Financial independence occurs when your savings is enough to support your expenses and work is completely optional. Here are four essential steps to reaching financial independence and having the option to quit your job for good.
1. Pay off debts
Pay off any debts with an interest rate above 5%. This means credit cards, student loans, and expensive car loans. You don’t have to rush and pay off your mortgage, but it won’t hurt to make a few extra payments each year. If you have debts with an interest rate of 3% or less, you may be better off making minimum payments and investing in index funds because these funds will almost always return more than 3%. I’ll talk more about investing in Step 4.
2. Reduce your expenses
Look at your monthly expenses and determine where costs can be cut. Can you eat out less, cut your cable subscription, or switch to a less expensive cell phone provider or plan? Creating a budget will help you better understand how your money is being spent and what steps you can take to spend less.
See More: 11 Easy Tricks to Save Money Each Month
3. Increase your savings
Reducing your expenses will allow you to increase your savings rate. Use a high yield savings account for emergency funds and saving for short term goals, and put the rest into your IRA and 401k plan. There are contribution limits to these plans, so if you have money to save above these limits, put it in a regular brokerage account. For yoru IRA and regular brokerage accounts, I recommend choosing a firm that doesn’t charge commissions or management fees and allows you to automate the investment process. These reasons are why I recommend people use M1 Finance.
To amp up your savings, pick up a side hustle to put even more money toward your financial independence goals.
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4. Invest your savings
Investing in low fee index funds is one of the most passive ways to gain financial independence.. The ride might be bumpy, but these can give you the best bang for your buck in the long run. There is no better way to save for retirement in my opinion.
How much do you need to be financially independent?
You’re financially independent when your assets produce enough income to cover your expenses. If your portfolio is primarily in mutual funds, you can apply the 4% rule to find out how much you could draw from your account each year without depleting your portfolio. In other words, multiply your annual expenses to figure out how much you will need to accumulate to be financially independent and potentially retire early. For example, if you expenses are $40,000 per year, you’ll need to at least $1 million before entering into an early retirement. If you are retiring in your 30s or 40s, you can use a 3.5% rule to be even more conservative.
Of course, there are other ways to become financially independent. If you invest in real estate for example, you are independent once your profits equal your annual expenses.
It may take years of hard work, but it will be worth it. Financial independence allows you to work because you want to, not because you have to, and gives you the freedom to take your life any direction you want.