Do I Need to Retire?
Step #8: Eliminate Debt
You cannot achieve financial freedom with debt. Plain and simple, you need every account to have a zero balance except your investment and bank accounts.
We have been experiencing ridiculously low interest rates for years, and your mortgage rate should be extremely low and fixed. Mine is 3.25% for the next 13 years, and I pay nothing extra on it. I can make more investing that money than paying off my mortgage early.
Mortgage debt is the only acceptable debt, although this issue inspires passionate debates both for and against. I have compromised by adding the balance of my mortgage to my financial freedom number — so I have enough to pay it off while still being able to invest instead.
What does your debt look like? Large balances on high interest rate credit cards are going to hurt your credit score and your bank account the most. Lower interest rate cards, car payments, student loans and medical bills are typically going to cost you less because the amount you pay in interest is a lot lower.
Make a spreadsheet for all your outstanding balances, including interest rates. Sort by interest rate highest to lowest, and start paying them off. Make the minimum payment to every debt except the debt with the highest interest rate, and throw everything you can at that debt until it is paid off.
Repeat with the next highest rate debt, and so on and so on.
Step #9: Create an Emergency Fund
How much would wipe you out? If you suddenly received a bill for $500, could you cover it or would you be financially ruined? Could you cover $1,000? What about $5,000?
I mentioned an emergency fund in your budget earlier. Experts recommend having at least three to six months’ worth of expenses saved up as an emergency fund.
According to a June 2015 Bankrate survey, 29% of Americans had no emergency fund. An additional 21% said their emergency fund wasn’t enough to cover three months of expenses.
If a flat tire, broken leg, or layoff would financially devastate you, start funneling money into an emergency fund now, so you can cover your expenses until you get another source of income.
Step #10: Set Attainable Goals
Saving all your money and never having any fun isn’t the way to live your life. Neither is setting ridiculous goals and failing to meet them. You’re not going to achieve financial freedom tomorrow. Not unless you win the lottery.
To win the lottery, assuming you need to match six numbers, and the numbers go from 1 to 60, you have a 1 in 50,063,860 chance. Those odds are terrible. You have a better chance of being struck by lightning. I looked it up. You have a 1 in 960,000 chance of being struck by lightning this year.
Your odds are 50 times higher to be struck by lightning than to win the lottery, yet people flock to the lottery in droves. My husband actually works with a woman whose only retirement plan is to win the lottery.
OK, so ridiculousness aside, you need to set attainable goals if you want to achieve financial freedom. We’re almost to the end of the first quarter of 2016. Can you pay off one debt before the end of the year? Can you pay off five?
How much did you save when you challenged everything? Take that savings and fund your emergency plan, then use the rest to throw at your debts. Be prepared to sacrifice some of your non-essentials in order to have an emergency fund. Be prepared to cut back to pay down your debts.
But set attainable goals. If you’re a foodie, immediately cutting out all restaurant meals might be too big of a change. So reduce rather than remove. Do you go out four nights a week? Cut back to three. You’re already saving 25% in your restaurant category. After a few months, cut back to two. Boom, another 25% savings.
The easiest places to cut are from the “wants” categories. Clothing, travel, restaurants. But the easiest way to derail your entire financial freedom plan is to remove all the fun. Make time for things you do enjoy; just scale back, so your financial goal train doesn’t fall off the tracks.
Step #11: Start Saving
There are basically two ways to save money:
- Decrease expenses so less money leaves the pile
- Increase income so more gets stacked on top
We’ve talked about cutting expenses easily with Challenge Everything. Increasing income is a little more tricky. We’re trying to become financially free so our time belongs to us. Adding another job may seem counter-intuitive, but the goal is to become debt-free and then to build savings and investments to achieve financial independence. How much of your time are you willing to sacrifice now to open up 24 hours a day in the future?
But increasing income doesn’t always mean adding another job. When was the last time you asked for a raise? Have you compared your salary to the going rate in your area?
My husband started looking around after being in the same job for several years. He discovered that his position paid 50% more at other companies. (He’s in IT, and this was around Y2K.) He asked for a raise — and got one because his company knew that if they were to hire a new person to replace him, they’d have to pay close to that rate anyway. And that didn’t include the training and on-boarding costs associated with new employees.
If you are currently making an amount similar to the going rate in your field, do you have all of the qualifications in your field? Could you easily add another license or certificate and bump yourself into the next pay bracket?
Or maybe your company says “no” to the raise, and you’re already in the top bracket. If you’ve been there for a significant amount of time, perhaps it’s best if you look elsewhere. Get your resume together and start looking for greener pastures.
Do you have a hobby or considerable knowledge about a subject? Perhaps you speak another language. Do you have too much stuff around your house? Become a consultant, tutor students, or sell extra items on eBay. Adding income doesn’t have to mean adding another job. There are all sorts of creative ways to earn extra income that may not even feel like a second job.
Once that extra money starts coming in, treat it as though it doesn’t exist, and save or invest it immediately.
Step #12: Start Investing
The prospect of investing is scary to a lot of people. Everyone knows someone who “lost it all” in the stock market crash. My husband has a friend who took everything out of the market after it dropped, then did not ever put anything back in. He lost a ton of money by selling at the bottom, then lost out on even more by not reinvesting to catch the upswing.
The Dow Jones closed December 31, 2008 at 8776. It closed March 23, 2016 at 17,515. Look at all that growth he missed out on.
You can’t time the market. As much as I would like to get my hands on the book that Biff used to make his fortune in Back to the Future 2, time travel has yet to be invented — The Flux Capacitor just doesn’t exist.
You don’t know when there will be an up day. You don’t know how long the market will stay down. But over time, the market goes up. And there are ways to mitigate your risk.
Step #13: Take Advantage of Free Money
Does your company offer a retirement plan? Participating in pre-tax plans such as a 401(k) or a traditional IRA reduces your tax burden — pre-tax means you don’t pay taxes on the money you invest.
Company Sponsored 401(k) Plan
Many companies that offer a 401(k) also offer a company match, meaning if you put money into the program, the company will, too. If your company offers to match your contributions and you don’t put enough into the program to get the entire match, you are walking away from free money — money that could help you on your way to financial freedom.
If you saw a $100 bill on the ground, would you walk on by and say, “No thanks”? Of course you wouldn’t! You would stoop down and pick that bad boy up. So don’t walk on by the free money your employer is offering you to participate in their 401(k) plan.
Or perhaps your company doesn’t offer any plan. Set up a traditional IRA and make tax-free contributions on your own.
Another option is to invest post-tax. You can set up your own investment account through a brokerage firm to buy and sell stocks at your discretion. You can also open a Roth IRA and contribute money post-tax that grows and is available to you tax-free when you withdraw it. There are limits, and as with any government program, restrictions. But it’s an awesome program for the majority of Americans.
Yes, You CAN Use it Before Traditional Retirement Age
There are some misconceptions about retirement account funds not being available until retirement age — or 59.5 at the earliest — without significant penalties. While you can’t just start taking money out without incurring fees, you CAN take disbursements at any age — provided they are equal, regular payments for at least five years, or until you are 59.5, whichever is longer. You must also separate from your employer before taking these disbursements. Again, government program means rules and regulations, plus hefty fines and fees if you don’t follow the rules, so make sure to consult your tax advisor before trying this at home.
Step #14: Invest in Cash Flowing Real Estate
Obviously, we’re here at BiggerPockets because we love real estate. I am a hard-core real estate nerd. I love real estate in all forms. My favorite thing to do is view houses in any condition, and as a flipper, make plans in my head for what I want to do to fix it up.
I’m not alone — there are a ton of people just like me on the site.
While not truly 100% passive, real estate can provide a fantastic stream of fairly hands-off income, especially if you do it right.
A turnkey property literally means you can turn the key and open the door to everything being done for you. Yes, it costs a bit more to have everything done, but this is real estate at its most passive — a great way to make strides towards financial freedom.
Owning rental properties and having a property manager take care of them day to day is very close to turnkey. Being your own property manager allows a little more control over tenants and expenses, but is less passive.
Proper tenant screening goes a long way toward making rentals that you self-manage more passive. Doing the work up front to place an honest tenant who will pay you on time and report repairs in a timely fashion while treating your property with respect will make your life infinitely easier.
Remember that rental we talked about before? The one that was paid off and provided you with $12,000 a year in income, so you only had to take out $38,000 instead of $50,000?
What if you saved up enough money to cover your expenses ($1,250,000 in the example above) AND had five free and clear rentals throwing $12,000 a year at you? Now you’re withdrawing nothing from your retirement funds, and yet, you still cover your expenses.
Having a 9-5 job becomes a choice rather than an obligation. There are jobs that people truly love. I truly love my job, and I’m not just saying that because my boss will read this. I truly love my job, and would do it even if I were financially free.
Financial freedom doesn’t happen overnight. You didn’t get into debt instantly, and you won’t get out of debt instantly. Every one of the 14 steps above takes time to complete.
The journey of 1,000 miles begins with one step. The first day of your financial freedom starts with one dollar.
Where are you on your journey to financial freedom? Any tips you’d add if you’ve achieved it?
Leave your comments below!