7 steps to financial freedom. No, really

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Much has been written about the stages of financial independence (FI) in an effort to define financial freedom and the milestones along the way.

 

These steps for financial freedom are easy to understand, if a bit harder to actually reach. The good news? It gets easier as you go. Like riding a bike, the first few pumps are the hardest.

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As you plan your escape from the rat race, expect the following stages of financial independence.

Stage 1: Negative Net Worth (In the Hole)

Many of us start our journey below $0, with a negative net worth.

 

If you’re not familiar with how net worth is calculated, it’s simply the sum of your assets minus the sum of your liabilities (debts). If you owe more than you own, you have a negative net worth.

 

No bueno. But we all have to start somewhere. I’ve been there myself.

 

Whether it’s consumer debt, credit cards, student loans, personal loans, upside-down real estate investments, or other types of debt, you’re under water. That’s what comes of lifestyle creep and trying to keep up with the Joneses.

 

Consider it a one-way ticket to staying broke no matter how much you earn.

Stage 2: Financial Solvency

Once you realize you’re on the fast track to nowhere, you jump off the train.

 

You can then start building an emergency fund and tackling your high-interest debts. The next time you get hit with a surprise $1,000 car repair, it’ll still suck, but it won’t throw you into a panic. At this point, between your emergency fund and shrinking consumer debts, you’ll be able to absorb small financial shocks.

 

Word to the wise: you can supercharge your savings rate by house hacking. Check out this case study of how one man house hacked a duplex and covered his monthly payments with rent from his neighbor. Getting rid of your housing payment opens up lots of extra money to hit your financial goals faster.

 

Try the debt snowball method to knock out each debt one by one and build momentum as you go.

 

The higher your savings rate, the faster you’ll knock out your debts so you can proceed to the next level of financial freedom.

Stage 3: Financial Stability

Once you pay off all your unsecured debts, you’ve reached financial stability. You probably still have a mortgage loan in place, and perhaps a small car loan, but no high-interest loans.

 

By now, you’ve scaled your emergency fund to at least two months’ living expenses, and perhaps as many as 12 if you have unstable income or expenses. You can handle all the curveballs life throws at you, even if they still sting when they hit you.

 

At this point, you can put each paycheck’s savings toward investments rather than your emergency fund or paying off debts. This is where the fun really begins.

 

You can start investing for passive income from sources ranging from stock dividends to real estate crowdfunding to rental properties. If you need some fresh ideas, start with these passive streams of income from real estate.

 

Don’t ignore your retirement accounts either. If your employer offers matching contributions to your retirement plan, you effectively earn a 100% return instantly on your investments. But even if they don’t, consider maxing out your Roth IRA for tax-free compounding and withdrawals in retirement.

 

From here, you get to watch your net worth and passive income grow each month.

Stage 4: Halfway Point (Half FI/Coast FI)

You’ve calculated how much money you need to retire. You understand concepts like safe withdrawal rates and the 4% Rule.

 

When your net worth gets halfway there — what some FIRE pundits call “half FI” — you’ve reached the next milestone in financial freedom. As an aside, we use “FI” and “FIRE” synonymously, the latter standing for financial independence/retire early.

 

Despite how it may seem, you’re actually much closer than halfway there. Because each investment produces additional income and growth, it adds to the amount you can invest each month. These compounding returns mean it’ll probably only take you half as long to reach full financial independence as it took you to get where you are today.

 

In other words, if it took you ten years to reach half FI, it’ll probably only take you another five years to build up the other half of your target nest egg.

 

There’s another concept worth mentioning here, known as “coast FI.” Coast FI means that if you stopped investing today, you’d still be able to retire on time. The compound interest and returns on your investments would get you there on their own.

 

For example, if you have $500,000 invested and want to retire with $1 million, it will take you around seven and a half years to reach your goal if you earn 10% on your investments. That’s without you investing another cent.

 

Play around with this compound interest calculator to see just how powerful compounding is.

Stage 5: Financial Security (Lean FI/LeanFIRE)

When you can cover your basic living necessities with passive income from investments, working technically becomes optional. You wouldn’t be trippin’ the life fantastic, spraying champagne all over people at black tie galas, but you could survive without ever working another day in your life.

 

People in the FIRE community call this stage of financial independence “leanFIRE” or “lean FI.” For some, it’s the end goal. They don’t need trips to Europe or filet mignon dinners. They just want to live simply in a quiet corner of the world and do their own thing.

 

Most of us want more flexibility and “freedom” in our financial freedom, so we keep investing money. But if you don’t mind a modest lifestyle on a tight budget, this can serve as the end of the road for you.

 

As an additional thought, I’m a huge proponent of lifestyle design and using your passive income to help you change careers to something you love rather than tolerate. That could mean taking a huge pay cut to switch to a dream job, or it could mean starting your own business, or something else entirely. But when you can cover your basic monthly expenses with passive income, you have the freedom to quit your high-stress day job and never look back.

Stage 6: Financial Independence (FI or FIRE)

When you can cover all your living expenses — including discretionary expenses — with passive income from investments, you can retire without any loss of lifestyle.

 

Welcome to financial independence!

 

It doesn’t have to require passive income, either. You could simply reach a net worth that supports you, at whatever withdrawal rate (e.g. 4%) you decided on. A 4% withdrawal rate should last you at least 30 years, but if you want your nest egg to last longer, plan on a 3.5% withdrawal rate.

 

Reaching financial independence isn’t about getting rich. It’s about retaking complete control over your time. Most people who reach financial independence live a middle-class lifestyle, but they do work they love rather than slaving away in corporate hell.

 

Pursue financial independence to retire at 40, or at any age you like. Here’s how much you need to save to retire quickly.

 

Better yet, pursue FI as part of a larger effort to switch careers to do fulfilling work you love.

Stage 7: Financial Freedom (Abundance/FatFIRE)

If financial independence lets you continue living your previous lifestyle without a job, financial freedom shoots the moon.

 

People sometimes use financial freedom and financial independence interchangeably, but the definition of financial freedom as I see it is a life with few fiscal limits. You can afford luxuries like traveling around the world and fine dining without a second thought. You can pay for your children’s education effortlessly.

 

While many financially free people still live a middle-class lifestyle, they don’t have to. They are wealthy, at least by conventional standards.

 

Some in the FIRE community refer to this as “fatFIRE” as opposed to leanFIRE. You can expect to live comfortably without another cent of active income.

 

The longer you keep working and investing, the fatter your nest egg and passive income grow. But don’t continue working a miserable job just to reach fatFIRE. By the time you reach half FI or leanFIRE, switch to work you love. From there, every day feels like financial freedom.

Financial Freedom: Define Your Ideal Life

As long as you’re working a job you don’t love, you’re running in the rat race.

 

The FIRE movement gets a bad rap because critics assume that followers just want to lie on a beach sipping margaritas for the rest of their lives. But they’re missing the point entirely: reaching financial freedom is about retaking control and putting yourself in a position to do meaningful work rather than drudgery.

 

Work that, let’s be honest, doesn’t always pay well. Or if you’re starting a business, that comes with risk. I know all too well how harrowing the lean first few years in business can be.

 

I challenge you to dream bigger than just retiring. What would your dream life look like? Your dream work? How would you change the world for the better, if you only needed half the income to keep living your current lifestyle?

 

As you start climbing the steps toward financial freedom, start actively creating your dream lifestyle. It took me years, but I eventually built several sources of active income that I can earn from anywhere in the world, on my own schedule. I spend ten months a year overseas, and the other two months visiting family and friends in the US.

 

All the while, I continue investing and growing my net worth and passive income.

 

The irony is that in designing your ideal lifestyle, you no longer want to quit and retire. You want to keep working forever, because you love what you do.

 

In other words, the value in financial independence and early retirement lies in the pursuit, not in reaching a target number.

 

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This article originally appeared on SparkRental.com and was syndicated by MediaFeed.org.

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Are you living beyond your means? Here’s how to tell

 

Living beyond your means is an easy trap to fall into. And if you’re not keeping close track of everything that’s coming in and going out of your financial account, you may not even realize you’re doing it. But if you often run out of money before the month is over and you don’t know exactly where all the money is going, it could be a sign that you’re living above your means.

 

Over time, living a lifestyle beyond what you can actually afford can lead to mounting debt and also keep you from reaching your financial goals.

 

Related: Budgeting for basic living expenses

 

 

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Simply put, ”living above your means” means that you are spending more money than you are earning. People are able to do this by relying on credit cards, loans, and pior savings to cover their expenses. However, the process is not sustainable, and eventually overspending is likely to catch up to you.

 

Living beyond your means can also mean that you’re spending everything you bring in, and, as a result, don’t have anything left over for saving or investing, such as building an emergency fund, saving for a short-term goal like buying a car or a home, or putting money away for retirement.

 

Here are 10 red flags that you’re living a lifestyle you simply can’t afford — and tips for how to get back on track.

 

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If most or all of your paycheck is spent immediately on bills and you don’t have anything left over at the end of the month to put into savings, you are likely living over your means and may need to make some adjustments. If your current lifestyle has become a habit, you may feel there is no place to cut back. However, if you get out your monthly statements for the past three months and take a close look at where all your money is going each month, you will likely find places where you can cut back on spending.

 

This might be ditching cable, cooking (instead of ordering take-out) a few more times per week or quitting the gym and working out at home.

 

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If you’ve been putting a lot of your expenses on your credit card and/or don’t always pay your bills on time, you may see your credit score take a hit. This number is important because it can be accessed by anyone considering giving you new credit and may be used to determine the interest rate you’ll pay on a home or car loan, and also new credit cards.

 

If you aren’t sure what your credit score is, you can get a free copy of your reports from all three credit bureaus. Looking it over can help you understand why your credit score has dropped, and help you take the necessary steps to repair it.

 

For example, you might set up automatic payments for the minimum amount due on credit card bills and loans so you never miss a payment. You may also want to pay down your balances on your credit cards and lines of credit. This can lower your “credit utilization rate” (how much of your credit limit you are using), which is factored into your score.

 

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If money is feeling a little tight, you may feel that now is not the time to worry about retirement. But you likely won’t be able to work forever, so it can be wise to make saving for retirement a priority and to get started early.

 

Thanks to compounding interest (which is when the interest you earn also starts earning interest), the earlier you start investing in a retirement fund, the easier it will be to save enough money to retire well. You don’t have to contribute a lot; even just putting aside a small amount of each paycheck into a 401(k) or IRA each month can help you build wealth over time.

 

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Keeping your rent or mortgage below 30 percent of your monthly pre-tax income is sometimes recommended because it can leave you with enough income left over to save, invest, and build wealth in general.

 

Staying below 30 percent can be difficult, however, if you live in a region of the country where the cost of housing is high. Nevertheless, spending a lot more than a third of your income on housing can leave you “house poor” and put your other financial obligations at risk.

 

If you find that your housing costs are taking too large a chunk of your monthly paycheck, you might consider downsizing, taking on a roommate or finding a way to increase your income with a side hustle.

 

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Another sign you may be living beyond your means is that your savings have stagnated. Making regular deposits into your savings account in addition to your 401(k) or IRA allows you to work towards your short- and medium-term financial goals, such as putting a downpayment on a home or a car or going on vacation.

 

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An overdraft fee, or “non-sufficient funds fee,” is charged when there’s not enough money in your account to cover a check or debit card payment. Mistakes happen, and a one-off overdraft isn’t necessarily an indicator of overspending. But repeat offenses can be a sign that you are living too close to the edge and don’t have a clear picture of how much money is going into your account and how much is going out.

 

You may want to start tracking your spending and keeping a closer eye on your spending account to make sure you always have enough to cover your electronic payments.

 

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Many people think making and following a budget will be too complicated. But having a budget can actually simplify your spending decisions by letting you know exactly what you can and can’t afford.

 

Having a budget also helps to ensure you have enough money to cover essentials, fun, and also sock some away in savings. If you’ve never set financial parameters for yourself, you may want to consider taking an honest inventory of how much you are bringing in each month and how much is going out each month.

 

Once you get a sense of your own patterns and habits, you can work toward building a realistic budget that allows you to spend and save more wisely.

 

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Leasing a vehicle you would not be able to purchase outright or finance can be a major financial red flag. Leasing lets you rent a high-end lifestyle, but many people end up with leases they really can’t afford.

 

You might be covering your monthly payments, but if you can’t do that while meeting your other expenses and also putting money into savings, then your car is likely too expensive.

 

You may want to consider downgrading your vehicle or saving up enough money to buy a car — either outright or by making a solid downpayment so your monthly payments are low.

 

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It’s fine to use your credit card to pay for everyday expenses and the occasional big purchase. But if you can’t pay off most of the balance each month, you’re likely living beyond your means.

 

Rather than give over part of your paycheck just to interest each month, you may want to cut back on nonessential spending and divert that money toward paying off your balances.

 

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Not having a stash of cash you can turn to in a pinch can be a sign that you’re overspending. You may be gambling on the fact that nothing will go wrong. But life is unpredictable, and getting hit with an unexpected expense you can’t pay for can lead to a financial crisis.

 

Instead, you may want to build an emergency fund that can cover three to six months worth of living expenses. That way, you’ll be covered should something happen, such as an illness or injury, job loss, housing issue or any other expensive personal matter should come up.

 

AleksandarGeorgiev

 

Unfortunately, living beyond your means is all too easy to do. And while a few weeks or months of spending more than you earn may not be a major problem, overspending on a regular basis will likely catch up to you in the form of high debt and neglected savings.

 

Creating (and sticking to) a spending budget can help ensure that you can afford your bills and basic expenses, and still have money left over to save for the things you want in the future.

 

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

 

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