Everyone dreams of being financially independent. A solid bank account, a rising investment portfolio, enough savings, and no debt, are all components that together contribute to financial independence. If you’re wondering what it’s like to be financially independent, it its state wherein you have enough money for all your present and future needs and wants. In such a situation, your debt is zero or minimal, and your income flows are sufficient to cover all your expenses and financial goals. Financial independence is the ultimate goal of all financial plans and is extremely important in life. If you are financially secure, you can make your own decisions. You would not rely on others for their help and can choose to live life as you please. Financial independence can also impact your mental peace, healthcare, self-respect, education, etc.
While people may argue that money may not be the most important thing, it does have the power to affect everything that is important, like education, healthcare, security, and more. So, irrespective of whether you wish to be the most successful person in your field of work or not, you may want to work towards being financially independent. Further, being financially independent is critical at any stage and age. Ideally, the sooner you are able to earn enough to keep you by, the better it is. So, try to earn and save more from a young age by taking up part-time jobs or freelancing. However, financial security is equally crucial at later stages of life. Retirement and old age, in particular, may warrant the highest level of monetary independence. Likewise, it is also essential for all genders to be financially independent. Regardless of how much your spouse or partner earns, it may be advised for both partners to always have individual savings for their financial security. If you need guidance on how to streamline your expenses, boost your savings rate and build a substantial retirement fund for your golden years, consult with a professional financial advisor who can guide you on the same.
While a lot is said about achieving financial independence and why it is necessary, most people still struggle with being financial independent throughout their lives. If you wish to be financially secure for as long as you live, here are some things to know about how to become financially independent.
How much money do you need to be financially independent?
Financial independence can be a subjective thing. It can mean different things to different people, depending on their expenses, lifestyle, goals, incomes, financial responsibilities, etc. You may get by with a smaller fortune if you are single with no debt, no children, or any other financial liability. Your savings rate could be relatively lower than someone who has four children and is a single parent, as you would need a smaller corpus to cover your planned goals as well as financial emergencies. Typically, several factors affect your needs. For instance, the state you live in and the standard of living in your city can largely influence your status. A net worth considered to be financially sufficient in Texas may fall short in California or Hawaii.
Therefore, it is vital to ascertain your goals and needs to decipher how much money you need to be financially independent. Typically, some theories and studies suggest that you need at least 25 times your yearly expenses to be economically independent. You could have this money in the form of virtual assets like savings and investments. Similarly, CNBC reported that the average figure for Americans to consider themselves financially secure is at least $500,000 in savings. Some financial advisors also advise the 4% rule to determine financial independence in retirement. According to the 4% rule, you need to have a retirement corpus large enough so you can withdraw 4% from it every year in retirement for as long as you live. So if your annual expenses in retirement amount to $40,000 per year, you would require at least $1 million in your savings pool to last you an average retirement of 30 years.
However, there is no fixed rule of thumb here, and things may differ based on your unique situation. You can go with either of these theories and rules or devise one of your own as you see fit.
How to be financially independent
Achieving financial independence is all about building proper habits. While some people may be fortunate to be born into wealth, others may have to work their way through. You cannot control the circumstances that you were born in, but you can incorporate simple habits and practices to get to your desired goal. Financial discipline can be one of the most important things you do to be financially secure, and the following tips can help you develop it.
1. Start saving from a young age:
Financial discipline from a young age can reward you like no other. If you start concentrating on building a fortune from a young age, you can take care of a significant responsibility early in life. This removes the burden of creating a considerable nest egg later. Lifestyle inflation, expanding family, increasing healthcare expenses, etc., can come in the way of your goals when you are relatively older. Your financial concerns may peak in your 40s and 50s as this is the age where your kids would be off to college or getting married, you may be finishing off the mortgage on your house, and your health may start to show signs of regression. If you leave saving to this phase of your life, you will find it overwhelming to cater to all of these needs together. However, if you start young when you are single, have no kids or health expenses, likely no home loan, and have a less rigid lifestyle, you may be able to make adjustments to your budget in favor of more savings. By the time you reach your 40s or 50s, you will have already saved enough. Moreover, if you choose to invest your money in inflation-beating instruments, your money would have compounded to generate considerable returns by now. A longer time-frame also gives your money more time to compound.
2. Settle your loans and avoid debt:
Debt can be the biggest enemy to financial independence. It can interfere with your savings because of high-interest rates. It can lower your credit score and make it harder to get more loans in the future when you may actually need them. Additionally, paying it off can be a big problem. A lot of people find it hard to prioritize their savings when they have debt looming. While it is good to settle your debt on priority, a continued dependency on debt can be detrimental to your savings as you tend to get entangled in the web of never-ending borrowing. Debt is not limited to loans alone. It also includes credit cards. Credit cards can be helpful and help you save money if you use them correctly, but they can also be very problematic if you get stuck in the cycle. Therefore, paying off your debt at the earliest and avoiding taking on more unless absolutely necessary is essential.
You can start by clearing your student debt. You can use your 20s and early 30s to settle your student loans, depending on how soon you start working and earning. Meanwhile, instead of jumping on to the next loan for a home, try to invest your money instead. If you can get by renting or sharing an apartment with friends, you can use your early years to invest your money in the stock market, a 401k or individual retirement account (IRA), mutual funds, etc. Try to invest money in instruments that can help you cover the down payment of your future home. You can also consider investing in real estate investment trusts (REITs) and not physical real estate for pure investment purposes. Once you are ready to buy a house, try to be rational about your purchase. Bigger is not always better. So, be realistic about your needs and pick something that fits your budget easily without creating a giant liability.
3. Reduce your expenses:
It is crucial to track your spending to reach your goal of being financially independent. Expenses can very quickly stall your progress. So, try to create a budget and stick to it for as long as possible. A typical budget is inclusive of your essential needs, savings, and non-essential needs. Evidently, the non-essential needs should account for the smallest portion of your salary. So, pay attention to your triggers and impulses and try to control them. For instance, if you are easily lured by food delivery apps, try to delete them from your phone, so you cook more often than ordering in. If you are a shopaholic, delete consumer goods and apparel apps to avoid the urge to shop.
Additionally, make a list of unnecessary subscriptions to online streaming services that you rarely watch. If you are more likely to buy coffee on your way to work, start making coffee at home. It is also essential to understand the long-term effects of your purchases. For instance, a $3 dollar coffee every day can cost you $90 every month and $1095 every year. On the other hand, a decent coffee machine can be bought for $100. So, while the $3 may seem like a small expense at the time, in reality, the $100 machine is a better buy, keeping in mind your long-term needs. Any money that you save today can account for your financial security in the future. So, try to make a list of all your expenses and analyze them to understand your patterns. Once you identify those, you will be able to make better decisions.
4. Pay attention to your taxes:
Taxes are a significant blow to your savings. They can render your savings useless and disrupt your financial planning. The highest tax slab in the country at present is as high as 37%. In addition to this, there are several other taxes like the estate tax, property tax, state tax, capital gains tax, etc. Your investment returns, income, inheritance, etc., can all be exposed to taxes at some point in time. If you do not effectively plan to lower your taxes or account for them in your financial plan, you will not be financially independent. When planning your taxes, one of the first things to do is to use the right investments and savings options. For instance, a traditional IRA would be taxed in retirement but not in the present when you make your contributions. Contrarily, a Roth IRA would not be taxed in retirement, but you would owe tax on your contribution before you retire. The right pick here would depend on your present tax liability and your future tax situation. If you foresee a high tax bracket in retirement, you may pick a Roth account. However, if you are likely to pay more tax now, you can choose a traditional account to lower your overall taxes.
Similarly, you can use charity or lifetime tax exemption on gifts and estates to lower estate tax. This can be an excellent way to preserve your wealth. Tax-loss harvesting is also a helpful strategy to reduce taxes. This strategy adjusts your capital gains tax against your capital losses in a year. It is also essential to plan your retirement withdrawals wisely to avoid triggering a high tax. Planning your investment redemptions can help you enjoy their actual value, so you do not lose it to tax. If you find this hard, you can always hire a professional financial advisor or tax planner to suggest tax-saving techniques that can help you.
5. Set smart goals:
Setting goals can be an effective way to be financially secure. Goals cut your ultimate objective into smaller milestones. They simplify the planning process and keep you motivated to reach your final destination. Goals also help you streamline the process and pick the right strategies that can help you. Moreover, time-bound goals encourage you to not lose focus and stay diligent with savings and tracking your expenses. You can add goals like retirement, buying a house, saving for a child’s higher education, travel, etc., to your list and plan for them accordingly.
Achieving financial independence does not necessarily have to be challenging. You can get to your target by following these simple tips. However, the essential thing is to be consistent. Following these tips for a few years and letting go will take you back to where you started. But if you focus on the bigger picture, you will be able to pull through. Moreover, these tips are not as hard to follow. They only require some discipline that can be built with practice. And, if you think you are still lacking somewhere, you always have the option to seek professional help and assistance by hiring a financial advisor.
Use the free advisor match service to engage with a professional financial advisor who can help you become financially independent and create a significant retirement nest egg for yourself. Based on your requirements, the service matches you with 1-3 advisors suited to meet your financial needs and goals.