You may have heard of the “FIRE" movement—an ethos of saving and investing to become "Financially Independent and Retire Early." But financial independence can mean different things to different people, such as supporting oneself without outside help, being debt-free, working fewer hours or simply living without money anxiety. Whatever your definition of financial independence, the following tips can help you achieve it.
1. Know Your Finances
The first step to financial independence is getting a firm grasp on what money you have coming in and going out. Start by examining your income, paying close attention to your monthly take-home pay. If you work irregular hours or are self-employed, look back at a year's worth of after-tax income and divide by 12 to get a monthly average.
Next, create a list of your monthly expenses, debt payments and other spending. To make sure you don't miss anything, consult a year's worth of credit card bills and bank statements. List any withdrawals as “miscellaneous" and begin tracking your cash spending to see where that money is going.
Finally, use all this information to create or update your budget, making sure to include line items for “savings" and “investments." If you end up in the red, look for ways to lower your expenses, increase your income or do both (explained below).
2. Reduce Debt
One of the best ways to reduce your expenses is to pay down any high-interest debt you're carrying, such as unpaid credit card balances. The lower your balance, the less your monthly interest payments will be.
To pay down credit card debt faster, see if you can transfer your balance to a card with a low or 0% promotional interest rate. Just be sure to pay off as much of the debt as you can during the promotional period, and be mindful of what the full rate will be later to avoid even higher interest payments.
Paying off a mortgage is also a means to financial independence because you'll eliminate the majority of your shelter expenses (aside from property taxes and maintenance). If you want to be mortgage-free sooner, ask your provider how much more you could contribute monthly or annually without penalty.
Finally, consider these five tips to help reduce your debt.
3. Live Below Your Means
Living beneath your means isn't about utter deprivation; it's simply another way of saying you spend less than you earn. No matter what your definition of financial independence, you won't achieve it if you're outspending your income.
This brings us back to budgeting, and how to reduce your monthly expenses. Begin with an honest assessment of your needs versus your wants. Do you really need a car, or could you get by without one? Are there discretionary items in your budget you could cut down on, or give up—even temporarily—to save money and pay down debt? For true needs, are there cheaper alternatives (such as these ways to save on gas) or opportunities to share the cost with others (like carpooling)?
If you've cut back as much as you can and still can't make ends meet, shift your focus to the other side of the equation: your earnings.
4. Increase Your Income
There are two types of income: active and passive. Active income requires your direct participation, whether in the form of employment or other work. Passive income, on the other hand, doesn't require much effort from you. Examples of passive income may include investment returns or rental income on a property you own.
To achieve financial independence, look for ways to increase both types of income—at least in the short term. The idea is to build wealth by channeling as much money as you can from your active income into investments and other capital that will eventually generate enough passive income to support you.
So, for example, you could boost your active income by asking for a raise, finding a higher-paying job, picking up extra shifts at work, starting a side hustle or looking for casual or occasional gigs, such as babysitting or handiwork.
To increase passive income, you could consider renting out your basem*nt or a vacation property, contributing more money to your investment portfolio, and maximizing your interest income through different types of savings products.
5. Invest in Your Future
When it comes to investments that generate passive income, you don't want to put all your eggs in one basket. By diversifying into many different investment types with various levels of risk, you're more likely to achieve continued returns over the long term.
A diversified investment portfolio generally includes an array of higher-risk assets (but with greater growth potential), such as stocks, mutual funds or ETFs; lower-risk and more conservative investments, such as bonds; and very low-risk or no-risk FDIC-insured banking products, such as certificates of deposit (CDs) or high yield savings accounts.
Once you have a budget that allocates a monthly sum to invest in your future, automate your savings by setting up direct deposits or transfers to your investment and savings accounts, and watch your nest egg grow.
6. Build an Emergency Fund
Of course, your carefully constructed budget will only put you on the path to financial independence if your expenses and income remain stable. But what if you face an unexpected expense or job loss? That's where an emergency fund comes in.
By saving three to six months' worth of expenses in an emergency fund, you'll be able to stay on track with your budget even if you get laid off or have to cover a sudden auto repair bill.
Just be sure to choose the right kind of account for your emergency fund. You'll want a bank account that pays high interest on your deposits but allows you to withdraw funds at a moment's notice without penalty, such as a high yield savings account, CD ladder or bump-up CD.
7. Monitor Your Credit Score
A credit score is a number (generally between 300 and 850) that indicates your creditworthiness to financial institutions and lenders. A high credit score indicates that you're a responsible borrower, meaning you pay your bills and interest charges on time and don't carry too much debt relative to your income.
A high credit score is an important tool to help you achieve financial independence because it gives you access to lower interest rates on mortgages, car loans, lines of credit and other forms of borrowing. Lower interest payments, in turn, allow you to build equity and get out of debt more quickly.
To stay on top of your credit score, order a free credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion) once a year via annualcreditreport.com. If the number on your report is less than 800, consider the following tips to improve your credit score:
- • Always pay your bills (especially credit cards and loan payments) before the due date.
- • If you have no credit history, apply for a credit card and pay it off in full each month.
- • Don't apply for multiple credit products at once; this will lower your score.
- • Limit borrowing to no more than 30% of the total credit limit on all your credit cards and lines of credit.
- • Look for errors on your credit report, and contact the relevant credit issuer to correct any misinformation.
8. Seek Professional Financial Help
While there's an abundance of personal finance information, tools and calculators online for DIYers who want to chart their own path to financial independence, a little advice from a financial advisor can go a long way. After all, every situation is different, and it's not always easy to determine which solution is right for you.
A certified financial planner, for example, can crunch the numbers on your income and expenses to come up with a workable budget that can help you meet your retirement and other savings goals. A registered investment advisor can help you develop a diversified portfolio with an asset allocation that matches your risk tolerance and investment time horizon. A career coach may be able to help you identify ways to improve or leverage your skills toward a better income. There are even financial therapists who can help couples work together more effectively on money management.
To choose the right professional, start by identifying which accredited designationsspecialize in your area of need. Then, look for individuals who have those designations—preferably professionals who offer independent advice on a fee-for-service model so you know they have your best interests at heart. Finally, meet with them to do a gut check and see how you get along, since you'll need to feel comfortable sharing lots of personal and financial information.
Start Your Journey to Financial Freedom
While financial independence comes in many flavors, the recipe always includes the same basic ingredients: budgeting, spending less than you earn, paying down debt, increasing active and passive income, saving and investing, planning for emergencies, maintaining good credit and consulting professionals for advice when needed.
Whether you're a young adult looking to move out on your own for the first time or a FIRE devotee who wants to retire early, follow the above steps to get to your next rung of financial independence.
For more smart money advice and tips, check out Synchrony Bank's Money Matters blog.
Tamar Satov is a freelance journalist based in Toronto, Canada. Her work has appeared in the Globe and Mail, Today's Parent, BNN Bloomberg, MoneySense, Canadian Living and others.
READ MORE: F.I.R.E.: Why 'Financial Independence' Is as Important as 'Retiring Early'
