Tips for Becoming Financially Independent
It’s a common dream to become financially independent. While the phrase “financial independence” can mean different things depending on a person’s situation and outlook, it usually refers to living comfortably off one’s savings and investments. That often means you have no or low debt. In addition, it means that if you work, it’s probably because you want, not because you have to do so to pay bills.
If this sounds appealing, you’ll probably be happy to know that achieving financial freedom could be simpler than you think. The process often boils down to a relatively basic concept: Spending less and saving more.
Key Points
• Financial independence means living off savings and investments vs. relying on a paycheck.
• Budgeting is essential; track income and expenses, then save or invest the surplus.
• An emergency fund of 3-6 months’ expenses helps to ensure financial security.
• Prioritize paying off high-interest debt to improve financial health.
• Smart investing, including tax-advantaged accounts, can accelerate financial independence.
What Does It Mean to Be Financially Independent?
While there is no set definition for financial independence, the term often means getting to a point where you don’t have to work to pay your living expenses. Usually, financial independence is achieved by relying on savings, investments, and other forms of passive income to pay the bills. People who are financially independent likely don’t have to look at their checking account balance to know whether or not they have enough to cover, say, their utility bills.
Though financial independence doesn’t have to mean leaving behind a job or career path, it can. In fact, for many people, knowing the answer to “When can I retire?” helps them judge whether they are on track to financial independence or not.
The term “financial independence” is often used as a synonym for early retirement. What’s more, the two phrases are commonly strung together in the popular acronym FIRE, which stands for “financially independent, retire early.”
Benefits of Financial Independence
There are myriad benefits to achieving financially independence.
• One of the biggest perks is the ability to have choices. You can choose to keep working if you enjoy it, or you can kick back and relax. You can save money to pass on to future generations, or you can splurge on a trip around the world.
• Achieving financial freedom can also enable you to enjoy work more. If you’re no longer doing it for the money, you can structure your job responsibilities so you’re only doing the things you want to do.
• Financial independence can also benefit your physical health. Having the ability to work less allows you to exercise more and get more sleep. You may have more time and energy to eat better too.
• Financial independence may also have emotional benefits. It can allow you to spend more time with a partner, kids, family, and friends. Having stronger relationships can lead to increased happiness in life.
How to Become Financially Independent in 6 Steps
Here are some key steps that can help you reach financial independence.
1. Setting Realistic Goals
Being financially independent can look different for everyone, so a good place to start can be to define what being financially independent means to you. What do you visualize? Maybe you want to be debt-free by 40, or you’d like to retire at 50. Or perhaps you’d love to relocate to some place warm and sunny in 10 years.
As you develop your goals, you may want to give them a reality test by consulting with a financial advisor or chatting with a trusted financial mentor. You may find that you need to retool your vision based on your financial situation and how much time you have to achieve your dream.
Once you’ve honed in on some specific, achievable long-term goals, you can begin to figure out what you’ll need to do to make them a reality — whether that’s cutting your spending, boosting your income, and/or saving and investing more than you currently are each month. Even if you are just starting out or not earning that much, it can be wise to forge ahead. There are even ways to save on a low income.
2. Understanding That Income Isn’t Everything
Another step in how to be independent financially: Learning that your salary may not be the only thing that matters. Many people have a tendency to fixate on how much money they are making. And while income is an important part of your financial big picture, other factors also count. Yes, it’s easier to amass assets if you have more monthly income, but one key to increasing your net worth is to spend less than you make.
For example, if you are making a comfortable salary but haven’t gotten into the habit of saving and investing, then you may not be leveraging your income to its full potential. Becoming financially independent often requires an understanding that the amount of money you make is just one piece of the puzzle.
The path to financial independence may become a little less daunting once you realize that a high income alone is not necessarily going to lead to sustainable wealth. There are several other factors that play a role in how much you are able to grow your finances, such as how much interest your investments are making and the rate at which you are able to save.
More than a high salary, financial independence typically requires foresight, long-term thinking, and a holistic understanding of how your income overlaps with your expenses, lifestyle, and future goals.
3. Building a Budget
No matter what your income level, one of the keys to becoming financially free is to spend less — and potentially a lot less — than you are earning. Doing that typically involves finding a budget method that works for you.
Budgeting is the process of measuring income, subtracting expenses, and deciding how to divert the difference toward reaching your goals. It’s often considered the essential first task in achieving financial independence.
You can set up a monthly budget by first assessing what you are currently earning (after taxes) each month. Next, you can tally up your actual spending by looking at the last three to 12 months of bank and credit card statements and recording your expenses on a spreadsheet.
Seeing it all laid out in black and white can help you identify unnecessary expenses you might be able to cut out. You can then put the difference toward your long-term goals instead. One rule of thumb is to try to put 20 percent of your monthly take-home income into savings or investments. Working couples might try to bank a substantial part of one salary if possible.
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4. Establishing A Safety Net
Achieving financial independence also means thinking about financial security. Having a dedicated emergency fund that can help you weather a health emergency or another large, unforeseen expense means. Having money set aside can mean you may not have to run up credit card debt or dip into your investment or other savings account in order to cover these costs.
Experts often recommend having at least three to six months’ worth of living expenses set aside in an account. Ideally, that account earns interest but can be easily and quickly accessed when you need it. You can use an online emergency fund calculator to help you determine the right amount to save.
The more effective you are at dealing with financial emergencies, generally the faster your savings and investments can grow. In terms of growing your emergency fund as quickly as possible, consider adding any windfalls (like a bonus) to your fund, and keep your money in a high-yield savings account, typically offered by online banks.
5. Putting a Debt Pay-Off Plan Into Action
Taking care of your debt is another important step to achieving financial independence. Today, debt can take many forms — whether it’s student loan debt, a home mortgage, a car loan, or credit card debt.
If you currently have debt, consider incorporating a debt reduction plan into the budget you create and calculate how you would need to tweak your current spending habits in order to prioritize becoming debt-free.
It can be wise to start with the debt that has the highest interest first, since borrowing from those creditors is costing you the most money.
If you have multiple credit card balances, you may want to target them one at a time. You can do this by paying more than the minimum each month on one balance (paying just the minimum on the others) until that balance is wiped out, then move on to the next.
6. Being a Smart and Savvy Investor
Becoming a smart investor is another key step you can take on your journey to financial independence. The world of investment can be confusing and carries risk, but it also has the potential to be lucrative.
You may want to first focus on tax-advantaged accounts. If you have an employer-sponsored option, such as a 401(k) plan, it can be a good idea to contribute some of each paycheck, especially if your employer offers to match your contributions. Depending on your situation, you may be able to open a traditional IRA, Roth IRA, or SEP IRA as well. (There may be contribution limits to adhere to, however.)
If you have children, you may also want to consider the benefits of a 529 plan to help you invest for their college educations.
If you’re able to invest additional funds, you can choose a financial firm you want to work with and then open a standard brokerage account. From there, you can put your money in a mutual fund or an exchange-traded fund (ETF) (which bundle different types of investments together). Another option: If you’re prepared to do a fair amount of research, pick and choose your own stocks and bonds.
If you’re new to investing, you may want to consider opening an investment account through a robo-advisor, an investment management service that uses computer algorithms to build and look after your investment portfolio and typically charges relatively low fees.
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How Much Money Do You Need to Become Financially Independent?
How much you need to become financially independent will depend on a variety of variables, such as the cost of living you expect to have and the amount you plan to spend (will you be a no-car household? Two cars perhaps? How often would you like to travel?).
One way to look at this is to consider a formula used for retirement, which says you want to have 25 times the amount you plan to spend in a year, and that money needs to be invested in a 60/40 stocks and bonds portfolio to generate income.
Then, you would apply the 4% rule, which means that you would safely take 4% of your investments out each year (adjusting for inflation) in order to have those funds without outliving your money. Now, if you are a significantly younger person than the usual retirement age, you would have to adjust the numbers to cover more years.
Here, a couple of examples:
• Say you plan to spend $50,000 a year on your living expenses. If you multiply that by 25, you get $1.25 million. That would need to be the amount of your available assets to be financially independent.
• Now, say you plan to spend $125,000 a year on your living expenses. In this example, when you multiply $125K by 25, you would need $3,125,000 to be financially independent.
When looking at these numbers, don’t forget to consider other forms of income you might have coming in. Perhaps you earn passive income in some way or will eventually start to receive a pension. Maybe you will have money coming in from a side hustle you love or from Social Security. Consider all ways money could flow in your direction to understand your path to financial independence.
Habits That Can Get in the Way of Financial Freedom
As you pursue becoming financially independent, there can be habits than can hold you back. Here, a few to be aware of:
• Lack of planning: If you don’t take the time to dig into your finances and find a budget that works, you aren’t in control of your money or your goals. Thinking you can wing it typically doesn’t help you hit your marks or become financial freedom. Living with high-interest debt rather than figuring out how to pay it off is another example of how lack of planning can hinder you.
• Lack of financial literacy: This is another aspect of “winging it”: not educating yourself about how finances, net worth, and other facets of money management work can hinder you from reaching financial freedom. Seeing what resources your bank offers, listening to well-regarded podcasts, or reading well-researched books or websites can get you on the right track.
• Procrastination: Not getting started can hold you back financially. The sooner you begin saving, the closer you get to financial independence.
• Lifestyle creep and/or FOMO: If, as you earn more money, you spend more money, that’s lifestyle creep), and it can inhibit your ability to save. And if you shell out lavishly to keep up with friends, that’s FOMO spending, and it can prevent you from achieving financial independence.
If you avoid these habits and manage your money well and save steadily, you can be on the path to financial freedom.
The Takeaway
Becoming financially independent usually means that you don’t need to work for a living; you can rely on savings, investments, and passive income to pay your bills. Reaching this goal takes careful planning and management of your spending. One path to financial independence is to save regularly. Opening a savings account with a healthy return can be one step toward doing that.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
How do I start to become financially independent?
Becoming financially independent can involve budgeting well and avoiding overspending. It also typically involves managing your money to save steadily and invest your cash so it works for you.
How much money do you need to be financially independent?
One rule of thumb is to have 25 times the amount you plan to spend in a year in the bank in order to be financially independent. So if you plan on spending, say, $100K a year, you would need assets of $2.5 million.
How can I get financially free with no money?
With no money, it will be hard to be financially free unless you live off the grid. For most people, even those with low income, financial freedom is a matter of spending less than your make, paying off debt, saving aggressively, and investing.
About the author
Jacqueline DeMarco
Jacqueline DeMarco is a freelance writer who specializes in financial topics. Her first job out of college was in the financial industry, and it was there she gained a passion for helping others understand tricky financial topics. Read full bio.
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