- Live on less than you make.
This is foundational – none of my other financial advice works until you get this one right. It’s not how much money you make, it’s how much you keep! The janitor that saves 20% of his income is better off than the doctor that racks up credit card debt living a luxurious lifestyle. Living frugally goes a long way towards achieving this goal, but it doesn’t hurt to have an average to above average income as well (i.e., a big shovel).
- Know your why.
Why do you want to be financially independent? You’ll need to know your motivation because hard times they are a comin’ and you’ll give up if you don’t think the sacrifice is worth it. Is the juice worth the squeeze? Only you can answer this deeply philosophical question. Do you want financial freedom to pursue a passion project? Mission work? World travel? What are your 5 and 10-year goals? Dream big. Write your dreams down, let’s make your dreams a plan – writing your goals down makes them real.
- Save early and often.
Compound interest and time are on your side if you start saving in your early 20s. Albert Einstein said compounding is the 8 th wonder of the world. For example, $1 invested at age 20, could become $73 by the time your 65. That same $1 will only become $28 if you wait to invest until age 30, using 10% returns. Do it right, do it light, do it wrong, do it long (you’ll be working into your 70s) (Mr. Bo Hansen of Money Guy fame). If you start investing just a $100 per month at age 20, it could grow to $740,000 by age 65 (investing $54,000 in total). If you wait till age 50, and invest $800 per month (investing $144,000 in total), you’ll only have $303,000 at age 65, despite having invested almost 3 times as much as the 20-year-old (using 9% returns).
I recommend you save 20% of your salary (including company contributions). This might be aspirational in your 20s but start with 5%, if that’s all you can do, and work your way up to 20% (and beyond). Keep it simple, invest in a low-cost S&P 500 index. As you get closer to retirement, you should revisit your asset allocation, to add diversification (e.g., bonds).
- Avoid debt.
Especially consumer/credit card debt. The Bible says the borrower is slave to the lender. I believe there are times when debt is unavoidable, especially for purchasing a home and reliable transportation; but debt, like a chainsaw, should make you nervous. If it doesn’t make you nervous, you’re doing it wrong (Brian Preston, of Money Guy fame). Pay off your debts sooner rather later. It’s a key component on the path to becoming financially independent.
- Have an emergency fund.
Life comes at you pretty fast. Be prepared. Even a $1,000 starter emergency fund helps buffer you from those unexpected expenses, that are surely coming. If you don’t have an emergency fund then you will likely use credit cards or pay bills late and start the spiral towards payday lenders and stress filled kitchen table discussions; that might end in divorce. Start with $1,000 but work up to 3-6 months worth of expenses, saved in a high yield savings account.
- Get the company match.
If you are eligible to participate in a company 401k it’s highly likely the company will match a portion (50% up to 6% for example) of your contributions. This is free money! Don’t walk across the street to avoid someone who’s trying to give you money. Don’t leave money on the table. Contribute at least enough to get this free money – it comes with a 100% guaranteed rate of return! 34% of Americans do not contribute enough to get the full company match.
- Budget, budget, budget.
I said it 3 times because it’s really important. A budget isn’t a straight jacket – it’s telling your money where to go instead of wondering where it went. A budget is actually freedom to spend on your priorities. It’s the map on your journey to financial freedom. There are many ways to use technology to automate this “chore”. I use the Every Dollar app but others prefer mint.com (mint.com moved to the credit Karma platform in 2023). Either way this is a vital step to know where you are, so you can slowly build wealth, on your way to financial freedom.
- Know your net worth.
Add up everything you own, subtract everything you owe, and the result is your net worth. Do you own more than you owe? Do this calculation at least once a year. Set goals to increase your net worth over time. That which is measured tends to improve (over time). If you want to know how much your net worth “should be”, take your age, times your income, times .10. For example, if your 50, and make $100,000 annually, then your net worth should be 50 X $100,000 X .10 = $500,000 (Millionaire Next Door formula).
- Automate your saving/investing.
This is a compliment to #3. Setup your saving & investing to come out of your paycheck each month, before you see it! This forces you to adjust your lifestyle to live on less than you make. Make good habits easy (automated), and bad habits (i.e., over consuming) hard. Steady, consistent investing over time is the best way to achieve financial freedom, eventually. Slow and steady wins the race. Once you adjust your lifestyle, to match your take home pay, you won’t miss these contributions. Over time this saving & investing will grow because of your monthly contributions and the power of compounding, once given time to do its “magic”. Eventually, Mr. Market will be contributing more than you do.
- Take risks.
I’ll list 4 risks I’ve taken in my journey: 1) get a college degree – it’s risky because it might cost $100,000 over 4 years (or more); you might not get your degree, and the degree might not get you a good job. 73% of college graduates don’t work in their field of study. Having said that, I got my master of accounting degree and credit that with getting a good paying job. For me, the risk was worth it. 2) invest in the stock market. Over the past 100 years the stock market has averaged a 10.5% rate of return – but it’s not a guarantee – some years the stock market is up, some years it’s down. You have to be disciplined and stay invested, and give your investments time to grow. Compounding can only add its magic if you sprinkle in time. 3) Invest in real estate. We have a cabin we rent out. Real estate can be another great investment – but there are risks – real estate can go down in value. Renters can damage your property or might not pay the rent on time (or at all). 4) Start a business, many millionaires started their own businesses; but 70% of businesses fail in the first 10 years, it’s a lot of work and it might fail. We started a cabin rental business and it’s been a big addition to our retirement portfolio. In a couple years we’ll have a fully paid for house – that others paid for – that we can sell to become totally debt free and help us retire early.
- Start with the end in mind.
If financial independence is your goal, calculate 25 times your retirement expenses, (not covered by social security). Let’s do an example. Say you spend $100,000 annually per year pre-retirement. Let’s take 80% of $100,000 as an estimate of post-retirement expenses, to get $80,000 of annual retirement expenses. Let’s estimate your social security income at $40,000 (assuming both spouses qualify); which means you need your investments to fund the other $40,000 of annual living expenses in retirement. $40,000 times 25 = $1 million dollars. This is the amount you need to save by age 65. How much do you need to save per month to get to $1 million dollars?
We said earlier that saving $100 per month, from age 20 to age 65 would yield $740,000. I estimate you need to save approximately $150 per month from age 20 to 65 to have a million dollar nest egg by age 65. Starting with the end in mind also means saving up for your next big purchase; having sinking funds for inevitable future expenses. If you own a home, eventually you’ll need to replace the roof. Say a new roof costs $20,000 and you estimate you’ll need one 10 years from now. This means you should set aside $167 per month into a sinking fund, saved in a money market fund and earning 5% interest, while you hurry up and wait for the roof to leak.
- Buy a house you can easily afford.
Rule of thumb, 2.5 times your household income; or no more than 25% – 30% of your salary going towards your housing expense. If those numbers seem unreasonable you might need to get a roommate. Or buy a duplex and rent out ½ the unit.
- Buy a car you can payoff in 3 years.
20/3/8. 20% down, financed for no more than 3 years, payment no more than 8% of your salary.
- Choose your spouse wisely. You and your spouse are on the same team. Hopefully rowing the boat in the same direction. Most millionaires say their spouse was a huge reason for their financial success. Communicate with your spouse each month about how to set next month’s budget.
- Review your social security statement.
Check your work history for accuracy (compare to tax returns or pay stub/advice). Review their calculation of your benefit at age 62, 65, and 70; in today’s dollars and in future dollars (adjusted for inflation). The future dollar calculator on ssa.gov is excellent. Learn how ssa.gov calculates your benefit, which uses your highest 35 years of earnings (indexed/adjusted for inflation). Of all the earnings you have made over the years, how much do you still have in your net worth statement?
- How does your spending compare to the “average” American?
The idea is to live frugally – it’s a balance – live for today but don’t sacrifice tomorrow in the process. Compare your spending, nominally and on a % basis to see how you compare to the “average” American. For example, the average American household spends almost $780 per month on food (groceries, eating out, etc.), or 10% of their income. How do you compare? Is this an opportunity for you to become more frugal? You’ll need to be frugal enough to save and invest 20% of your salary for retirement. Plus, the more you lower your expenses, the smaller nest egg you’ll need in retirement. It’s the classic win-win scenario. Don’t be too frugal though – you need balance (this is the way) – which includes experiencing life today, as well as saving for tomorrow. Invest in experiences, save up and spend a little on a family vacation (e.g., visit a national park). Enjoy each season of your life (your kids are only young once). But don’t let lifestyle creep rob you of a “great big beautiful tomorrow” (Brian Preston).
- Work hard.
I believe God designed us to work hard – to have a purpose – to enjoy the satisfaction of a job well done. To enjoy the fruits of our labor. Being lazy is not a recipe for success. The job market rewards hard work, integrity, humility, emotional intelligence and a positive attitude.
- Keep learning.
Just because you finished high school and college, doesn’t mean you should stop learning. Read personal finance books (e.g., Millionaire next door), watch personal finance channels on YouTube (e.g., The Money Guy), and read financial blogs (e.g., Mr. Money Mustache). This education will help you level up your personal finance knowledge. Personal finance success is 80% behavior and 20% knowledge. Don’t skip leg day.
- Choose your occupation wisely.
Read the book Strengths Finder 2.0. This book is interactive and will identify what occupations you are likely good at. Something like 75% of folks dislike their job. Don’t just complain about it, do something about it! Find out what your good at – your strengths, your passion. Maybe you’re already living as frugally as you can. You can only reduce your expenses so far, maybe you need a better paying job; one better suited to your strengths and abilities.
- Make sure you get the right insurance.
If you’re married and have kids, you need to get some term life insurance; preferably when you’re younger (and healthier). It’s less expensive when your younger (and healthier). Someone is depending on your salary. Make sure you have health insurance. Medical debt is a leading cause of bankruptcy. While you need health insurance, do what you can to stay healthy in the first place – eat right, exercise, go to the dentist – take care of yourself! Consider disability insurance. 58% of folks will be disabled at some point in their working life. Consider an umbrella policy. Once you’ve accumulated some assets, you’re vulnerable to litigation – basic car and homeowner’s insurance don’t provide much coverage – in the event you get sued.
Finally, don’t compare your personal finance journey to the proverbial Jones (living it up on their European vacation as seen on Instagram). Comparison is the thief of joy. While personal finance is a competition; you’re not competing against your neighbor, you’re competing against yourself!