Clear Steps to Financial Independence

There are many people who are stressed about losing their job or fearful about ever being able to retire. Worrying or complaining will not resolve these concerns. You have to create a plan and implement it. This could be the year you resolve these fears and create financial stability in your life. The steps below will help you get there, but you must take action if you want results.

What is Your Freedom Number?

If you want financial freedom you need to know your numbers. Calculate all your monthly living expenses and then look for ways to reduce them. You will see a gravitational decline in your spending the closer you track your money. Expect a 10% to 20% decline in spending without any change in your quality of life. This includes cutting unwanted subscriptions, eating out less, conserving to reduce utilities, making fewer purchases and finding bargains.

The four biggest categories for spending are housing, transportation, food and entertainment. Downsizing your apartment, taking on a roommate, selling your car and using public transportation are all ways to dramatically cut spending. When I was first starting out I used these strategies to cut most of my expenses in half and create the cash I needed to invest and save for real estate.

Several months of tracking and reducing spending will help you determine your freedom number. This is the amount you need to earn each year in passive income to be financially free. Do not forget to add in the cost of home repairs, replacing major appliances, or future vehicles, along with the cost of medical and dental care in your freedom number. It only works if it is accurate. Index this freedom number for inflation to ensure your income will continue to cover your expenses in retirement.

Create Wealth to Fund Your Freedom Number

If your freedom number is $70,000 (indexed for inflation) you have to create a portfolio of wealth to finance this budget. This process is about no longer trading your time for a salary. Side hustles and consulting work are great to generate extra income in retirement, but they cannot be part of meeting your freedom number. The income generated by your wealth has to cover all of these expense Wealth from income can include rental income, dividends, interest income, annuity payments as well as slowing drawing down a portfolio of stocks and bonds. A diverse range of assets will help a diverse range of income streams in down markets.

Steps for Creating Wealth

401k Accounts

A large component of wealth for most retirees comes from their 401k account. To accelerate wealth creation, maximize contributions to these accounts and take advantage of any employer matching funds. A 25-year career of saving in these accounts can lead to $500,000-$2 million in account values by the age of 59.5, the age at which you are able to withdraw from these accounts. Invest your contributions in a broad index of stocks. Do not try to time the market by changing portfolio allocations, set it and forget it. You will not pay tax now on contributions to your 401k but you will when you withdraw these funds in retirement and will most likely be in a lower tax bracket.

Roth IRA

Once you have maximized the benefits of your 401k, open a Roth IRA and contribute as much as you can until you reach the maximum for the year. The Roth IRA has the benefit of allowing your investments to grow tax free. You can withdraw these funds in retirement and have a source of tax free income.

Rental Properties

The returns on rental property investing is not as easy as they were a few years ago but opportunities exist if you have hustle. Look for rental properties where the total costs of ownership are covered by the rents. This could be a small condo, a single family home, or small multifamily properties. If you can live in one unit and rent out other units, or buy a house and add roommates, you will rapidly accelerate your wealth creation goals. Even if your monthly profits on rental properties are nominal, over time the property will be paid off and rents will rise. If properties are too expensive where you live it may make sense to rent at your location and buy rentals in a less expensive market.

As your properties appreciate you can perform a cash out refinance to withdraw some of your equity and use these funds as the down payment on your next property. A single rental property can be used to recycle your down payment for several future rental properties. Also consider investing in real estate syndications as a limited partner, which allows investing passively in larger real estate projects.

When you are ten to 15 years away from retirement, purchase a retirement home in the location you intend to live in once retired. Put this property on a 15 year mortgage and use it as a rental. Over the next decade your tenants will pay down most of your retirement home. Having a paid off home in retirement dramatically reduces your annual expenses and your freedom number. If you are not sure where you want to retire, buy a house where you might want to retire. If you change your mind on where you want to live in retirement sell this home and pay cash for the next one.

A Few Years Before Retirement

A few years from retirement you will revise the allocations in your portfolio to a mix that reduces volatility. Spend some time researching this decision to make a wise choice. I highly recommend A Richer Retirement by William Bengen for this step. Some people prefer a mix of 60% stocks and 40% bonds, while others also include a percentage of precious metals and commodities. A common approach to drawing down your portfolio of stocks and bonds is the 4% rule. This includes drawing down 4% of the portfolio each year in retirement (indexed for inflation). Hence, a $1 million account will result in a withdrawal of $40,000 in the first year of retirement.

This is also the time to do preventative maintenance on any rental properties. This includes new roofs, HVAC systems, painting, flooring, water heaters, and kitchen appliances. It is preferable to have updated rental properties that will require lower expenses in the first ten to fifteen years of retirement.

If mortgage rates are lower it may be a good time to refinance loans or do a cash out refinance for any future real estate acquisitions. It is much easier to qualify for a mortgage when you are still working. This is also a good time to consolidate mortgage debt to property one or two properties. Paying off mortgages eliminates the risk of foreclosure on the property.

Establish an emergency fund of six to eight months of expenses in a high yield saving account. These funds provide a cushion for monthly spending and also provide peace of mind in retirement. Some people who are more risk averse may have a full year to 18 months of funds set aside in an emergency fund. A portion of these funds can be rolled over in certificates of deposit if rates are higher than high yields savings accounts.

Get Started for Peace of Mind

The best time to work on becoming financially free is now. The power of saving and the exponential growth of compounding interest helps assets grow. The earlier you buy a rental property the faster you will pay it off. One of the greatest gifts of gaining financial independence is slowly watching your need for job disappear. Once my passive income hit my freedom number I realized I was financial free. Bosses loses their power, employers become optional and economic uncertainty is less threatening. It is a great way to live if you want to be happy. For more detailed information on investing and creating a plan for financial freedom see Become Loaded for Life and the 10 Stages Workbook.