As you begin down the path toward financial independence, you should stop for a minute and ask yourself, am I really ready for this? If you think it will be easy, you are mistaken. If you think you won’t be challenged, you are mistaken. Achieving financial independence can and will change your life, but it’s not just the end that matters. As they say, “getting there is half the fun.”
The path to financial independence is filled with pitfalls and the temptation to go the wrong direction will often be overwhelming. And when you find yourself locked in uncertainty, the self-doubt can overtake you.
Keep a level head. Do the best you can. And be persistent. In the end, consistency will get you there more than always making the right choice.
One of the first things we need is to get our financial system established. As a Financial Slacker, we’re busy people. So to make things as painless as possible, we need a system that’s automated. We need a system that doesn’t rely on us remembering to do something.
There are three principles we need to acknowledge and adopt:
- Spend less than you earn
- Save what you don’t spend
- Invest what you save
Financial Independence First Step – Track Your Expenses
- I recommend using an automated system for tracking your expenses. Personal Capital is probably one of the easiest to use. Mint is another option. Quicken provides a little more functionality than either Personal Capital or Mint in this area, but it costs money and requires more set up. With Personal Capital, you sign up for an account, enter in your bank and credit card information, and it takes care of the rest. It should be noted that for security purposes, Personal Capital doesn’t have the ability to move money in or out of your accounts, it only pulls the balances.
- Once you have some information downloaded, determine your monthly fixed costs (rent, utilities, phone, etc.) as well as your monthly discretionary spending (restaurants, shopping). Depending on your income and your purchasing habits, your monthly spending shouldn’t exceed more than 60% to 75% of your after-tax, net pay. If it does, you’ll need to start looking for ways to save.
- Figure out your worst-case scenario (what’s the minimum income you need without making major, life-altering changes). Make sure you have access to 6 months of worst-case scenario living expenses (cash on hand, credit cards, or a home equity line of credit). Depending on how risky your income stream is, you may prefer one of these over another (having the cash on hand is the least risky, but you’re also giving up any investment returns on those funds).
- Maximize contributions into your employer-sponsored 401(k) plan especially if there’s an employer match. The maximum you can contribute is $18,000 although there are rules specific to your company’s plan that might impact this. Whatever amount you contribute reduces your taxable income, but cannot be accessed without penalty until you’re 59 1/2 years old. This money is automatically pulled from your check. Perfect for the Financial Slacker.
- Start allocating a portion of your after-tax, after-401(K) pay into a cash reserves account and an investment account. Ideally, you should set this up as an automatic withdrawal otherwise you won’t do it consistently.
Next we’ll discuss the actual investment process as well as more specific numbers, but that’s enough to get you started down the path.