End the Paycheck-to-Paycheck Cycle: 10 Steps to Financial Freedom
Financial freedom looks a little different to everyone, but these 10 steps can get you on the right path.
Contributing Writer at Tally
September 2, 2021
Having financial goals is key to successfully managing your money. Without goals, you're flying blindly with no target in sight. One common goal is financial freedom.
What is financial freedom, though? Honestly, financial independence can be drastically different from one person to another. Maybe your idea of financial freedom is being able to buy the boat you've always wanted, but your friend's idea of it is traveling freely.
One common theme in the strive for financial freedom is having your money work for you — instead of the other way around — and being able to do what you want to do instead of what you're told to do.
With this common theme in mind, here are the key steps to financial freedom.
1. Learning money management skills
The path to financial freedom starts with learning how to manage money. Without proper money-management skills, you'll often wonder where that dollar went and the next dollar and the dollar after that. Next thing you know, all your income is gone, and you have no idea where it went.
Learning money management starts with a sound budget. There are countless budgeting options, but some popular and easy-to-follow budgets include:
Envelope budget: Set a budget for every category, create an envelope for that category and put cash in the envelope. Once the envelope is out of cash, that part of your budget is exhausted.
Zero-based budget: Ensure every dollar of your income has a job, whether that's paying a bill, paying down debt or going into savings.
50/30/20 budget: Split your income three ways: 50% goes toward daily bills and living expenses, 30% goes toward your wants and 20% goes toward savings or paying down debt.
Regardless of the budget you choose, stick with it through thick and thin. If you fall off the budgeting wagon, pick yourself up and get back to it.
2. Living within your means
The desire to “Keep up with the Joneses” has been a part of human nature for as long as we know. We often see some great new items our neighbor has and wonder how they can afford that when we can't. In some cases, we'll overextend ourselves to buy that item.
While that big credit card purchase may feel good now, it can become a burden once the bill comes and you're scrounging to make the payment.
Instead of keeping up with the Joneses, stay financially ahead of them by living within your means. In some cases, you can even live below your means.
For example, you may get a big promotion and finally have enough money to afford a luxury car you’ve always wanted. But instead of using that extra income on something that will depreciate, consider putting that extra cash toward saving or debt repayment.
Or maybe you can afford that 3,500-square-foot, five-bedroom home, but your family only needs 2,000 square feet and three bedrooms. If you opt for the smaller home, you can use the savings to pay debt or invest.
Living within your means isn’t just about the big purchases. It involves your day-to-day and smaller monthly expenses as well. For example, let’s say you love to eat out often or have multiple streaming services to enjoy, but they are a strain on your income. You can choose to either cut back on those expenses or earn extra income in a side hustle to pay for them.
3. Understanding your finances
It’s important to understand the condition of your finances. First, add up all your after-tax income so you know exactly how much money you work with each month. If you have variable income that changes monthly, look at the past six to 12 months to determine an average.
Next, add up all your debt balances and monthly payments to get a firm grasp of how much you owe and your minimum payments.
Then, add up your monthly expenses for all your needs, including:
Rent or mortgage payments
After adding up all your income and the costs of your needs, determine what discretionary cash you have left. Discretionary cash is the leftover money after covering all your needs.
If there is no discretionary cash left, you're living outside your means and should consider downsizing expenses or taking on a side hustle to make ends meet.
You can also use this as a chance to determine what gaps you have in your finances, like lacking an emergency fund to cover three to six months of expenses or no 401(k) or individual retirement account (IRA).
4. Protecting your family
Part of financial freedom is a clear conscience if something happens to you. One way to protect your family is with a life insurance policy. Generally, your policy should at least be enough to cover your debts. However, some personal finance experts recommend a policy worth 10 to 12 times your yearly salary on a 15- to 20-year term.
With a life insurance policy, if something should happen to you, your family can pay off any remaining debt and continue living within the same financial means. Be sure to talk to a financial advisor to see if a life insurance policy is a good fit for your long-term financial planning.
5. Starting an emergency fund
A key part of financial independence is being able to manage an emergency without reaching for a credit card. This is where an emergency fund comes in.
Most experts agree that having an emergency fund covering three to six months of your expenses is sufficient. However, this may not be possible given your current financial situation, so you may want to start with $500 or $1,000 and increase it later.
6. Setting up and funding your retirement accounts
Does your employer offer a sponsored 401(k) program? If so, this is a simple way to begin a retirement account.
First, find out if your employer offers a contribution match. For example, the company may match 100% of your contributions up to 4% of your salary. If it offers this match, check your budget to see if you can meet the maximum match. If not, start at the highest contribution rate you can afford and increase it by a percentage point each year or every time you get a raise until you maximize the employer match.
If you're self-employed or your employer doesn’t offer a 401(k), you can look into a Roth IRA or a brokerage account to put post-tax retirement savings in. Consult a financial advisor before opening retirement accounts, and remember it’s never to take to get started.
7. Managing your high-interest debt
High-interest debt can keep you from achieving financial freedom. Many experts say anything above a 6% annual percentage rate (APR) is considered high interest. So, most car loans, mortgages and federal student loans won't fall into this category, but personal loans and credit card debt usually will.
There are two main ways to manage your high-interest debt: the debt avalanche and the debt snowball.
In the debt avalanche repayment process, you make all your minimum payments on your high-interest debts, then apply any extra money you have left to the debt with the highest interest rate. Repeat this every month until that debt is paid off, then move on to the debt with the next highest interest rate.
Continue this process until you're debt-free.
The debt avalanche is the most effective process because it focuses on interest rates, saving you the most money along the way.
In the debt snowball plan, you make all your minimum payments on your high-interest debts, then apply any extra money you have left to the debt with the lowest balance. Repeat this every month until that debt is paid off, then move on to the debt with the next lowest balance.
Continue this process until all your debts are paid off.
While you'll likely pay a little more in interest charges with the debt snowball, it can provide a boost of confidence when you pay off low balances early in the process.
8. Don't forget self-care
All this investing, saving and debt management will eat up a lot of your discretionary income. But don't forget that you still have a life to live and enjoy along the way. Try to budget some money for yourself.
Whether it’s money for takeout or to go out on the town with friends once a week, this self-care cash will keep you motivated and satisfied while working toward future financial independence.
9. Building wealth
Once your high-interest debts are paid off, and your emergency fund is built, it's time for the home stretch toward financial independence: building wealth.
When saving for wealth building, the common rule of thumb is to save at least 20% of your income.
One way to start is by maximizing all your retirement accounts, like a 401(k) or traditional IRA. As of 2021, you can contribute up to $19,500 into your 401(k) and $6,000 in an IRA. If you're over 50 years old, those limits increase to $26,000 in a 401(k) and $7,000 in an IRA.
If you’ve maxed out your retirement account and still haven’t saved 20% of your income, you can consider putting the rest in a range of interest-bearing investments, including:
Real estate investment trusts (REITs)
Before settling on your final investment strategies, consider speaking with a financial advisor or investment professional to determine your best strategy.
10. Determining long-term goals
Once your money is working for you and building your net worth, you might wonder how long you need to continue on that path until you no longer need your salary. This is the ultimate financial freedom.
Here’s how you can determine the savings you’ll need to reach this long-term goal.
Add up all your monthly expenses and multiply them by 12 to get your yearly expenses. For example, if your expenses are $5,000 per month, your annualized expenses would be $60,000.
Now, look back at your investments to get their average return percentage. If you can't find this average, a safe average to assume is 6%.
Divide your annualized expenses by 0.06 to determine how much you need in your investments until the interest covers your yearly expenses. Using the $60,000 number above, this would come out to $1 million in investments before you're truly financially independent.
If you plan to earn money in some sort of side hustle or potentially start a new, more rewarding career, consider this income in your calculation as well.
While these calculations can give you a general benchmark to aim for, it’s always best to consult a financial advisor.
The steps to financial freedom are clear
From learning the basics of money management to growing your wealth, the 10 steps to financial freedom are clear and simple to follow. The key is to take those first steps as early as you can, because the sooner you get started, the shorter the path will be.
Remember, financial freedom is a long-term goal. So, if you stumble, don't get discouraged and give up. Pick yourself up, dust off and get yourself back on track. Your future financially independent self will appreciate all the hard work you're putting in today.
Tally can help you along your path to financial freedom with its credit card debt repayment app. Tally offers a lower-interest line of credit* to help repay your higher-interest credit card debts. The app will roll all your credit card debts into one monthly payment, repaying for you based on the debt avalanche method.
*To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate.