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How to become financially independent – a 3 step plan.  (i.e. how we’re doing it!)

We’ve defined financial independence, but how do you actually become financially independent? In this post, we’ll describe the 3 steps we took.

What you’ll learn:

• Step 1 – Become debt free
• Step 2 – Grow the gap between your income and your expenses
• Step 3 – Save and invest the difference

It really is that simple. There are tons of nuances within these steps but this is the fundamental path we all must take on our path to becoming financially independent.

Step 1 – Become Debt Free

Before you build a positive net worth, you first need to eliminate any negative net worth (i.e. debt). Very simply, your net worth is everything you own minus everything you owe. If you owe the bank (credit cards, student loans, car loans, a mortgage) like we did, your first step needs to be eliminating that debt so that you start building a positive net worth. Yes, the house counts! We know of no better tool to do that than Dave Ramsey’s Total Money Makeover and his 7 baby steps:

• Baby Step 1 – Save $1,000 to start an Emergency Fund
• Baby Step 2 – Pay off all debt using the Debt Snowball
• Baby Step 3 – Increase your emergency fund to 3 to 6 months of expenses
• Baby Step 4 – Invest 15% of household income into retirement
• Baby Step 5 – Save for kids’ college
• Baby Step 6 – Pay off home early
• Baby Step 7 – Build wealth and give

What we like about this approach:

1.  It’s simple. Just read the book and follow the steps. Note: don’t confuse simple for easy. This is hard work (but it’s worth it).
2. You can see the progress. You’re moving through steps. It’s clear where you are and where you’re going. You’re seeing your debts disappear, your emergency fund grow, and you build momentum. It feels great!
3. It has the priorities in the right order: set aside money for an emergency, pay off your debts, start to save, pay off your house. That’s when you can really start building a positive net worth, which is the key toward reaching financial independence.
4. It focuses on “gazelle intensity.” Get on this plan and go after it like you’re a gazelle and a cheetah is chasing after you. Becoming financially independent is a bit more like running a marathon than sprinting away from a cheetah, but getting out of debt and starting to save is so important; this is the only way to go.
5. It is a debt-averse plan. Don’t use credit card debt or chase consolidations, refinances, or lower interest rates in a shell game to try to get ahead.

Step 2 – Grow the Gap Between Your Income and Your Expenses

This breaks down into four basic areas:

• Reduce expenses (be frugal)
• Increase income (hustle)
• Make wise choices
• Beware of lifestyle inflation

Reduce Expenses (Be Frugal)

If you followed step 1 and got through baby step 2, you’re probably already good at this. You’re living on a budget and have built the muscles to have money left over at the end of the month. Where the baby steps leave off at baby step 7, the FI community picks up and encourages you to continue to have the intensity and focus on minimizing your monthly expenses. You do this through wise choices and living on a budget, to make is possible to save more. We have a whole section on this blog about frugal living, but for us this includes buying things used on Craigslist or at consignment shops or estate sales, and squeezing as much out of our monthly budget as we can.

Increase Income (Hustle)

This comes in the form of working hard at your day job and being opportunistic about career advancement, but also side hustling if you can. Although having a stay-at-home mom in our home is important to us, Jennifer has always had side gig work-from-home jobs to bring in extra income to help us accelerate our path to financial independence. I also started a side business to bring in extra income doing something I already love. We also increase income by selling our unused stuff on Craigslist or Facebook marketplace. 

Make Wise Choices

Don’t go back into debt. Purchase good, serviceable, re-sellable items rather than throw-aways. Watch out for items that are a large percentage of your monthly budget and try to reduce them. Cars can be this way. We buy good used cars that hold their value (with cash). Don’t ask us about the dreaded “Land Rover Years.”

Beware of Lifestyle Inflation 

When you get a raise, rather than increase your lifestyle by adding it to your vacation and dining out budget, save that extra % of your paycheck. Do this year after year and one day you’ll wake up with a high savings rate and be well down the path to financial independence.

Step 3 – Save and Invest the Difference Between Your Income and Expenses

As you start building your retirement savings, you want to invest it so it grows.

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

Albert Einstein

Believe us, you want to earn it. Compound interest is the way you will become financially independent. Here are the keys:

• Invest in low cost investments: we prefer index funds (read The Simple Path to Wealth)
• Invest in tax advantaged accounts
• Invest consistently to take advantage of “Dollar Cost Averaging”
• Invest in things you understand
• Diversify and don’t chase the latest shiny thing (Bitcoin, Tesla)
• Get a trusted fee-based Certified Financial Planner (CFP). Run away if they push an “assets under management” model where they take a “small” percentage of your account for their services. This was one of our biggest financial mistakes.
• Don’t freak out. Keep your money in the market even if it drops and you’re scared. Stay the course. Hopefully your CFP can help with this.

Conclusion

There you go. These are the basic 3 steps we took on our path to financial independence:

• Step 1 – Become Debt Free
• Step 2 – Grow the Gap Between Your Income and Your Expenses
• Step 3 – Save and Invest the Difference

Although boiling it down this way makes it look simple (and it can be), the work you do and the years you spend on each of these steps to reach financial independence is hard. One of the keys, though, is to become educated about how you can form a plan for your own financial independence and execute to that plan. I hope you’ve gained some insight into this family’s plan. You can do it! It’s worth it!