If you don’t know what financial independence is—or what it might look like for you—start here.
As the saying goes, money doesn’t buy happiness. But that doesn’t stop most folks from longing for financial independence. Having a firm grip on your money—where it’s coming from and where it’s going—is considered a marker of adulthood and success (and many people see financial independence as part of adulthood). But what does financial independence mean, and how do you get there? Two experts weigh in.
Financial independence definition
For many people, defining financial independence is personal. You might consider yourself set if you’ve managed to pay down all of your outstanding debts, or maybe you won’t feel you have financial independence until you hit the lottery.
For Kimberly Palmer, a credit card and banking expert with Nerdwallet, financial independence is something a little less tangible.
“I think about it as feeling confident that you can always pay your bills and then also having money left over so you have the freedom to eat out at a restaurant if you want or save up for a vacation,” Palmer says.
Palmer likes to stick to the 50/30/20 rule of budgeting. That means that you are able to allocate 50 percent of your after-tax income to your needs, including your housing and food. For your wants, such as entertainment and clothing, you’ll dedicate 30 percent of your budget. And the remaining 20 percent should be going toward your debts, savings goals (such as a rainy day fund), and other financial goals.
“Financial independence is a constant work in progress,” Palmer says.
In that sense, you can have financial independence at any age, regardless of income and outstanding debts, Palmer and real-estate firm owner and personal finance expert Constance Carter agree.
“Financial independence isn't defined by how much money one makes, but moreso the freedom they have to live their life without limitations and financial burdens,” Carter says.
And there’s no age or destination in life at which you achieve it.
“I've seen self-made 23-year-olds who are financially independent because they adopted wealth habits early on in life, and I've also experienced many seasoned individuals who lack common principles that keep them impoverished,” Carter says.
How to reach financial independence: taking baby steps
While you can achieve financial independence at any age, experts agree the journey should start early. Carter believes young people should start by learning about credit: how to build it and leverage it in investments.
“In order to invest, you must have good credit,” Carter says. “Building your credit to build your wealth is the best thing a person can learn.”
Then, she says, it’s time to tackle debts.
“Write down all of your debt, then create a goal by which you will begin paying it off,” Carter says. “Having it in writing is critical to your success. You need to see it every day, and start to scratch them off your to do list as you complete the task. You will become motivated and have a sense of accomplishment by doing so.”
Once your debt has been paid off, Carter suggests considering a real estate investment.
“Real estate has one of the greatest returns on investment, whether it’s equity or monthly cash flow from a multi-unit,” she says. “You can purchase a multi-family property with as little as 3.5 percent down. This is the easiest way to start your investment portfolio. Live in it for a little while, then purchase your next one.”
If real estate isn’t in the cards for you just yet, Palmer says not to worry.
“It’s not universally true that everyone should own a house,” she says. “If you constantly move for your job, for example, or travel a lot for work, it might not be for you.”
The same goes for owning a vehicle, Palmer says. Depending on your lifestyle, these items aren’t necessarily markers of financial independence.
Palmer has four steps for those working toward financial independence. The first is saving up three to six months’ worth of living expenses as an emergency fund. “After that, you can think about saving up for a home or a vacation,” she says.
The second is to prioritize debts with high-interest rates. “You want to make sure you’re making more than the minimum payment each month,” she says.
The third is to tackle retirement and savings in addition to that retirement. Many people hope to retire early after finding financial independence—in fact, there’s a saying for it: financial independence, retire early, aka FIRE.
And the fourth step is to employ that 50/30/20 rule of budgeting to make sure you can maintain your financial independence in the long term. Without a smart budget, Palmer says you can lose your financial independence.
Carter agrees. When she was just 33 years old, she was making more than $250,000 a year, but she managed her money poorly and had to file for bankruptcy. The experience was a huge learning opportunity for her and has helped her to advise others in their personal finances.
“Do not overindulge,” she says. “Just because you have it, doesn’t mean you have to spend it.”
Saving for the future (or, financial independence, retire early)
Perhaps one of the more difficult markers of financial independence is saving for retirement. It’s easier to picture paying off your car loan than setting aside enough money to last for the rest of your life. Success (in financial independence and in saving for retirement) then depends on planning, and as Carter points out, diversifying your assets can protect you from the unpredictable factors that can affect your retirement, such as recessions.
“A diverse portfolio is key,” Carter says. “Do not have all your eggs in one basket. Make sure you have liquid assets, have real estate, invest in stocks, bonds, mutual funds, 401(k)s. This is the best defense mechanism against a recession. Diversify!”
Palmer suggests that young adults start a 401(k) as soon as possible and work their way up to the maximum contribution ($19,000 per year in 2019) once their debts are under control.
“It can get overwhelming, and it’s something you’ll never feel like you’re ready for,” Palmer says of saving for retirement. “It’s something you’re always working toward.”
The same is true of financial independence, but achieving financial independence means having the means to save for retirement, which sets you up for financial independence in the future: a real win-win.