Achieving financial independence is a herculean task for most of us. The most difficult part of this is, people don’t know where to start and what to aim for. The purpose of this post is to explain to you the steps to achieve financial independence in simple steps.
Following are the steps to achieve your financial independence.
Table of Contents
- Secure a job
- Identify your monthly expense based on the present lifestyle
- Identify your monthly expenses bases on the minimum lifestyle you desire
- Identify your monthly expense based on the lifestyle you desire
- Understand where you stand now comparing with your minimum standard lifestyle and your desired lifestyle
- Set your monthly budget
- Monitor your monthly expenses and budget
- Buy health insurance
- Buy life insurance
- Clear out all your debt
- Achieve emergency fund
- Work on passive income
- Start investing in equity
- Live below your means
- Wait till your investments and passive incomes create a monthly inflow
- Take a small percentage of your return from your investments and passive income to improve your lifestyle
- Reinvest the remaining amount from the returns from your investments and passive income and let it compound
- You may retire from your full-time job once your investment returns and passive income cover your monthly expenses and you have a networth good enough to cover your retirements
- Work on anything that excites you even if it won’t provide any monitory value
Secure a job
First things first. Even if you want to build an empire, you should start everything from the first basic steps. Just like that, to become financially independent, first, you need to find a job that provides you some kind of assured monthly cash inflow. See, anything multiplied with 0 is 0. So whatever you try to do, unless you have some kind of magic skills or you are one among the crores who gets some kind of lucky jackpot, you need to build your finance from some level of steady monthly cash flow. No matter how small it is, you need something to start with and build on that slowly but steadily. For me, at the age of 26, in the year 2012, I was doing my PG in Hospital Administration and based on my knowledge about the industry, I was at least sure that I am gonna earn an income which is good enough to pay my expenses and meet my basic entertainment needs.
Identify your monthly expense based on the present lifestyle
This step is important and vital, this is the foundation for everything. First, you need to take a paper and pen or open your computer and create an excel file and give a name that matched with the purpose and start noting down each household, miscellaneous and other expenses that you need to address. Now, you might be a teenager or youngster, who doesn’t carry the responsibility of funding many of your household expenses as most of the expenses might be funded by your parents or elder siblings. Whatever is the case, I suggest you sit with your family and identify each source of expenses. As I said earlier, use a simple excel sheet to do this. Once it is done, you are clear with your monthly expenses. In the last year of my PG, I was wondering whether I could live independently and meet at least all my personal income with the salary I earn at the beginning of my career and this thought led me to jot down our family’s monthly expenses.
The above-given table is an example of how your present expenses can be. You can access the excel template here which you can download and customize according to your personal preference.
Identify your monthly expenses bases on the minimum lifestyle you desire
In the above step, you identified your family’s present monthly expenses. Now, the minimum lifestyle that you desire to achieve might be above what your present lifestyle is. In that case, you need to jot down a rough estimation of expenses you might need to bear once you achieve your desired minimum standard lifestyle (YDMSL). Now the term “Minimum Standard Lifestyle (YMSL) ” is subjective and it is up to your decision and perspective what it should look like. Accordingly, your monthly expenses to cover your YMSL will change accordingly.
Identify your monthly expense based on the lifestyle you desire
Once the above steps are completed, now you need to draw a line where you will feel that you have achieved a lifestyle that you desired to achieve. Like I mentioned in the above point also, this decision is highly subjective. Also, there is no real limit to set a point for your desired lifestyle (YDL). Here, you should be rational and practical. Setting goals that are unrealistic and irrational makes this whole exercise useless.
Understand where you stand now comparing with your minimum standard lifestyle and your desired lifestyle
Understanding where you stand now and what you want to achieve and what distance you need to cover to reach your destination is highly important you give the right vision to plan your personal finance. Earlier you jotted down your present situation, the minimum standard of living as per your perspective, and what is your desired standard of living. This exercise now enables you to objectively analyze where you are right now and what you want to achieve. It gives clarity on what you should do to achieve to target. Based on the above tables I showed you as an example if the present expense is Rs. 45,450 your minimum desired lifestyle expense is 68,000 and your desired lifestyle expense is Rs. 1,04,000.
From your present expense to your desired minimum lifestyle expense and to your desired lifestyle expense, there is a difference of Rs. 22,550 and Rs. 54,550 respectively. So, definitely, there is a long way to go to achieve YDMSLS and YDLS. This you can achieve by setting a monthly budget, monitoring it, protecting any kind of unexpected events in life with insurances, and through proper financial management and investing.
Set your monthly budget
Now you know the expenses and you have some sort of monthly cash flow from your job. As you have already noted your expenses, now you know which expenses can be cut short and which all expenses are unavoidable. Based on this you set a budget for each item in the expense table which can be used against your actual monthly expense.
Now in the above table, you can see a new column with the heading “Budget”. You were about to define your budget against each particular only because you have identified your present expenses. Without knowing where you are right now, how can you set targets? Right?
Monitor your monthly expenses and budget
Now comes the best part, something which I have been practicing now for almost 10 years. Monitoring your monthly expenses. Earlier people used to write down all the expenses in a diary at the end of the day to calculate their monthly expenses. Gone are those days. Now you can simply download an expense tracking app and track all your expenses. The name of the app that I use to monitor my expenses is TOSHL. Either you can search Toshl is Google Play Store or Apple Store or access it from their website which is https://toshl.com/.
You must realize that, without tracking your daily expenses, it is difficult to keep your expenses within your budget. Budget managing apps like Toshl ensure that all your expenses are kept under the set budget. In case, if any or some of the categories of expenses have gone beyond the set budget limit, you can easily identify that. This process helps to keep all your expenses under check. The only thing that you need to do is, make an entry in the app each and every time you make an expense.
Buy health insurance
If you are a breadwinner in the family, God forbid, if you die, apart from losing a family member, the only financial impact that your family should face is loss of monthly cash flow. But what if that same person falls sick and needs to take bed rest for a long period of time, not only your monthly cash flow will stop, but also, you need to take out all your savings and emergency fund to meet the healthcare expenses. In case, if the cost of treatment is so high, then you might be forced to sell your assets and investments and sometimes even you may end up taking debt to cover the healthcare needs of your dear ones. Not only that, you may need to find a source of funds or income to cover up the stoppage of salary arisen due to the breadwinner in the family falling sick. So falling sick can completely shatter your financial planning and your life even if you survive from the ailment. Sufficiently covered by a health insurance policy is not just a great option or idea. It is a must.
Buy life insurance
Life insurance is not a mandatory thing for everyone. But if you are the only breadwinner in your family or if you think that if your monthly income is stopped, your family’s total monthly cash inflow is won’t be good enough for your family to lead a good life, then you must buy life insurance. Also, if you are a person who is not backed by assets/wealth inherited from your ancestors and you and your family is solely relying on your monthly income or any other revenue sources to create wealth and also to meet your expenses, then the expiry of one income-earning family member can cause a serious dent on your or your family’s financial planning. So in this case also you need life insurance.
Clear out all your debt
Albert Einstein once said
Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn’t, pays it.
The later part of the statement is for people who manage their life with debt. Compounded money grows like a “J” Curve. Initially, the growth of your investments will be negligible, but as the returns on investment grow like a snowball, it will start growing exponentially. For those who take debt, compounding works in the same manner but unfortunately in the opposite direction. Initially, you feel like you can manage the debt and its interest, but as it compounds, you will reach a stage where you cannot literally manage it.
Achieve emergency fund
What will happen if all of a sudden you lose your job? Reasons can be anything, you met with an accident and you are forced to take long 1-year bed rest and during this period your company won’t pay you or company fired your due to the financial crisis during a pandemic like COVID or due to your underperformance or maybe anything else. During these situations, when you are not having a monthly income, from where do you think you will meet your monthly expenses? Emergency Fund will help you to run through the tough time that comes occasionally during your working age which helps you to stay away from selling your assets and investments. In an emergency fund, you need an amount that covers expenses for at least 1 year.
Work on passive income
Just like creating and maintaining an emergency fund, you need to work on creating passive income. Now, what is passive income? Passive income is a source of income that you create that provides you cash flow at regular intervals without working on it every day. In other words, you are not actively working on something on a day-to-day basis to generate income. Even though to create passive income, you may need to take some effort during the initial stage to set up the system and running, but after a period of time, the system itself will start working automatically that provide you a regular source of income without putting effort each and every day.
Start investing in equity
The problem with everyone is, people start spending money on things that they really don’t need using the income they get from their active job. No matter what, if you can’t keep aside some part of your salary as your investment amount, then you can’t help yourself. Equity investment is the right decision to make if you want to generate a higher rate of return over inflation, especially over the long term. Even, investing in index funds like Sensex NIFTY 50 that represents the entire Indian equity market in general can reap a return anywhere around 15% over the long run. Past returns are never a guarantee for future returns, still, if you can wait patiently, considering the position India is in, in the long term you can expect a return anywhere around 15%.
Live below your means
When you have a steady flow of income, and when you expect that this income will be stable and will keep increasing year by year, you tend to get overconfident and start spending. Now the problem with spending and enjoying a materialistic life is that you unknowingly get into a hedonic treadmill where you continuously but unknowingly start improving your consumption but still your level of happiness will stay where it was earlier. Slowly you will take everything for granted and you will lose your capability to enjoy what you have right now. To save you from this what you need to do is to set a target that is very well below your means and ensure that all your expenses are below the set budget. This, in turn, gives you a cushion effect in your mind, Back of your mind you will be aware that your monthly spending is only 25% of your total income. In another way, when you earn one monthly salary, you are earning an amount to cover 3 more months. Again to put it differently, when you work for one year, you get an income that is good enough to cover 3 more years’ expenses.
Wait till your investments and passive incomes create a monthly inflow
This takes a long time. As you start working on your investments and passive income parallelly, you might need to do a lot of reading and working. You need to learn about investments and also about the right passive income strategy that is suitable for you. This will really take a long time, sometimes even up to 10 years. Yes, 10 years. But for all those efforts that you take during these periods, you will start reaping its benefits once you cross a stage, and till that time you need to wait patiently and work continuously.
Take a small percentage of your return from your investments and passive income to improve your lifestyle
At this stage, you may start upgrading your lifestyle a little bit by taking a small percentage of your investment returns and passive income. But make sure that you don’t go overboard. Because we are yet to reach our final destination of financial freedom. We are definitely on the way now, but still not yet reached.
Reinvest the remaining amount from the returns from your investments and passive income and let it compound
You should maximize all the opportunities to compound your returns and investments. You will be tempted to reap the benefits of your initial efforts and patients. But as you waited for such a long time, I would suggest you wait a little more to make it big. Whatever returns from your investment and passive income, instead of spending, you should take it and re-invest into equities or into your passive income system. Them helps to speed up your growth exponentially.
You may retire from your full-time job once your investment returns and passive income cover your monthly expenses and you have a networth good enough to cover your retirements
Finally, you will reach a stage where your returns from investment and passive income create monthly cash flow good enough to manage all your expenses and upgrade your lifestyle and also to do reinvestment both to your equity investments and passive income stream. Here you have created an automatic system where even without working 9 hours every day you can expect a steady flow of income. The only thing that you need to do is to monitor the system you have created and also to keep updating it occasionally. Here, at this stage, you can say to yourself that you have achieved financial independence and you don’t need to rely on others or work a 9 hours job 6 days a week to make your living. It takes time, as I said earlier, sometimes even 10 years or so, but all those efforts make sense when you realize the impact it can have in your life. Slowly and steadily, you build an empire of your own.
This is what Warren Buffett meant when he said
If you don’t find a way to make money while you sleep, you will work until you die.
Work on anything that excites you even if it won’t provide any monitory value
Now you have the freedom to do anything in your life without worrying about meeting your expenses. You are a free bird to take a decision based on your likes and passion. Remember, financial freedom is not about sitting at home, doing nothing, and watching movies 24*7. Instead, financial freedom is your ability to do whatever you want to do or achieve in life. Being a social animal, as long as you are healthy and fit, no matter what’s your age is, you should stay productive. How to stay productive is the choice you achieved by being financially independent. Doing something that you like makes a hell of a lot of difference in your life.