6 Steps Towards Financial Freedom in 2009 and Every Year
How to Achieve Financial Freedom
Among the melting pot of New Years resolutions posts over the next week you’ll see a lot of the familiar staples: save X amount per month, pay off X in debt, eat out less, exercise 3 times a week, give more to charity, etc. All good stuff, but I thought I’d go with a little something more concrete this year that can be carried over from year to year.
Here are six steps that you can set goals towards over the next year (and every year). Each step will ideally lead you one step closer to financial freedom over the long haul. I realize that this list will not be applicable to everyone and few will have the financial resources to do everything on this list every year, but that shouldn’t prevent us from setting stretch goals.
1. Set a Budget
Before you can attack debt and figure out savings, you have to know how much is coming in and how much is going out every month. I’ve created a free budget planner to help you do so. You can also utilize budgeting sites like Mint, Yodlee, and others.
A budget will help you square away all the necessities in your life (water, energy, food, shelter, insurance, etc.). Beyond necessities, have the attitude that you are going to attack your ‘wants’ to get them down to a minimal level that results in the optimal return on your happiness (i.e. scale back your cable, phone, and transportation expenses). After that’s been accomplished, move to step 2.
Whether you’re in good or bad standing financially, without a concrete budget you’re in no place to strategically plan how to move yourself forward towards other financial goals. You should re-budget at the outset of every year or more frequently if circumstances demand it.
2. Attack High Interest Debt to Stop the Bleeding
If you have any credit card debt that carries over from month to month, attack it, so that you can stop the bleeding. You should not have any savings in the bank or elsewhere if you have this kind of debt. The odds of your savings outperforming the 10+% you’re probably paying on credit card fees consistently over time are not very good. Any positive cash flow after creating a budget should go towards this goal before savings.
Part of this process is going to be knowing the difference between good debt and bad debt and negotiating lower rates on your bad debt. The following debt spreadsheet should help you classify your debt as a good starting point.
3. Get your Employers Full 401K Match
The one exception to the previous rule would be if the rate of return on your 401k match is better than your credit card fees. In this case, I would personally go for the 401k match first. For instance, if you get matched 50 cents for every dollar that you contribute to your 401k up to a given amount, your return on that match is 50%. This is probably a much higher return than what you are paying on most, if not all, of your debt. More simply:
- If 401k match return rate > debt effective annual rate (EAR) then max out the match.
- If 401k match return rate < debt EAR, then pay off debt (each debt should be judged separately).
4. Max Out your IRA’s
The max IRA contribution for 2009 is $5,000. After getting your employers full match and paying down high interest debt, this is ideally the next place to put your money. I suggest going this route vs. non-matched 401K because you will have wider flexibility in the investment options in your personal retirement accounts than you have in employer sponsored plans, such as 401k’s. Need to start an IRA? I personally have my IRA with TradeKing because of their $4.95 trades and zero IRA fees.
5. Max Out your 401k
Next, continue capitalizing on the tax benefits of retirement accounts by fully maxing out your 401k. This means contributing the amount from where you left off with getting your employer’s match all the way up to the maximum amount allowed by the IRS. The max 401k contribution in 2009 goes up to $16,500, for an increase of $1,000 over 2008.
6. Save for Life Goals
You can’t save for everything at once, so you’ll have to start with budgets for each. Life goals could include things like going to school, early retirement, saving for your children’s college expenses, down payment for a house, etc. I can’t tell you where or how much to allocate towards these goals because it all depends on your personal priorities.
The immediacy of some life goals may force you to take funds away from previous steps, such as maxing out your 401k. That is OK, and you shouldn’t feel guilty about it.
The one thing that is very important to keep in mind is that many ‘life goals’ can be financed very cheaply. For instance, why save for own school expenses when you may very likely be able to get very low interest loans to pay for school?
Your savings should, at the very least, be earning 3% or so from a high interest savings account, money market account, certificate of deposit, or savings bond. Those with a longer time line to their life goal (i.e. early retirement) may want to seek higher risk, higher reward potential from stocks or mutual funds.
Concluding Thoughts on Financial Freedom
Perhaps you won’t get all the way to step 6 with this plan, but use this list to push yourself to the next level. For instance, for those who’ve never gone beyond step 2, perhaps you push yourself to get to step 3 this year. Best wishes for financial and personal success in the new year!
Financial Freedom Discussion:
- What are your financial goals for 2009?
- If you’ve followed a similar path, how far did you get this year and where do you plan on getting to next year?