My 7 Steps to Financial Freedom are in order for a reason, we must play defense before we play offense.
One of my favorite sports to watch is boxing. I love the sport because it is 2 people alone in the ring and go blow for blow until one of them is left standing.
There is so much blood, sweat, and tears shed between the two fighters. If you are a fan of the sport you know that a good boxer must play offense and defense at the same time.
Unlike football and baseball where either your defense or offense is on the field, you need to be ready to play both offense and defense at the same time.
Investing is the same way. Lets take a look at the path to Financial Freedom!
Step 1: Save 6-9 months of expenses in a separate checking account as an “Emergency Fund”
According to CNBC in 2019, 40% of Americans could not afford a $400 emergency. This is a disaster waiting to happen for millions of Americans. We need to have a safety net in case something goes wrong. Whether your emergency fund should be 6 to 9 months depends on a multitude of factors.
Household Income, Job Security, Children, Cost of living, etc. If you have a stable job with great opportunities you can afford to only carry 6 months of expenses, however if you have lower income or not a stable career profession, consider having closer to 9 months.
This first step to financial freedom is foundational because this is the first line of defense for keeping you out of high consumer debt such as credit card loans. If an emergency happens such as a car breakdown, hot water tank goes out, etc, and you do not have an emergency fund in place, you are more likely to rack up credit card debt and even worse, withdraw money from your retirement.
We never want to withdraw money from retirement accounts because withdrawing early means we have to pay a penalty and potentially taxes! By having a 6-9 month emergency fund you will be better prepared for life’s unexpected events.
Step 2: Health Insurance Covered
This one might be self-explanatory. After you complete Step 1, you need to make sure that you have health insurance covered, whether that is through your employer or you are paying out of pocket.
In the early stages of wealth building, a hefty hospital bill can set your wealth building journey back so far and we can’t afford to let that happen.
Step 3: Invest Up to the Employer Match in Your 401(k)
The portion that your employer matches is free money. It is a guaranteed rate of return on your money. If you have a Roth 401(k) option with your employer that would be preferred over a Traditional 401(k) because our investments will have tax free earnings, more on this to come.
Step 3 is to get you to start investing early, as mentioned in my previous article, time is your #1 wealth building tool. This is why I put investing up to the employer match in your 401k before paying off high interest debt.
3a: If You Do Not Have An Employer Match You Should Contribute Straight to a ROTH IRA
Again, time is the most important wealth building tool. If you don’t believe me, check out my previous article to see the numbers! A 25 year old only needs to invest $160 a month from age 25-65 in order to retire a millionaire! If you do not have an employer match, contribute directly to your ROTH IRA.
Step 4: Pay Off High Interest Debt (7% or Higher)
Debt is the montra of the middle class. The average American family has $6,270 of credit card debt. Credit card debt is often at very high interest rates, I have seen it up to 20%. Credit card interest also compounds daily! You should be paying off high interest debt because it is costing you money over time and it is eating into your wealth building power.
Step 5: Max out Your ROTH IRA
If you personally know me you might think of me as the ROTH man. I can’t say it enough that every single American should have a ROTH IRA account. These accounts get taxed when you contribute, but the earnings grow COMPLETELY TAX FREE, assuming you withdraw at 59.5.
Let’s go back to the example above, assuming a 25 year old contributes $160 a month in a ROTH IRA account, until they were 65, they would have $1,000,000 completely tax free. You can contribute up to $6,000 a year to a ROTH IRA, and $7,000 a year if you are over age 50.
Side note: one of the sneaky features of the ROTH IRA is that you can always access your contributions penalty free. I do not recommend this because there is a reason that the government only lets you put $6,000 a year into this account, they know how powerful it is!
Step 6: Pay off Low Interest Debt (6% or lower)
At this stage of the game you already have your higher interest debt paid off, and you are starting to fund your retirement accounts. Time is now on your side because your investments are growing! This is the time where I would look to eliminate some of the lower interest debt, you can include your home mortgage in this step, but you do not have to.
Step 7: Invest 15-20% of Your Total Income In Order To Become Financially Free
Once upon a time Americans were able to only save 5-10% of their income in order to retire inspired. Most companies had costly pension plans that would allow most of Americans to retire.
Over the years many companies are moving away from pensions, and into defined contribution plans, which means the employee is responsible for their retirement!
Also, If you are 20/30/40 reading this I would not count on social security to be there when you retire. Investing 15-20% of your total income ensures that you will become financially free and not have to be dependent on the government.
Thank you for reading and If you have any questions, please reach out to me on Instagram/Twitter @LearnLikeaCPA Again, this is my list but it can be tweaked for your personal situation. Guys, there’s a reason why it’s called (personal) finance.
