No such thing as a quick fix
Every article I have ever read titled something like 5 Steps to Financial Freedom only ever lists a few regular personal finance tips which everyone should be doing regardless of financial situation. Things like saving, investing, paying off debt, and having an emergency fund. While all are important in their own right, they won’t lead to any form of financial freedom.
So I’ve written my own 3 Steps to Financial Freedom article to provide you with some actionable knowledge that you can put in practice, and start taking your first steps toward financial independence. First up, is your financial health.
Step 1. Know your financial health
Before you can begin down the financial freedom route you need to know what your current financial health looks like. But what is financial health? It is the term used to describe the state of your personal finances and factors in things like how much savings you have, debt you carry, money you earn and spend. Each financial aspect is important and once tallied up you get an idea on whether or not your financial situation is healthy.
As figuring out your financial health is time consuming and a little bit daunting, most people give up at this stage. If you think this might be you, hit the button below to book me for a financial health session.
But this article exists to help you do it yourself!
Net worth
The first thing you need to know is your net worth; and, I don’t just mean a rough figure. You need to have a definitive $ value. To get this you add up all of your assets, and subtract all of your liabilities.
Your assets are everything that you own that has a value, in addition to any money you have in checking accounts or cash, as well as any savings and investment accounts, or pensions. Everything of value.
Your liabilities are essentially your debts or any sum of money that you personally owe, or are liable to pay. These include things like credit card debt, mortgages, student or car loans. They can also include overdue rent or utility bills which you owe in arrears.
Subtract the latter from the former and your final net worth will be revealed. The higher the number, the better! But don’t be dejected if your number is low or even negative. We all (well at least most of us) start with a negative net worth and it’s nothing to be ashamed about. Just decide to do something about it!
Monthly Cash Flow
Usually used by companies to see how they’re doing but also perfect for us individuals when assessing our financial health. What we want to figure out is our monthly cash flow and if this is positive or negative. Similar to net worth, we subtract all of our monthly expenses from our monthly income and the higher the value, the better.
Knowing exactly, or even roughly, where our money goes can be very difficult if you’re not used to keeping track. If you struggle with this then the best thing you can do is Starting a budget. Thorough or rough it doesn’t matter, but by running a budget you’ll quickly see where your money is going and how much money you have left at the end of each month. If you don’t currently run a budget, then you’ll have to guesstimate.
By hitting the link above you can read a little bit about budgeting and how I recommend beginners should go about starting a budget, and also the importance of one.
Financial habits
This is one that no-one ever mentions in their so called “steps to financial freedom” but from a financial planning perspective, it is one of the most important. Our financial habits not only define us, they also define our future financial success. While a pretty simplified view of financial habits, Clevergirlfinance.com covers it well in her article Bad Money Habits To Drop, Good Money Habits To Build. You should make a list of any good and negative habits that you believe may be impacting on your financial health. By doing so you will identify areas of improvement and areas of focus that can steer you towards financial freedom and success.
Most of our habits are taught to us by our guardians. If they never spoke to us about saving, we probably won’t save. If they didn’t teach us how money grows through investing, we probably won’t invest. The same goes for running a budget, or living on credit cards. Their habits are our habits, and a lot of us haven’t had very good teachers.
The worst habit that was passed down from the former generation was to never talk about our finances. I have a few theories on why, but we as a collective now know just how important it is to talk about our finances, especially our salaries, in order to break pay inequality.
Risk
Lastly, are your personal finances at risk?
The biggest problem I find when working with clients is the lack of understanding when it comes to protecting your assets. A lot of people are more than happy to work hard, save and invest, but rarely take the time to consider protecting their hard work – especially when protecting it comes at a cost. However, ignoring risk is one of the biggest factors inhibiting financial freedom. After all, you can’t truly be free if your freedom is threatened.
The easiest way to protect your wealth is with insurance. This can be through Life, Health, Home & Contents, Car, Liability or Travel insurance. It can be any type of product or service that helps you pass on the risk of unforeseen costs to a third party and, thereby, protecting your overall assets. It shouldn’t matter that it will cost you money now.
As an expat in Vietnam, the single most important financial tool I use to protect my assets, and my overall capital, is health insurance. I gladly pay a premium for an insurance provider that I know will work, because why would I want to cut costs on a product that exists for the sole purpose of protecting my health and wealth.
You can also protect yourself and your future financial freedom through income protection or critical illness insurance. These types of cover will provide you with a monthly or lump sum payment if you can no longer work and/or suffer from any number of major medical conditions, such as heart attacks or strokes. Despite the fact that 1 in every 4 people are now likely to suffer from a chronic, life altering illness, this form of insurance is often shunned. Planning for your own mortality is no fun, but why would you ever risk your financial future when you can so easily protect yourself.
Insurance isn’t the only the only to build a financial barrier to protect assets and cover risks. After insurance, my favourite strategy is to build cash reserves for specific, known upcoming events, as well as an emergency fund for unknown events. By doing so, you know that you have several cash reserves to hand which would effectively stop any assault on your capital.
So review any risks to your assets, and identify ways to pass on the risk to others or build a barrier against them.
Reviewing your financial health is the first step down the road to financial freedom. So where do we go from here?
Step 2. Make a Financial Plan
The only way we’ll ever be able to reach any form of financial freedom is by making a financial plan. This is where people pull their hair out. What is a financial plan? It is a document that contains your current monetary situation (financial health), short, intermediate, long-term goals, as well as any strategies you will implement to achieve your goals.
Simply put, your financial plan will be your road map to get you from where you currently are, Point A, to financial freedom, Point Z. All the letters of the alphabet in between will be your pit stops and goals you want to hit on the way. An in-depth Financial Plan should include:
- Financial Health information (step 1)
- Goals to improve financial health (short to intermediate term goals)
- Long-term goals
- Retirement & estate planning (sometimes included in long-term goals)
- Review & repeat
If you’re a beginner though, all your financial plan needs is numbers 1, 2, and 5.
Armed with the information you gained from the financial health analysis in step 1, you should immediately be able to identify some short to mid term goals.
Short to intermediate goals
The main two immediate goals anyone should work on is having an emergency fund of at least 3x monthly expenses, and no bad (credit card type) debt.
For the emergency fund simply look at your monthly cash flow and build up a specific fund that you can use on a rainy day such as being made redundant or having to travel to attend a funeral. This money should only be used for truly unexpected events.
As mentioned, paying off bad debt is also extremely important and should be at the top of any financial plan. You can use any number of debt payment techniques, but the most important is to target one debt and pay it off as fast as you can before moving on to the next. The goal is to be debt free from bad debt, but in order to get there, your goals need to be actionable. Preferably you would follow the SMART goal setting technique for each of your targets.
If your cash flow statement says you have $500 left at the end of every month but you’re sitting on $3500 worth of debt, then it might be reasonable to put $300 towards clearing your debt every month and target being debt free in 12 months.
If you have already got the emergency fund sorted and cleared your debt, you can look for other goals.
For example, if you’re living paycheck to paycheck you can see about cutting down on unnecessary spending. You probably don’t need Spotify Premium, Disney+, Amazon Prime, Hulu, and Netflix – get rid of a few. Or consider cheaper accommodation if you work from home, or more expensive accommodation if it is closer to your place of work and would save you money on travel. Every individual situation is different, so figure out what you need to do from your financial health analysis.
Short to mid term goals shouldn’t just be practical; they should also be fun and give you something to look forward to. They may include:
- Going on holiday in 12 months?
- Create a holiday fund and set aside $300 every month.
- Want a new road bike valued at $2500?
- Sell 25 items of clothing you don’t wear anymore for $20 each, and set aside $200/month for 10 months.
If you break a goal down into actionable steps you will be much more likely to succeed. It will also keep you from using money that you’ve ear marked for certain things. For example, if you’re 1 month away from your dream bike, you won’t flippantly splash $600 on a weekend away as you know that would set you back at least 3 months.
Long term goals
Your short to mid term future should be sorted and secure from the above. Now you can focus on building toward your future financial freedom.
Long term goals are often big ones.
- Travelling the world
- Wedding
- Down payment on a house/apartment
- Childrens’ education
- Retirement
- Relocating to warmer/colder climates
It could be anything that comes with a hefty price tag, so you need to factor these goals into your plan now. Especially your retirement. In order to be able to retire comfortably, you need to get comfortable investing. That’s a whole article in it’s own right, but the only thing you need to know is the sooner you build an investment portfolio, the sooner you’ll be financially free!
As you can see from the above, the goals you may have are endless and depend entirely on your situation. Likewise, any strategy that you need to implement to tackle your goals within your dedicated timeframe will be equally as specific. There is no one size fits all. Sometimes you should pay off debt quickly, sometimes you should focus on investing.
We’ve now covered 2 of the 3 steps to financial freedom and while they are big, the last one is short and sweet.
Step 3. Rinse and Repeat.
The only way you will find your way to becoming financially free is by reviewing your financial health every year, and subsequently re-evaluating your goals and amending timelines. You will then also see if the goals you are setting are achievable and right for you depending on how your financial health changes.
If after a year you are still living paycheck to paycheck, then maybe you haven’t focussed enough on eliminating bad financial habits like over spending. Or, it could be that you didn’t build up enough of an emergency fund to stop you from taking on new debt to cover an unexpected cost such as replacing a stolen phone.
In Summary
There is no one, single, correct way to financial independence. The above 3 steps to financial freedom are written to give a general guide of what you have to do to get yourself started and on the right track. The point is to take the first step since if you don’t even start down the path you will never reach the finish line.
It should go without saying, but note that everything in this article is general advice. Everyone’s financial situation is different so every plan will have to be tweaked in accordance to each individuals’ unique circumstances. For example, if you carry a fair amount of debt, but your debt doesn’t have any interest, then you might not need to pay it off immediately. Ultimately, I would always recommend that you find and spend money speaking to a fiduciary fee only financial planner if you are not comfortable dealing with matters of personal finances yourself. But hopefully the information in this post has helped you understand what you need and can do yourself!
