According to Wikipedia, financial independence is “the state of having sufficient personal wealth to live, without having to work actively for basic necessities”. Many of the things we do right now to improve our personal finances are meant to reach this ultimate goal in which we no longer have to worry about money and/or its source (ie working).
This is also synonymous, and a prerequisite, for retirement.
No matter what age you plan to retire, you must achieve financial independence (FI) first. In order to achieve FI, you must start planning and managing your money at an early age. The earlier the better.
The following are the most important habits that you must start now in order to be financially independent later on:
Save Money & Pay Yourself First
I highly recommend that you must always pay yourself first each and every time you receive a paycheck by setting aside at least 20% of each paycheck. But, 20% is your first goal. Ideally, if you want to reach FI at an earlier age and retire before the traditional age of 62, you must increase your savings rate to 40-60%.
Start out by slowly increasing your savings every 2-3 months. Start savings 5% of your net income this month. Then in 2 months, increase it to 10%, and so on. Keep adjusting and examining your budget. Find ways and areas to decrease or eliminate expenses, and then send that extra money to savings.
This way, you will be able to build your savings quickly. Doing this consistently as a result will make you more disciplined and judicious with your spending habits since you are teaching yourself to live on a smaller budget.
Keep Your Expenses Below Your Income
Piling on and taking on debt will definitely hinder any goals of achieving FI. This can really be challenging at first because the natural tendency is to spend more money when you make more money. Actually, in our consumeristic society we encourage people to spend all their hard-earned money… and then some. People like to reward themselves when they get a pay raise or a bonus. It takes a lot of discipline to be able to curtail this desire to splurge, but once you overcome this financial-pitfall, it can open up great opportunities for you to save more money towards achieving your long-term life goals.
The first step of this, if you aren’t already doing so, is to track all your spending. Find out where all your money is going to. You might be surprised. Then, set a budget and find areas where you can save money.
Max out your Retirement Funds
In truth, people aren’t saving enough for retirement. Saving 5-10% of your gross income each year is not going to be enough, even if you don’t retire until 65. The more you save and the higher your investing percentage, the faster you can retire. In fact, simply increasing your savings by 1% can make a massive difference in how fast your retirement funds grow. Just by increasing your savings rate by 1% can allow you to retire up to 2 years sooner. If you increase this and save 5% more, you may be able to retire up to 10 years earlier.
Your actual goal you be around 25% when saving for retirement. If you implement the 1% Early Retirement Strategy, outlined by Grant @ Millennial Money, you can easily reach this goal in a few years.
With an employer sponsored 401k plan, you can contribute (for 2017) up to $18,000 per year (not including any employer match).
Start Investing & Keep Investing
Investing is essential in making your money grow over time and reach its highest potential. According to investment expert Warren Buffett, “if you don’t find a way to make money while you sleep, you will work until you die.” Investing can provide passive income, making your money work hard for you instead of the other way around. You need this passive income to live off of when you reach FI and retirement.
In addition, don’t try to time the market. It never works. The best return of your money is to put money in, hold and keep investing. Don’t sell. Hold, hold, hold. Don’t sweat the day-to-day market volatility.
Don’t Fall Victim to Lifestyle Inflation
This is similar to Habit #2. Always keep your lifestyle in check and learn to live within your financial means. In addition, don’t let lifestyle inflation take hold. Instead of increasing your expenses and spending every time you receive a pay raise or a bonus, you should divert it into savings and investments. Most people tend to reward themselves when they make more money, but this usually results in increasing recurring expenses and sometimes incurring debt.
Implementing this practice into your financial planning allows you to keep your current lifestyle, but also increase your savings rate and reach FI faster.
Forget About the Joneses
You should not try to copy the lifestyles of other people. Just because your neighbor Mr. Jones bought a brand new Benz does not mean that you should also go out and purchase an equally expensive or more expensive item just to send the message across that you are not poor. You will be poor if you try to compete with other people’s lifestyles and spending habits. Keeping a low-key way of living, can bring you one step closer to achieving FI in your life. Even when you reach FI, you should continue living a frugal lifestyle, especially if you plan to retire early at the age of 40 and need that money to last 40+ years.