8 Steps to Reach Financial Independence

If a professional athlete can go bankrupt after making $20 million a year, and a high-income earner can live paycheck to paycheck, then everyone should make the time to manage their finances better.

While a high-paying job will certainly help, you will only become financially independent if you properly handle and manage your finances and make good decisions to build and grow your wealth.

Consider your colleagues. Physicians make far more money than the average American. However, although they work long hours, have large amounts of debt, and are often unhappy with the hefty administrative burdens they now bear, they cannot leave their jobs even if they want to—they simply don’t have enough saved up.

Everyone’s goal should be to reach a point where they can be financially independent. Setu Mazumdar, MD, CFP, often discusses in his column the importance of become financially secure enough to walk away from a job that no longer makes you happy.

What exactly is financial independence? It means being able to cover your living expenses without having to work a full-time job. Becoming independent does not simply mean saving enough money to live off of. In fact, that may be the most difficult way to go about it.

While financial independence should be a goal most people strive for, it takes careful planning. Setting the appropriate goals and taking the right steps will make it more attainable.

8. Be a planner

Make a short-term plan to control spending, but also flesh out a long-term plan that will take you to your final destination of being financially independent. This plan should establish the level of savings you maintain, a plan to get out of debt, and an investment strategy. Throughout the years, the long-term plan may need to be adjusted and reevaluated, but it should never be abandoned.

Set goals and timelines for them, along with actionable plans with steps you can follow and check off to show you are making progress. According to marketing firm NowSourcing, 81% of wealthy people maintain to-do lists and make sure their daily actions are aligned with their long-term goals. And while 80% of wealthy people focus on a specific goal, just 12% of poor people do the same.

7. Involve your spouse

Finances are a huge problem in marriages and money is the leading cause of divorce. If only person in the marriage is adhering to the budget, then the other can ruin all the hard work being done.

According to investor Joshua Kennon, the marrying the wrong person can take an emotional, financial, and social toll on your life and overwhelm any progress being made.

“As you try to build a life, he or she will be out spending your money on status symbols, making it nearly impossible for you to achieve financial independence,” he writes. “To truly build a life, you need to have the kind of support that allows you to take risks…”

6. Become financially literate

People with financial knowledge are more likely to become financially independent than those who are ignorant. The wealthy never stop educating themselves and often take financial classes or read financial books to continue learning. Plus, the more you know, the more mistakes you can avoid. When it comes to finances, a mistake can derail your savings, push back retirement or even bankrupt you.

Knowledge is power and you can use all the ammo you can get. Sometimes, this might mean knowing when you need to seek professional help. In a recent survey from deVere Group, 23% of millionaires admitted that before they sought professional help, they had not been diversifying their portfolio, which could have been disastrous.

5. Pay less taxes

This does not mean “stop paying taxes” or “lie about your taxes.” There are plenty of legal ways to reduce your tax burden and there’s nothing wrong with taking advantage of each and every one available.

Take advantage of tax-sheltered accounts, such as a 401(k) or an IRA, as well as health savings accounts, if they’re offered, according to Rick Rodgers, CFP, president of Rodgers & Associates. The government offers tax credits for children, higher education, dependent care, and retirement savings. There are other credits available that usually go unclaimed by people who are eligible for them.

Take a look at the 10 deductions filers often overlook.

4. Track your spending

In order to build a viable financial plan and set realistic goals, you need to understand how much you currently spend and save each month. If your cash flow is negative, then it doesn’t matter how much money you make: you’ll never become financially independent.

Even people who know they are spending less than they earn should track every cent. They might find that there are places where they can cut more expenses or increasing savings. This is a lot of work, but it pays off in the long run.

There are plenty of ways to track your spending, some more sophisticated than others. For instance, you can simply sent up an excel sheet with a column for expenses and a column for savings and subtract them both from your net monthly income. However, there are plenty of tools available that do the work for you, such as online tools (like Mint), apps (like LearnVest), and software (like Quicken).

LearnVest app for iOS

3. Get out of debt

One of the main reasons physicians find it so hard to save money for retirement despite their high income is their student loan debt. Paying off these loans, and credit card loans, should be a priority. Often these loans have high interest rates attached to them, so paying them off quickly, even if it means not being able to save much else during this time, will pay off.

However, if you need a psychological boost to pay off those loans, J.D. Roth, founder of the website Get Rich Slowly, recommends the debt snowball. While not mathematically ideal, using this strategy will at the very least keep you motivated to pay off the debt without letting it feel like an insurmountable object.

Instead of paying off the debt with the highest interest first, start with the debt with the smallest balance. Each month you allocate a specific amount of money to pay toward debts. For all debt except the one with the lowest balance, you pay the minimum. All other money for debt repayment should go to the debt with the lowest balance until it is paid off. Once that debt is gone, all the remaining money each month goes to the second-lowest debt.

Keep in mind the difference between good debt and bad debt. Credit card debt, used for short-term desires, is counterproductive. Those balances should always be paid off at the end of the month.

2. Earn extra money

Reducing spending and setting a budget are both important, but a boost in income can really accelerate your progress. Physicians can look to earn extra money by taking leadership roles in their organization, ask for a raise, turn a hobby into a money-making venture, and part ways with some of your belongings that may be worth something. Private practice physicians can add ancillary services to their practices to boost revenue at work, and, therefore, their income.

Physicians with money saved might also consider buying a rental property. Private Wealth CFOs encourages investors to continue building. After finding success with one rental property, consider getting a second one to increase your assets and your income.

For physicians considering a rental property, read James M. Dahle, MD’s article on evaluating an investment property so you aren’t taking on undue risk.

1. Invest for independence

There is a difference between investing for short-term gains, investing for retirement, and investing for independence. In the latter, the goal is to get your money to work for you, according to Rodgers.

“Start by controlling spending so you have money to save and invest,” he writes. “Continue the process until the return on your investments exceeds what you earn by working.”

However, your portfolio needs to reach critical mass first. As Kennon puts it, “…earning a 10% return on $10,000 is only going to net you $1,000 before taxes - hardly earth shattering, but the same return on a $1,000,000 portfolio is $100,000…”

Amassing the type of wealth for a large enough investment portfolio will take time and may seem like a slow process, but it can be done with small moves that add up to a big difference.