Financial Independence: Your Step-by-Step Guide

Become free through financial independence - here's how:

It can feel overwhelming and confusing when you first dive into the world of personal finance. ETFs, stocks, bonds, GICs, advisors, compound interest, tax sheltered accounts, tax deferred accounts, retirement funds, education savings plans, mutual funds, robo-advisors and that is just a small taste… the list goes on and on and on.

To start we need to lay the groundwork for everything else that’s to come: you need to get out of the paycheck to paycheck cycle of living and start creating systems for long term wealth generation. There are so many snake oil salesmen in this space promising quick riches and genius schemes for passive income. What I’m proposing is a long term approach to getting rich slowly. Using the tools at your disposal as a normal person to make money sustainably and setting up a better future for yourself.

Today, you’ll learn about the first few steps you need to do before everything else can be possible. Take a minute to congratulate yourself for even thinking about committing to a richer future. Ok, let’s go!

Step 0: Make a budget, reduce expenses

You just knew I was going to say this didn’t you? This probably isn’t anything earth shattering that you haven’t heard before but it’s where everything else starts. What gets measured gets managed. If you have a way to easily see all your cash in and out in front of you, you’ll be able to identify what is standing in the way of your financial freedom.

The first actual step should be for you to create a rough budget. You don’t need to track every single micro-transaction but having a general idea of where your money goes is the foundation for everything else. This will help you see where spending can be reduced to have extra money for the next steps.

Your budget should include expenses related to:

  • Rent / Mortgage
  • Utilities
  • Groceries
  • Restaurants & Take Out
  • Personal items (clothings, toiletries)
  • Health (gym membership, classes, equipment)
  • Vehicle (payments, fuel, insurance)
  • Taxes (income, property)
  • Minimum payment on all debts

Step 1: Build an emergency fund

An emergency fund is money you keep somewhere that can be accessed at any time. You might use cash in a (possibly high interest) savings or checking account. This money is for expenses that are unexpected. Maybe you lose your job… maybe your car breaks down suddenly… maybe you need to replace your furnace. Shit happens.

If you use part of your emergency fund, you need to fill it back up before going back to any of the next steps (so that you’re prepared for the next emergency).

How much money should I have in an emergency fund?

The usual recommendation for most people is 3 to 6 months of expenses. If your income fluctuates, it might be a good idea to keep a bigger stash like 9 to 12 months of expenses. If you are currently repaying high interest debt (anything above ~10% interest), start with a smaller emergency fund of 1 or 2 months of expenses while you pay down the high-interest debt.

Where should my emergency fund live?

Your emergency funds should be in safe, liquid accounts like a checking or savings account. You never want your fund to decrease in value and you need to be able to withdraw the money very quickly.

It should not be put in any type of investment as this could result in losses or inability to get the money out quickly. No, your credit card is not considered an emergency fund because of the high interest. Neither is a line of credit.

Step 2: Pay down high-interest debt

At this point, you should focus your extra money on paying down high-interest debt. High-interest debt could be defined as debt with an interest rate of 10% or higher. This kind of debt is what leads to a vicious cycle of compound interest that can keep you trapped for years. Do everything you can to eliminate it as quickly as possible.

Once all high-interest debt has been paid off, it might be a good time to bump the emergency fund to a full 3 to 6 months of expenses if you opted with a smaller one first because of the high-interest debt.

Once high-interest debt is paid off and a proper emergency fund is saved, extra money should be focused on paying down moderate-interest debt. Moderate-interest debt is debt with an interest rate of 4-5% or higher, excluding mortgages.

Step 3: Take advantage of employer-matched retirement funds

If your employer offers you any kind of company matching in a retirement account, use it! Contribute the amount needed to get the full employer match, nothing more. This is basically free money, definitely take advantage of it. This option isn't available for many, including self-employed people.

Step 4: Save for required large expenses

If you need to make a large purchase in the near future such as a car, or a large personal investment such as college, now's the time to save money for that. Money towards that purchase or personal investment should go in a high interest savings account.

Step 5: Invest for the future

At this point, you can start to save and invest for the future and benefit from the magic of compounding interest over a long time frame. Aim for investing at least 15% of your pre-tax income for retirement. This number might be higher if you think you are behind on retirement savings.

At first when you start to invest, you will probably have some tax-advantaged accounts you can invest within for the fastest rate of asset growth. If you are a US tax resident, these include a 401(k) and a Roth IRA. In Canada, we use RRSPs and TFSAs. It is absolutely worth the time to look up the options available for wherever you are a tax resident since using the room given by these accounts can make a huge difference in the eventual money you take out. Fill up these accounts first before opening a taxable investment account!

You’ll want to look for a low cost online investment broker. Personally I use IBKR (worldwide) and Questrade (Canada only). There are a number of other great choices out there. Likely you won’t want to go with the same bank you use for everyday checking accounts since the commissions tend to be higher for no additional benefit.

How you should invest is a personal strategic decision that we will cover advice for in another post. Many normal people (myself included) choose the “couch potato” approach. Despite the lazy sounding name, this strategy has been proven to provide solid expected returns over a long time frame. The goal is to regularly buy low-cost index ETFs (exchange-traded funds) which try to track the return of entire stock markets covering the whole world in an easy super-diversified package. These ETFs bundle tens of thousands of stocks into a single one that you can buy. Diversification is the only free lunch you get, so you might as well eat it. I’m not a financial advisor and am not responsible for any losses you might incur - yadda yadda yadda legal stuff. Anyways, back on track.

After you fill up your tax-advantaged accounts and have invested within them, you might move onto investing in taxable accounts. As the name implies, you will be taxed on capital gains in these accounts so make sure to track your investments’ cost base and keep enough cash on hand to pay the tax bill that is coming. At this point you’re doing quite well though and you are ready to move to next steps that look beyond the short term.

Step 6 (optional): Pay down low-interest debt

Any other remaining debt can be paid off in full at this point, or you could decide to go directly to step 7 while keeping steady payments on the low-interest debt. Manageable debt is actually not necessarily a bad thing if it is being used to help you increase your net worth (like a mortgage generally does). Almost all businesses and people maintain some debt to provide cash flow and finance their assets. This is something that will come down to your emotions around debt and if the peace of mind from being debt-free is worth the potentially lower investment returns you can get from investing your free cash. No one can tell you what is the right choice here except yourself.

Step 7: Save for other life goals!

Congrats, you've now reached personal finance maturity. It's up to you to decide what to do with the leftover money. Some common suggestions could be:

  • Increasing retirement savings to retire early
  • Use your savings to start a business
  • Saving for travel
  • Saving/investing for childrens’ education
  • Saving for property down payment

Don’t forget to live your dreams! Seriously, saving more money is not the be-all end-all that many otherwise smart folks obsess over. Your life is short and finite. Don’t be the person who died rich but failed to live the full life they could have. Ultimately money is just a means towards providing the ability to live on your own terms.

Note: Almost all of this has been thought of, spoken about, or written about by others - I’m not the original mastermind behind nearly everything here. It’s all been previously pieced together in personal finance forums, but it is more approachable, easier, and faster to find it in one place here. Feel free to bookmark this and come back to it whenever you need a refresher of the next step for wherever you might be in your personal finance journey.

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