- Nate Carter
Three Big Steps Towards Financial Freedom
No one hands you the keys to financial freedom, but you can earn it by taking small disciplined steps each day. Over time these small steps add up to major, lasting results. On the bright side, it is not nearly as difficult to achieve as you might think. And as you wake up early for work each morning, it feels much nicer knowing you are one day closer to making your job obsolete.
To be successful you need a plan that works in both good financial times and bad. If the global financial crisis from 2007-2008 and the COVID-19 recession taught us anything, it is that we all need a solid financial plan. These recessions were a wakeup call for households who suffered significant financial setbacks and discovered they were far less financially secure than they originally thought. Do not put this off, the time to prepare for the next recession is now.
Make A Plan for the Next Recession and Financial Freedom
A properly designed and executed plan will not only ensure you weather future recessions but it will also help you emerge in a stronger financial position. Below are three steps to include in your plan for financial freedom. If you want a more detailed step-by-step plan to follow, consider the Become Loaded for Life: Ten Stages Workbook.
1. Pay Off Your Housing
Step one of your plan for financial freedom is to pay off your housing. Housing expenses account for 33% or more of the average household’s monthly spending. Many financial experts recommend not paying off your house as you can get a higher return on this money elsewhere. However, I disagree, because financial freedom is as much about reducing stress as it is about earning returns. Eliminating your housing expenses allows you to dramatically flatten your monthly expenses. It also provides the peace of mind of owning where you live. If a recession hits you never have to worry about losing your home in foreclosure. Paying off your housing eliminates this risk and the potential stress it would cause. You will still owe property taxes and insurance, but these are a small component of overall housing expenses. In addition, once you pay off your home you can convert your former mortgage payment into savings, dramatically increasing your savings rate.
How to Pay Off your Housing
There are several ways to pay off a home quickly. By switching from a 30-year mortgage to a 15-year mortgage, you can pay it off in half the time. It will also save you tens of thousands of dollars in interest charges. Some people do not realize that when you pay off your house over 30 years, you are actually paying for it almost twice, once for the actual cost of the home and a second time for the interest paid to the bank. For example, if you borrowed $200,000 at 4%, at the end of 30 years, you would have paid $143,739 in interest charges. You can shave years off your loan just by setting up weekly versus monthly payments or making extra principal payments each month. I have used this strategy to pay off a 15-year mortgage in seven years and saved more than $60,000 in interest expenses. Another option is to refinance when interest rates reach historic lows, like they are now. If you refinance from a 5% interest rate to a 3% interest rate you can save hundreds of dollars per month.
Lower rates and extra payments allow more of your monthly payment to go towards paying down the principal on your loan. This in turn, reduces the amount of interest you pay to the bank. Another strategy to reduce expenses is to eliminate your private mortgage insurance (PMI). If your house has appreciated you can get a new appraisal and remove this monthly bank fee. PMI is insurance to protect the bank if you stop paying, but if you have a sufficient amount of equity in your home, the bank has to remove this fee. An appraisal on my first property allowed me to remove PMI years earlier and saved me thousands of dollars. One of the best ways to pay off your property quickly is to use it to increase your income. If you can rent out a room or turn your basement into a separate apartment, you can use this revenue to pay down your mortgage. A little creativity and perseverance can help you pay off your home in half or a third of the average time.
2. Create an Evolving Emergency Fund
Your second step on the path to financial freedom is to create an evolving emergency fund. The reason I say evolving is because this fund will start out small but grow over time to suit your long term needs. This emergency fund will work as both an offensive and defensive tool. On the defense side it will protect you from relying on expensive credit cards in the event of a job loss or a medical emergency. It will also protect you from having to sell assets like stocks, bonds, or real estate during a severe recession when values have significantly declined. As an offense tool, it will provide you with cash to acquire income producing assets that have fallen in value during market downturns, but always remember to keep enough on hand for emergencies. This is how you come out of a recession wealthier than you went into it.
Six Months Salary is Too Much, At First
Although some financial advisers recommend an emergency fund equal to six months of your salary, I think this far too much at the start. Allocating that much money to a low interest savings account often limits the ability to take advantage of tax deferred savings plans like a 401(k) or Individual Retirement Account (IRA) which are a far better use of your money. As a alternative, let your emergency fund grow over time. Start with saving two or three months of your current living expenses, not your salary, as a goal. If this seems daunting, start with automatically saving $50 a week to get started. The key is to take action and by starting your emergency fund and paying into it on a regular basis.
You Will Spend Less
As you implement these first two steps of paying off your home quicker and saving in an emergency fund, expect to find that you begin spending less. This is part of the process of becoming more conscious about where you money goes each month. You can also save by canceling monthly subscriptions, eating out less, spending less on clothes, or finding cheaper entertainment options. If you want additional advice on setting up a budget see Five Steps to a Financial Freedom Budget. Eventually you will pay off your housing, significantly lowering your monthly expenses and allowing your emergency fund to cover many more months of your expenses if you were to ever lose your job. It will also provide you with an ample amount of cash to take advantage of undervalued assets. This takes us to the third step.
3. Diversified Income Streams
Step three of your financial freedom plan is to build a portfolio of diversified income streams. You are trying to replace your traditional wage income with income from investments that do not require an immediate investment of your time. You want to get the same income each year but not have to show up to a job for 40+ hours per week. These investments may include bonds, stocks, real estate, annuities, or owning part of small businesses. You can initiate this process just like you did with your emergency fund; you begin investing a small amount each week and gradually increase the amount as you cut expenses or increase your income. If you want to know more about building these income streams see 12 Types of Passive Income for Financial Freedom.
Saving 100% of What You Earn
Over time your portfolio will grow to cover all your annual living expenses, which means 100% of your job income can go to savings. Think about how quickly this will help grow your portfolio. Your goal is to create a portfolio large enough to cover all your expenses and generate surplus income to reinvest. Once you reach this goal you may choose to keep working or change jobs to work you enjoy more. By following these three steps you will dramatically increase your financial options, protect yourself in recessions, and reduce money related stress. And best of all you will be in a financial position where you choose to work and no longer need to work.