#1: Confront Your Financial Reality
The first step to getting on the path to financial independence is confronting your financial reality. A high net worth should be your end goal, so ascertaining your current net worth should be your jumping-off point.
To find your net worth, simply subtract your total debts from your total assets (how much you have minus how much you owe). Next, take some time to get a big picture idea of your cash flow situation—in other words, where is your money going? How much do you make? How much do you spend? How much do you save?
#2: Set Goals
Goal setting is an essential part of any good financial plan. Having concrete financial goals will give you focus, direction, and accountability.
This doesn’t have to be complicated. You want to live your entire life in comfort, stability, and security, right?
If so, then your ultimate goal should be to amass a net worth large enough to sustain your desired lifestyle for the rest of your life, without relying on outside income or credit. Of course, getting there will require you to hit many smaller goals along the way—and that’s where the rest of the steps come in.
#3: Build an Emergency Fund
Having an emergency fund is crucial to achieving and maintaining financial freedom. As the name implies, this is a cash pile you set aside for emergencies such as a large, unexpected expense or drop in income.
Your emergency fund should consist of somewhere between six and twelve months (or more) of your fixed expenses, and it should be in cash that you can access at a moment’s notice. Fully funding this should be your number-one financial priority. Without it, you run the risk of having to take on debt to cover costs when something unexpected happens.
#4: Reduce Debt
Any debt you have sucks away your ability to achieve financial freedom. You must get rid of it if you ever want to have true financial independence. For most people, the best way to do this is by using the Avalanche method, which prioritizes paying down debts in the order of highest to lowest interest rate.
Put as much as you down on your highest interest debt each month while continuing to make regular payments on all other debt. Once you eliminate your highest interest loan, move onto prioritizing the next highest interest loan.
Keep going until all loans are wiped out.
#5: Decrease Spending
Attaining financial freedom means saving enough money to live comfortably on. The issue for many people however is that their spending rate isn’t necessarily a decision unto itself, but is rather just the result of what’s left over at the end of each month or year. If you’re in that position, it will likely be easier for you to shift your focus to decreasing your spending rate (the amount you spend divided by the amount you make) rather than focusing on increasing your savings rate.
You can decrease your spending rate by: 1) increasing your income while spending the same amount, 2) maintaining your income while spending less, or 3) increasing your income while also spending less. Obviously, the third strategy is the most powerful for building wealth.
Your goal should be to get your spending rate low enough to leave you with at least 15 percent to channel into savings if you’re in your twenties (20 percent if you’re in your thirties).
#6: Start Investing
Making your saved dollars work for you by investing is one of the surest ways to build wealth. It doesn’t have to be complicated, either. In fact, most people are better off with a strategy of simple, long-term, buy-and-hold investing into a diversified portfolio of stocks.
This strategy takes discipline, but requires very little work or cleverness—actually, the less you do, the better.
#7: Increase Tax Efficiency
Don’t pay more in taxes than you absolutely need to. The less you spend on taxes, the more you can save for your future. There are two very simple ways to build wealth in a tax efficient manner.
The first strategy is to maximize contributions to tax-preferred retirement accounts (like 401(k)s and IRAs). Every dollar you contribute to a pre-tax retirement account is a dollar subtracted from your taxable income (AGI). If you want to save one dollar after-tax in a 35% bracket, you’ll need to earn $1.35. To save a dollar into a pre-tax retirement account, you only need to earn $1. Of course, if you’re in a relatively low tax bracket, it may be reasonable for you to make after-tax contributions to retirement accounts (such as a Roth IRA). Either way, contributions to retirement accounts can be invested to grow tax-free for decades.
Once you’ve maximized contributions to all available tax preferred savings vehicles, the second strategy is to accumulate wealth that is favorably taxed as long term capital gains. You can do this by implementing a strategy of long-term, buy-and-hold investing into a taxable account.
#8: Protect Your Assets, Yourself, and Your Family
Accumulating wealth is key to achieving financial independence. But you also must protect that wealth from financial catastrophe.
Being properly insured is the easiest way to do this. Most young earners should have long-term disability insurance that will replace at least 60% of income in case of disability, uninsured motorist insurance, and at least $1 million in personal liability umbrella insurance. If you have financial dependents who would be financially worse off if you died tomorrow, you should also have some life insurance.
This article was adapted from the book, 21st Century Wealth, written by Rachel Podnos O’Leary. Rachel is a Certified Financial Planner™ who is particularly passionate about working with other millennials to help them achieve financial independence through wealth building.