5 Steps to Financial Freedom

What is financial freedom?

Buckle in, because this is going to be a long one.

We’re also going to look over the 5 steps to Financial Freedom and, hopefully, you leave with more of a plan to achieve it.

Grab your coffee or favorite drink of choice, a notepad, and if you already have spreadsheets with your financials open them up. 


The 5 Steps to Financial Freedom

What is financial freedom?

This is perhaps the biggest cornerstone in creating your New Rich life.

There are several other pieces that make up the New Rich life, but they’re all in service of helping you achieve this. 

Regardless of your sentiment towards capitalism or a free market, this is the economic system nearly all of us are born into.

We need money to live.

We need to work to get that money.

Boiled down, financial freedom is this:

Financial freedom is when work becomes optional, instead of a necessity.

(This is also why financial freedom is sometimes referred to as ‘early retirement’.)

And though getting to that point is a big endeavor, and one where virtues like patience and self-discipline are built and tested, the steps in getting there are simple.

Step 0: Your Starting Point

Not everybody who gets started on their journey to financial freedom starts off at the same place.

In order to construct a plan that is customized to your specific situation, knowing where you’re at at the start is an important step.

You need 2 things for this:

  • Your current net worth
  • Your annual expenses

Current net worth

Put simply, net worth is the difference between your assets and your liabilities.

When calculating this, it’s important to put things in the right category.

I don’t have to tell you that debt goes in the liability category, but where do you put, for example, your car?

The car itself, usually, is both an asset and a liability.

The current value of the car goes in the asset bucket (so not the amount you paid for it!) & any taxes that are levied because you own the car go in the liability bucket.

Same with a home (equity you have is an asset/debt & property taxes on it are a liability)

Do not get discouraged when you see your net worth. It’s completely normal should it be negative. And even if your net worth is positive but relatively low, you’re actually in the top 15% of wealthiest people in the world!

Annual expenses

At this point, we’re only going to be needing your current annual expenses.

For right now, do not worry about whether or not all your expenses are necessities or luxuries. We’re simply taking a snapshot of your current situation.

Even if you’re ballparking it for now, I encourage you to spend more time on it later in more detail.

Before we move on to the first step, I want to remind you again to note this down somewhere.

Even if it’s a ballpark, even if it doesn’t include the exact calculations that you’ve done. Note both your net worth and current annual expenses down somewhere.

Step 1: Financial Security

You probably know the feeling all too well.

Living paycheck-to-paycheck, there’s always a worry that, if something bad were to happen, you wouldn’t know how to keep supporting yourself financially.

While financial independence, and definitely financial freedom, are a result of setting up passive income streams and an investment portfolio, financial security means immediate access to cash should you need it.

Note that financial security does not come from having a job. As 2020 has shown, anything can happen to your workplace or job that nobody can predict from coming.

Prepare for the worst, hope for the best. Right?

This is also known as a nest egg or your emergency fund.

There is no strict rule on how much this should be, though there seems to be some consensus that, if you’re a traditional employee, your emergency fund should be 3 times your monthly expenses, and 6 times if you’re self-employed in some way.

Let’s say that your monthly expenses (the necessities) are $1,500 a month.

You’d need $4,500 in a savings account to achieve financial security.

This is set up so that you’re protected should something unexpected happen that has a direct impact on your income, and can help you sail through the financial storm while fixing your income situation.

I’ve talked to several people in the personal finance industry and successful entrepreneurs, and they’ve all confirmed that, if you don’t have an emergency fund, all your attention and efforts should be going to that.

This does not mean to not pay back your monthly debt repayments, since those are necessities.

But it does mean holding off on investing, or paying more than your debt repayments minimums.

Speaking from experience, where money was always an issue and it always was a worry that carried over into mental & emotional duress and even took its toll on my personal relationships, having an emergency fund will simply make you sleep better.

Step 2: Financial Vitality

Not often talked about in the personal finance space, financial vitality means that you don’t have to sacrifice an enjoyable life now in order for you to have all the glasses of wine you want when you’re 65. (Also part of the New Rich life – you can have your cake and eat it, too!)

Financial vitality is where you calculate your comfortable monthly expenses.

Going with the example above, $1,500/month covers all of the necessities.

$2,500/month covers your necessities + your luxuries.

Once you’ve set up your emergency fund (minimum 3 months of monthly expenses) and have saved up $4,500, now aim to save a minimum of 3 months of your comfortable monthly expenses ($7,500 in this example).

The great thing here is that you’ve already crafted some patience + self-discipline when you were building your nest egg.

So, in theory, saving up to your comfortable monthly expenses will be much easier for you to do and accomplish.

Doing this step is optional, but highly recommended. We both want you to have a good life later AND now.

Step 3: Calculate Your Financial Freedom Number

At this step, we’ve already safely set you up for the present.

Should anything happen, you’re now able to weather the financial storm.

It’s time to start setting future-you up for a good life.

To be able to steer a ship (= your life), you need to know where you’re going, what you’re aiming towards and in this step we’ll calculate your financial freedom number.

Work can become optional, but you’ll always have expenses.

First, we need to calculate how much your annual expenses are going to be in a financially independent situation.

What you include as expenses can be just your essentials, but can also include your luxuries. Obviously your financial freedom number is going to be significantly different based on going with one or the other.

Once you have your annual expenses, you then multiple this number by 25. And there’s your financial freedom number.

$1500/month x 12 months = $18,000 (annual expenses) x 25 years = $450,000.

$2500/month x 12 months = $30,000 (annual expenses) x 25 years = $750,000.

The point of your financial freedom number and portfolio is to withdraw 3 -4% every year, which is why you needed to know your annual expenses.

However close, this isn’t an exact figure.

The formula above doesn’t take into account what your monthly income would be. (like government pension, rental income, social security income, …)

But it’s much better to be ballparking it so you can get started on it vs not taking any action because you can’t paint an exact picture.

Just like with your net worth, do not get intimidated by your financial freedom.

Step 4: The vehicle

I like to use mechanical analogies.

We’ve figured out where you currently are (your current net worth), and have put in the GPS where you need to go (your financial freedom number).

We’ve even built-in airbags, should you have any accidents on the way (your emergency fund).

Now, it’s time to get in the car and drive to your destination.

That car is investing.

There are more qualified experts that can back up what I’m about to say (and I’ll even link to one in particular at the end of this post).

You may have some assumptions when you hear ‘investing’ such as “How the hell do I know which company to invest in?” or “I don’t have 1000s of dollars every month that I can invest”.

I also had these, and more.

However, that’s before I learned a few key things that can set virtually anybody up to start investing.

Don’t invest in 1 company

Rather than researching various companies and deciding which one to invest in, it’s much better to invest in an index fund. I even wrote a beginner's guide on index investing.

An index fund is basically a collection, or portfolio, of various stocks and bonds.

This eliminates the need to invest in 1 company and eliminates some risk.

Say that you invest only in 1 stock that we’ll call ABC for now.

If ABC has a bad financial year, or multiple years, your net worth takes a severe hit.

However, if you invest in stocks ABC, DEF, GHI and XYZ, with ABC in that same bad financial position, but the other stocks perform relatively well, you can still end up with year-over-year growth of your net worth.

This is what an index fund does, but on a much bigger scale.

“I don’t have $1000s to invest”

A very common misconception. And one that I had as well. 

Good thing that you don’t need a ton of money to invest. The key to investing is to invest whatever you can AND consistently.

Even if it’s $200/month.
Even if it’s $100/month.
Even if it’s $50/month.

Take a look at this graphic.

investing calculator graph
(Assumes an initial deposit of $100, with monthly contributions of $100 over 20 years)

You may be underwhelmed by that number seeing that this is over a 20-year period.

Hold on for a bit longer, I promise you it will get more exciting for you in a bit.

Compound interest

albert einstein compound interest quote
no idea if he actually said this, you know how that goes

The graphic and situation above pretty much treated investing in an index fund as a savings account.

Because when you do invest compound interest is where the money you’ve invested makes you more money.

An index fund like the S&P500 historically has an average annual return of 10%. Inflation eats about 3% of that, so we’re going to use 7%. (Source)

The graphic below shows the exact same situation as above ($100 initial investment + $100 monthly contributions for 20 years) + a 7% annual return.

investment calculator graph with compound interest

This is the power of compounding!

I hope now it’s clear that you don’t need 1000s of dollars to invest, or that you need to research a bunch of companies only to invest in a handful of them.

A relatively safe index fund to invest in is the S&P 500 (more on that below).

Step 5: Getting there faster

Remember where you’re at?

  • You’ve got your current location (net worth)
  • You’ve input your destination in the GPS (financial freedom number)
  • You got yourself some nice cushion-y airbags should you have an accident along the way (financial security & financial vitality)
  • You got in your car and started driving (investing)

As we saw above, making $100 monthly investment contributions in a low-cost index fund like a Vanguard S&P 500 for 20 years at an average annual return of 7% can definitely make a big financial difference in your life.

However, $49,000 won’t allow you to make work optional.

Your financial freedom number will, and the difference between the two is too big right now.

How can you get there?

Increasing your monthly contributions.

To get to your financial freedom number (let’s say it’s $450,000) with the same situation above ($100 initial investment, over 20 years with an annual return rate of 7%), you’d need to make monthly contributions of $950.

That’s quite a big jump from $100 monthly contributions, right?

But it’s definitely not impossible. Let’s talk about how you can get there.

Decreasing your monthly expenses

Say that your current monthly expenses are $1500 (including the $100 monthly contribution), take a close look at the expenses you can decrease.

Do you need all the luxuries that are currently in your monthly expenses?

When I did this exercise for myself, I found that, on average, I was spending $500-$600/month on takeout.

Now, I like my takeout. I’m all for convenience and I can get pretty lazy.

So, I put myself on a monthly limit for takeout of $100/month.

Still a lot, perhaps. But being disciplined (very easy for lazy people #sarcasm) gave me an extra $400 that I could contribute.

Now, all of a sudden, I was able to contribute $500 every single month.

You may not have large expenses that you can decrease. Everybody’s situation is different.

Even if you can find an extra $50, that is still an extra $50. Do not forget the power of compound interest. The little bits do add up and investing is a marathon, not a sprint.

Creating another (passive) income stream

Taking your expenses and looking for where you can decrease can only go so far.

At one point, you just can’t decrease any more.

This is where creating another income stream comes into play.

There are several ways for you to do that, but as I’ve argued in these posts, setting up an affiliate marketing income stream is the best way for beginners to create an additional income stream.

An additional income stream, like affiliate marketing, really is the Big Enabler. It’s the key that enables anybody that is able to read this to achieve financial freedom and make work optional.

Final thoughts and notes

That was lengthy, right? But you made it to the end!

If you’ve followed along, you should now have a clear plan on how you can actually achieve financial freedom.

It does take work, discipline and a lot of patience. There’s no use in denying that.

I know that financial freedom sounds nice, but also that knowing how to begin on that journey can be intimidating. That’s why I’ve done my best to lay it out sequentially and in a simplistic way.

Some of my final thoughts.

If you’re anything like me, you may convince yourself that you need to do more prep work before you can start building financial freedom.

If you’ve followed along, even if you’ve  just ball-parked it, you’ve already done plenty of prep work.

Also, I need to iterate again that you don’t need to wait with investing or building your emergency fund until [insert whatever excuse you have]

It is much better to invest something now rather than later. The winners of the investment game all abide by this rule:

“Time in the market > Trying to time the market”

I’m by no means a financial expert or advisor. However, should you have questions about anything that was discussed here, feel free to leave them in the comments section.

I’ll do my best to get back to you as soon as possible AND with a helpful reply.

Recommended Reading

Recommended Reading
The Simple Path to Wealth: Your road map to financial independence and a rich, free life

Here’s an important truth: Complex investments exist only to profit those who create and sell them. Not only are they more costly to the investor, they are less effective.

The simple approach I created for my daughter and present now to you, is not only easy to understand and implement, it is more powerful than any other.

We earn a commission if you make a purchase, at no additional cost to you.
07/24/2023 06:22 pm GMT


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Disclaimer:  I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only.

This post may contain affiliate links, which means that I may receive a commission if you make a purchase using one of these links, such as from the Amazon Associates program.

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