6 Habits To Set Your Path To Financial Independence
Over the past two years, financial and investment related matters seem to be soaring high as everybody suddenly becomes more aware of their money as well as their future. The pandemic has seemed to have successfully slapped a dose of reality to humanity. Therefore, previously, I had written an article to share about what to do before you start investing to help fellow newbies who are like me.
This time, I want to share more about personal finance. This is because I realised another topic has come up often which is about your financial situation and how you should or can plan for your (early) retirement. Yes, there are a lot of people or articles talking about how they aim to retire early or at least retire comfortably. You can search them online and you can keep on reading for hours.
Now, I am by no means a professional as I am also just another person who is still learning like you. However, I will share with you with the hope that you can be more aware about it too. So, my fellow learners, let’s get started!
Personal finance is called personal for a reason. There is no one number that fits all. There are, however, guidelines that can help you plan for your better financial situation and, eventually, future. For that case, you might start hearing people talking about being financially independent or aiming for financial freedom. What? What are those?
Well, those are terms that people often refer to as their life goal usually. Why so? Let’s talk about the different terms first. For those who are aware about this topic but want to get more clarity, it will benefit you too.
There are a lot of terms that start with “financial”, but in this article, I feel like I need to talk about the three (or maybe five) main financial terms that are often mentioned first:
- Financial Security
- Financial Independence
- Financial Freedom
Bear in mind that these definitions are what make the most sense to me, as I understand that some terms can be used interchangeably like “Financial Independence” and “Financial Freedom” according to other people or articles.
So, what do they mean?
Financial Security
I have read quite a number of articles on wealth stages but the one thing that I remember is that it simply means your wealth asset’s annual cash flow should be more than your annual basic survival expenses. In a simpler term though, this is pretty much a stage or level where you can comfortably cover your basic survival expenses annually.
Make sense? You are financially secure, if you can cover your recurring needs like food, clothing, home and utility bills, transportation, etc. Some might be in the grey area but they are necessary for your day-to-day survival.
Financial Independence
For this one, it is like one level above Financial Security. Your wealth asset’s annual cash flow should be more than your annual current expenses. In my opinion, this is pretty much a level where you can comfortably cover your basic survival expenses annually plus any other expenses like eating in a restaurant, watching movies, or whatever other expenses that can be categorised as not part of survival expenses.
I tend to see this as the capability to really comfortably spend without thinking much about money outflow. So this part really depends on your lifestyle. Also, perhaps at this stage you already have some passive income that can help to cover your expenses.
Financial Freedom
Now this stage is where you are pretty much already financially independent and on top of that, you can pretty much live the lifestyle that you want. Your cash flow would be enough to do what you want to do.
Now, if you are going to have multiple cars and travel multiple times per year, this financial freedom is gonna be expensive. However, you can also be free with just a simple life and living frugally as well. So, this part can be just about your mindset. The main point though, is that you are already financially independent and you can move on to focus on what your goals are for your life (which can be working for something meaningful and yet earning less).
Two bonuses that start with “financial…”
Financial Stability
This term could be commonly found. In my opinion, this is like the combination between Financial Security and Financial Independence whereby you can comfortably pay for your recurring expenses and also have some cash set aside for emergency use.
Your financial situation should be pretty set to reach financial freedom without any big issues.
Financial Abundance
This one is interesting to me probably because you can only start hearing this after you get really rich. Yes, just like the term says, your cash flow is pretty much more than what you ever need. It is more than just freedom. With this, you can really buy multiple cars and go travelling multiple times a year without having to care at all.
Looking at them, they seem like over-simplified versions, but the basis is pretty much there. Of course, personal finance stuff is not simple and it varies from person to person, so you can educate yourself further, which is one of the habits that I will talk about.
Now, having explained about terms, let’s move on to the habits that can help to guide you towards financial independence.
To become a financially independent person (early) in your life, the first step to get you going in the right direction is to emulate the habits of those who are already financially independent, or perhaps those who had done it before.
From my perspective, the way to reach Financial Security, Financial Independence, and even Financial Freedom is about the same. You need a certain amount of discipline and control. After all, those three stages are lined up one after another. It can be hard to form the habits but after a period of time, it can seem like a routine that your mind would subconsciously do, which can seem less tedious. So, keep that in mind and keep going!
Some habits that you can emulate:
- Pay yourself first
- Track your spending
- Set good financial habits
- Have emergency fund
- Work your dollar
- Educate yourself
The first step to financial health is to be aware of your situation. Even though it is only up to this point, you are already taking the first step by being aware of them!
Pay Yourself First
This saying is pretty common. It basically means what it means, but let me explain further. The habit here is to set aside your savings first once you receive your monthly salary. Then you use the remainder to pay off bills or spend on expenses.
Therefore, by putting your savings in the picture first, you are prioritizing your future first. The reason behind this is because if your mindset is to pay bills first, then spend on your expenses, it’s very likely that you would be left with little to none since saving has become an afterthought. If you prioritize saving first, it seems like you care about your money more and also your future self more and hence your retirement. As such, you will be more mindful of your spending.
However, the tricky part is how much you should save. You cannot just take 80% off without any context. You still have some bills or basic necessities that you have to spend on or pay off at least, like paying your utilities or property or food, which basically combined as your basic cost of living. Hence, I would think your basic formula should be:
Savings = Income — Basic Cost of Living
Track Your Spending
This part is somewhat a continuation from the previous point. Now we know we need to save as being financially independent needs money after all. We also know that we cannot just pick a random percentage to just save, as we have to be realistic about our own basic cost of living.
So, the question is how can we maximize our savings? After all, based on the simple math formula, if our cost is less, our savings would increase. The most common answer that I have heard or known of is to cook for yourself as cooking would definitely cost less as compared to taking away from restaurants or some sort.
Now, I have not done extensive calculations on the comparison between cooking and taking away food so I cannot really confirm it 100% but I would say it is very likely so. However, this is just an example. Another example is riding a bicycle instead of using a car or taking Uber or Grab. However, what is the main habit that one can draw out from this?
The main point is to take note of your expenses and track them. If you are fully aware of where your money goes, you can make adjustments to your spending habits easily by reducing the costs that you think can be reduced. Also, tracking your spending is a really good way to help you do budgeting as well since you now have a full picture of your money inflow and outflow.
Now, I know there can be temptations whereby you feel like splurging more on yourself is fine to pamper yourself. If it is once in a while, it is alright. If it is not and you don’t have the discipline to control yourself, you might go down the spiral and end up spending all again and without a way to track your spending, you cannot review and make changes. Therefore, tracking your spending is important here. You don’t have to live starving yourself, but being conscious about your every dollar is good. Distinguish between your needs and wants. After all, a dollar saved is a dollar earned.
Set Good Financial Habits
This one is more like a brief summary on overall good financial habits which include the previous points plus other points that I will discuss later on. Overall, having good financial habits is a good thing. You can feel less stressed or worried in regards to your finances. Also, by no means this is exhaustive but I will try to explain the main, important points only.
If I were to sort of order my points, I would go with conscious spending that leads to more savings and makes your excess money work for you. During the process, avoiding bad debts can help you not to derail too much. Don’t worry, I will explain.
We all know that having conscious spending is important as not only you are aware of where your money goes, it can lead you to easily budget and save for your future. By budgeting, you are forcing yourself to form the good habit better and faster. To ensure that you really stick to it, you can utilize the readily available apps out there. If you are a nerd like me, you can construct your own using excel.
Saving is one thing that might not be important now (for a YOLO mindset), but definitely is important for your future. Your future self is going to thank yourself that you start now. The longer you save, the more you will have. It’s simple logic. With that said, every purchase that you make derails you further from your financial independence. I know there are people who count each purchase by the number of hours they have to work (like if you earn $10/hr, you do the math for the purchase). However, for me I think it is troublesome so budgeting is the easiest way as you know whatever the remainder is the savings that you can’t touch.
As you save more, you might have excessive cash sitting in your bank account. Make them work for you, perhaps by investing.
Now, I am not saying you can’t spend on yourself, again, but you should spend accordingly. If you have more money and spending a bit more once will not hinder your goal, then go for it. The point is to be mindful.
The last one from this good financial habit is probably avoiding bad debts. We all know that taking consumer debts is usually not a good thing as the snowballing of their interest rates can really set you back a lot plus they might not be necessary in the first place. Logically speaking, the less debt you have to pay, the more you can set aside. However, not all debts are bad, like your mortgage. Hence my emphasis. Credit cards can be not bad too if you know how to use them properly, else they can be really really bad as the fees are costly. Therefore, limiting how much debt you take on and only use it for bigger purchases such as a house probably is the better practice. Otherwise, don’t spend until you have earned enough.
With that said, automating your bill payments and regular investments would be really helpful to avoid debt snowballing and ensure your money regularly grows. Perhaps, you can also set up a new separate account and automate the transfer of a portion of your income to it as a no-touch-savings to ensure that you have always automatically saved for your future.
Have Emergency Fund
The summary of good financial habits turned out to be long. However, there is one part that I missed out, which is setting aside a (fixed) sum for your emergency use from your savings.
This is typically called your emergency fund. Having this is important just in case, well, for your emergencies. This can come in handy if you got laid off, or any other emergencies that you can think of. At least by having this fund, you can feel at ease as you know you have something to fall back to.
If you recall the financial terms that I mentioned above, this makes up your financial security. Basically, you should be secure if you have this set aside. How much? I have talked about it in this article of mine but as a rule of thumb, you can keep about 6 months of your expenses for emergencies. In that article, I also talked about how this can be more than 6 months or the fund can be of expenses or income, as well as what to do before investing.
This habit though, is more like a one time thing. However, you can review it from time to time to see if you want to increase the fund. Also, there is this process of accumulating your fund that also needs discipline.
Work Your Dollar
This next point makes sense to me too. When you keep saving, you will reach a point whereby you will think there is a lot in the bank but they are doing nothing (apart from your emergency fund). Then you will start hearing people saying to invest your money, make them work to make more money. This is it.
The first one that I think makes the most sense is to invest often (bi-weekly, monthly, etc.). Compounding effect is the one compelling thing that works wonders. Not only the frequency of investing will help your money grow faster over time, the compounding effect will boost it up even further. There are plenty of online calculators out there that can help you to calculate the amount 20, 30 years down the road and you can see it for yourself. This one though, is more on the stock market, because I don’t think you can invest in property bi-weekly or monthly, but you get what I mean. If you are interested in it, perhaps you can look at my article on what to do before starting investing.
By allowing your investments to compound and grow over time, you can eventually build up a sum large enough to generate enough passive income to cover your expenses. The key thing here is to invest what you can, it is not a must after all. However, it is worth doing as it can help to gradually bring you closer to your goals.
The second one is for passive income if you are into dividends. Speaking of dividends, you can invest in properties as well and rent them out to earn them rental income. Basically, there are a lot of things that you can invest in that can help you earn passive income or can appreciate in values over time.
Educate Yourself
Well, after all the explanations above, especially on investing, it is clear that the more you learn the more you become more knowledgeable and eventually the better you become in regards to this topic as you apply what you learn.
So, even though this article is supposed to help and guide you, I suggest you broaden and deepen your knowledge further. For example, investing is not an easy feat, so you should spend some time reading and understanding at least the basics of the stock market from any resources you can find from Google, or you can start by reading some of my articles about basic terms like assets or market cap.
Educating yourself is so as to improve yourself and of course, your money too.
Wrap-Up
We all know that money management is a good habit and staying on top of your financial situation will definitely help you navigate your life’s ups and downs. We all also know that sometimes it is more tempting to just splurge for the now rather than save for the then. However, delayed gratification can be rewarding and don’t lose faith on it just because you can’t see the results immediately.
With that said, I feel that it all boils down to this fundamental habit called discipline. If you have the discipline to be patient and persistent, you will be able to form the habits as a new habit won’t form overnight.
If you don’t have the discipline, you would not be able to control as perfectly as you want as your mind would just try to “justify” anything for you to be out-of-control. As such, you would not form the habits perfectly too.
Needless to say, it will all be rewarding at the end. I hope you enjoy this article and if you find it useful and can be helpful for other people, feel free to share! Also, if you have anything to add, feel free to comment down below as we all learn from each other.
Thank you for reading.
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