Most people say they plan for retirement, but they are really planning for financial independence. The day you achieve financial independence is a great day – you have accumulated enough wealth to not have to work again, and will be able to retire whenever you choose. (We use the word “day” symbolically; as a practical matter, your financial independence is likely to arrive more gradually.)
How do you plan for financial independence? Here are seven simple steps to follow.
Set A Target Date and Plan Accordingly
Decide when you want to achieve financial independence, and use online calculators to help you run different scenarios based on that date. This will help you plan your savings and investment needs.
Being frugal is not being a cheapskate. Cheapskates will not pay for anything. Frugal people will pay for value. If it doesn’t bring you value – and that could be emotional enjoyment as well as financial value – don’t buy it. You will be surprised at how much you save with that attitude.
Save and Invest Early
It’s extremely important to start saving early, so you can enjoy the benefits of compound interest in savings accounts to build an emergency fund, and invest in higher growth vehicles as soon as your emergency fund is built. Saving 20% of gross income may not be practical for everyone, but it is an excellent target. Save whatever you can, as early as you can.
Minimize Your Debt
Debt is not all bad, but it must be managed. For example, mortgage debt is useful because it builds equity, as compared to rent payments with no extra value. Moreover, mortgage interest payments are tax-deductible. However, you should not buy more house than you need just because you can afford it. Also, add extra principal payments early in the mortgage – it can save staggering amounts of interest payments.
Credit cards are not necessarily harmful, especially those that offer benefits. The trick is to never charge more than you can pay off every month. If you never carry a balance, the interest rate does not matter.
Invest for the Long Term
Maintain a diversified portfolio – do not randomly chase higher yields or be too conservative. There are several proven strategies to rebalancing portfolios to maximize risk management and growth, so find your favorite model and stick with it.
Plan your asset purchases to provide several sources of retirement income to supplement Social Security or pensions. Examples are dividends from stock, IRA distributions, rent from real estate investments, and annuities.
Leverage Tax Advantaged Investments
IRAs and 401(k)s are excellent vehicles to provide tax-deferred growth. Take advantage of them early, and contribute the maximum amount if possible – especially when there is an employer-matching program. Manage all your investments with an eye on tax benefits, and seek professional help if you do not feel comfortable doing this yourself.
Maintain Healthy Habits
For those who do plan well, a major source of derailing their plans is poor health. Maintaining a fit and healthy lifestyle does not guarantee lower health care costs, but it improves the odds. Besides, most unhealthy habits cost more to maintain than healthy ones. You should also reap cost savings through lower insurance premiums.
There are no magic steps to wealth accumulation. It is application of the basics – save early, spend wisely, keep debt low, and start early. If you have not yet planned for your financial independence, start today. People with better credit can save more for retirement because they pay less in interest.
When you wake up in complete control of your life and your finances, you will be glad that you planned ahead. Go ahead and set off some celebratory fireworks – after all, it’s your Independence Day.
The Short Version
- Save whatever you can, as early as you can.
- Use debt sparingly and pay it off as soon as possible.
- Maintain a diversified portfolio.
- Manage all your investments with an eye on tax benefits.