Achieving financial freedom is possible. There’s a process that can be learned and followed. To achieve financial freedom, you need to become financially literate. That means having a good basic understanding of some day-to-day financial concepts and having the ability to use them in your life. It’s not rocket science, but it does take a little work — as does anything worthwhile.
The steps to financial freedom can be broken down in a variety of different ways, depending on how detailed you would like to get. I suggest seven steps, as they are distinct areas of knowledge and skill, yet cover the realm of what is required to gain control of your financial life.
1. Manage Income/Earnings
There’s a simple equation to personal financial freedom: What comes in needs to be at least as large as what goes out. This means that our income has to be at least as high — or higher — than our expenses. It means we don’t get to spend more than we make, or else we will have financial trouble.
There are two sides to that, the income side, what we make or otherwise have to spend, and the expense side. There is a limit to how much we can reduce expenses. There is no formal limit on how much we can earn.
We can make more by getting a better job, by getting another job, or by improving our skills to move up more significantly. Managing what we make, by making as much as we reasonably can, gives us more to work with.
2. Managing Spending
Spending is the second side of the financial freedom equation. We get to spend only up to the level of what we make. The spending side has the advantage of speed; we can generally change our spending faster than we can change our income.
We need to plan our spending. That’s how we manage it and keep it from getting ahead of our income. People who don’t plan their spending tend to overspend. Little things add up, and it is easy to spend more than you should or want to.
We plan our spending with a budget. A budget can be simply written out on a piece of paper, it can be formally drawn up with a spreadsheet, or you can use one of many budgeting apps. There are many ways to budget. The key is to find one that works well for you — that way you’ll keep doing it long term.
3. Emergency Fund
An emergency fund is savings that allows you to pay for emergencies or unexpected expenses without resorting to debt. A small emergency fund is better than no emergency fund.
Emergencies and unexpected expenses happen. They’re inevitable. If you don’t have your own money to use for an emergency, then you’ll end up using someone else’s. Often that “someone else” is a high-cost credit card. The third step to financial freedom is to build an emergency fund. Start where you can, even if it’s $5 or $10 per week. Anything helps.
Ultimately it would be great to have three to six months of expenses saved for an emergency. For some people, that’s not realistic. Do the best you can, but do something.
4. Reduce or Eliminate Debt
Debt is a present claim against your future earnings. When you borrow now, you promise to pay later. It puts a drag on your future income, making it more difficult to keep expenses below earnings.
Debt always has a cost. That cost is interest, expressed as an annual percentage of the amount you owe. The cost to pay back debt is greater than what you borrowed.
Sometimes debt is necessary.
There seem to be many talking heads in the media telling you to never take on debt. Perhaps if Mommy and Daddy are rich and generous, that’s possible. For most of us, it is neither practical nor possible. For most of us, getting a car, or getting a house, or getting a college education, or even educating our children, will require the use of debt.
The biggest problem with debt isn’t car loans or mortgages or school loans. The biggest problem with debt is revolving debt. Credit card debt is a revolving debt. Credit card debt shouldn’t be something you have, not long-term. That’s the first thing to work on getting rid of. Take care of that and then work on the long-term debt.
5. Protection
This I’ll break into a couple of different parts. We need to protect the things we cannot afford to lose, such as our house or ability to earn an income. We need to have our affairs in order, such as a will and healthcare proxy. And we need to consider how we are addressing identity theft.
Protecting what we can’t afford to lose often means insurance. We need to consider if we would want or need to leave something for survivors if we were to die prematurely. We might also consider how a funeral would be paid for if we aren’t leaving something behind for others.
And we need to consider how we would pay our bills if we were sick or injured and unable to work. This can be addressed with disability insurance. Naturally, we may also need auto insurance and either homeowner’s or renter’s insurance.
If you have any degree of assets, other than retirement assets, you should probably have a will. Retirement assets name a beneficiary and pass outside of your will. If you have children, you should definitely have a will.
You should learn enough about identity theft to make some basic decisions to help protect yourself. Identity theft is a huge problem that’s not going away anytime soon.
6. Savings
Savings is how we start to build financial assets. The difference between saving and investing is the type of assets we use for each. Savings involves stable assets such as CDs, which don’t fluctuate in value. They also don’t grow very fast either. But they are there when you need them.
We typically save for goals within the next five years, where it is more important that we don’t lose money, as opposed to trying to make the most we reasonably can.
We might save for things like replacing our car, a vacation, or a down payment on a home. Since these are all relatively short-term goals, we put the money somewhere safe. We save it.
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7. Investing
Investing is placing funds into financial vehicles that we expect to grow at a rate greater than the rate of inflation across time. We expect that investment dollars will be able to purchase more for us in the future than they could today. They work for us to make a better future.
We invest in assets we expect to outperform savings or other conservative investments. We can do this simply by using index funds, asset allocation, or time horizon funds.
Many people think that investing is the key to getting ahead financially.
Investing, however, is not a matter of making brilliant selections.
Successful investing comes from choosing assets that have a high probability of growth over time.
That is neither difficult nor glamorous. You can forgo the excitement of high-risk investments and choose what we know has worked well time and time again. A good low-cost index fund, or asset allocation fund, or time horizon fund, can get you where you need to go.
Yes, you do need to learn a little about investing. But it does not need to be difficult, stressful, or time-consuming. Successful investors pick solid investments and hold them for long periods of time. Slow and steady still wins the race.
The Bottom Line
It’s really that simple. It’s not always easy, and sometimes the choices can be tough. Sometimes saying no to a frivolous expense can be difficult when we are stressed or tired and just want to treat ourselves. But we also don’t have to be perfect. We just need to get a little bit better, then do that again, and again.
The seven steps are simple. It may help to keep things simple when putting them in place. Do one, work on it, move on to the next.
Getting fit financially is a lot like getting fit physically: You don’t start at the top; you start where you are. You do a little more and get a little better and you keep working and don’t give up. And you find that the process is fun and rewarding. You find that you get into it, and that it really is simple, and it really does work.
