Everyone likes the idea of being financially independent. But how do you get there? What steps should be taken to get to the point where you no longer worry about money?
What Does It Mean To Achieve Financial Independence?
Financial independence means different things to different people. Some might say as long as they can afford to put food and beer in the fridge, they’re happy! For others, financial independence means not having to work.
What Does Financial Freedom Mean To You?
It’s important, to reflect on what financial independence means to you, not everyone aspires to travel First Class, for example. But whatever your personal preferences are, in our view the only sensible definition of money is purchasing power.
With that in mind, your greatest challenge is not to preserve your capital but to preserve your purchasing power!
What Are The 5 Pillars Of Financial Freedom?
The concept of the “5 pillars of financial freedom” is not something that’s universally defined. However, there is a commonly referenced set of principles that are often associated with achieving financial freedom. The 5 pillars of financial freedom are:
Financial Planning
Saving & Investing
Debt Management
Income Generation & Career Development
Financial Risk Management & Protection
1. Financial Planning
Financial planning should start by setting a budget that tracks your income and expenses, and noting your savings goals, which should help you make better-informed decisions and prioritise your spending. If you don’t need it, don’t buy it!
2. Saving & Investing
Developing a habit of saving and investing is essential if you are to achieve financial freedom.
First, you should start by accumulating cash in an instant access cash deposit account to form an emergency cash fund, a financial cushion in other words to meet unexpected expenses.
Once you’ve done that, if additional cash is available you’ll be able to take on additional risk by investing in other assets such as stocks, bonds, real estate, and so on which over the long term should provide a better return than cash deposit accounts.
3. Debt Management
Aside from taking on a mortgage loan to purchase real estate (necessary in most cases and typically sensible), other forms of debt (especially high-interest debt) are best avoided completely if possible.
However, should you find yourself in debt, fully understanding your obligations and the risks involved is imperative. By managing debt effectively you can become debt-free, thereby reducing financial stress and freeing up resources for your other financial goals.
4. Income Generation & Career Development
Expanding your income potential is essential for attaining financial freedom. Strive to improve your skills, pursue career advancement opportunities, and seek additional passive income streams, thereby increasing your earnings potential over time.
5. Financial Risk Management & Protection
Protecting your financial well-being from unexpected events is another key element of financial freedom.
This final pillar includes having appropriate insurance coverage, such as health, life, and property insurance, as well as building an emergency fund to cope with unforeseen expenses or job loss.
When it comes to investing, it’s best not to participate in investments that you don’t understand, especially those that sound too good to be true – unless you receive sound fiduciary-level advice.
What Is The 50, 20, 30, Budget Rule?
The 50/30/20 rule is a budgeting method that can help guide your monthly saving and spending.
To follow the 50/30/20 budgeting rule, simply put your after-tax income into three categories:
50% for needs
30% for wants
20% for savings or debt repayment
50% For Needs
Items like your rent or mortgage payments, groceries, transportation, basic utilities, and minimum loan payments fall in the “needs” category and should consume no more than half of your take-home pay each month.
30% For Wants
The next largest category of “wants” includes discretionary expenses like travel, entertainment and subscriptions. This should not exceed 30% of your take-home pay.
20% For Savings Or Debt Repayment
Use the remaining 20% to repay debts, invest or save your money.
When should I be financially independent?
The age at which you achieve financial independence depends on your personal goals and circumstances. The below life stages can serve as a general guideline.
20s-30s
Build a solid financial foundation by focusing on career development and financial literacy
Pay off any high-interest debt to avoid financial strain
Start saving and investing to benefit from compound interest
Keep an emergency fund on hand to cover 3-6 months’ worth of expenses to allow for unexpected situations
30s-40s
Aim to save and invest a large portion of your income to build your wealth If owning a home is part of your financial plan, work towards paying off your mortgage or at least building equity in your home
Contribute to retirement accounts and maximise your employer-matching contributions ● Remember to account for healthcare costs as you get older
50s-60s
Aim to be debt-free or at the very least have a clear plan as to how you will eliminate any remaining debts before retirement.
60s+
Focus on achieving financial independence by having enough passive income from investments, savings, pensions and other sources to cover your living expenses without needing to work
Review your financial plan to ensure it meets your needs and adjust if necessary
6 Expert Tips To Be Financially Free
1. The enemy is inflation
Over time, inflation erodes purchasing power. More cash chasing fewer products may increase the rate of inflation.
2. Company stocks consistently outperform inflation
Historically, company stocks (shares) have consistently outperformed inflation over the long term. Examples include PayPal, Microsoft, Philip Morris, and Estee Lauder all of which are high quality and resilient global growth companies that are considered good value for money.
3. Remember that company stocks can fall!
Be wary that your investment in company stocks can fall in value as well as rise. The price of admission is market volatility!
4. Watch for drawdowns
Throughout every year, stock markets have periods when they decline (drawdowns) typically by around 15%, and in extreme circumstances (Covid being an excellent example) by at least 30%.
The timing and reasons for those market drawdowns cannot be predicted and often do not coincide with economic trends. When you look at Covid for example, who could have predicted that markets would fall like a stone in March and bounce back to finish the year 2020 in positive territory?
Those investors who panicked and sold their stocks in April or May learned an awfully expensive lesson. Investors who bought the dips, so to speak, profited immensely.
5. Market volatility cannot be avoided
Stock market volatility can only be avoided by choosing not to invest at all – but that means sacrificing long-term returns which does not make financial sense.
6. Avoid stress!
Most people struggle emotionally with the ups and downs and unpredictable short-term nature of stock markets. In the words of world-renowned investor, Warren Buffet, “Be fearful when others are greedy, and greedy when others are fearful”.
This is where reaching out to a fiduciary can come in handy to help take that pressure off!
FAQ’s
What is the difference between financial freedom and financial independence?
Although the two terms sound very much the same, there is a difference in their meaning.
Financial independence usually refers to having enough wealth to live without the need to work for basic necessities. Being financially independent usually involves a passive income, a substantial net worth to sustain your ideal lifestyle, and being financially self-sufficient to the point where your financial needs are met without a salary.
Financial freedom, on the other hand, can mean different things to different people.
Typically, it means living without financial constraints e.g. being debt-free, having an emergency fund available, or having the ability to afford the luxuries you desire.
Someone who is financially free will be able to make life choices that aren’t driven by financial necessity. For example, they can change careers or take time off to travel, without worrying about their income.
It also means being in control and feeling financially secure to the point where you can plan for future financial goals comfortably while being able to pursue your personal goals, hobbies and interests without stress.
Financial independence is often seen as a path to financial freedom, as it removes the necessity to work for an income, allowing more freedom and flexibility.
Is an active fund manager worth the cost?
Conclusion
While there is no one-size-fits-all answer to being financially free, there are proven steps that you can take to help you on your way.
If you’re interested in finding out the best plan for your situation, contact one of our fiduciaries to arrange a free Discovery Meeting.
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