How do you go from being flat broke to achieving — if not wealth — a state of financial comfort, freedom, and security?
One step at a time.
But: Do you know what your next step should be?
I estimate that about 80 percent of questions I get fall into one category: “What next?” And it makes sense. After you accomplish a financial goal or make a big life change, you often don’t know where to focus your efforts. For example:
- You’re eligible for a 401(k) plan but still have credit card debt. Should you contribute?
- You graduate with a ton of student loans. Do you pay them off early?
- You’ve saved up six months’ living expenses. What now?
As I’ve been thinking a lot about my goals for this site in the upcoming year, I identified the need to start packaging my financial philosophies and advice in ways that are direct and consistent. So creating a few simple steps to navigate the road from being flat broke to becoming financially secure seemed like a good starting point.
Here are the steps:
1. Build a buffer. $500-$800 cash saved. Just enough so you’re not living paycheck to paycheck.
2. Invest a token amount for retirement. Retirement is a vital but often-overlooked part of financial health. Even if you have more pressing money priorities, you want to get in the habit of saving for retirement early. Set up automatic investing by putting between 2 and 5 percent of your salary into a 401(k) or IRA (or, if your employer matches contributions, the maximum they’ll match).
3. Get rid of “bad” debt. Credit cards. Personal loans. Anything with an interest rate of more than seven percent. Pay it off, fast.
4. Save for emergencies and retirement. In my opinion, it’s equally important to put cash in an emergency fund and jump start retirement saving in a Roth IRA. Learn to pay yourself first. Then, once your emergency fund is where you want it, contribute the maximum to your Roth IRA.
5. Save for something you want. Vacations, travel, weddings, a home, etc. Put money aside so you can afford whatever it is you want, debt-free. Balance saving for shorter-term goals with your retirement savings about evenly.
6. Invest and donate as you see fit. Max out retirement accounts, then invest in taxable ones. When you can afford it, give a percentage of your income back to charities and community.
6.5. Create an additional stream of income. I made this a half step because it doesn’t have come in order (actually, the sooner you start, the better). But don’t discount it: Earning more money will always be a quicker way to your financial goals than trying to spend less.
Here’s a printable version you can save and slap on your fridge:
HOW I ARRIVED AT THESE STEPS
You may be familiar with Dave Ramsey’s Baby Steps, which, in part, inspired this list. His steps have helped a lot of people, but like all canned advice (including my own), they’re not going to fit everybody. In creating my own steps, I thought carefully about today’s 20- and 30-somethings who:
- Are starting from scratch, often with modest incomes.
- Have ever-increasing student loan debt loads.
- Cannot rely upon social security and pensions to provide retirement income.
- May not own a home or have kids for many years.
The steps focus are designed to create financial stability by building cash savings for emergencies, making saving for retirement a habit as soon as possible, eliminating consumer debt, and learning to save and invest for specific life goals.
They don’t specifically focus on things like paying down a mortgage or saving for children’s education because those steps don’t apply to all of us (at least not yet).
Finally, you might be surprised to see the emphasis I place on retirement savings. After all, I recommend you start putting something away in a retirement account even if you have credit card debt and then contribute to a Roth IRA at the same time you save for emergencies!
Basically, I know so many people working through retirement because they didn’t save earlier in life. And I also know that only about 10 percent of my friends are actively saving for retirement. All of this DESPITE the fact that every dollar you save in your twenties will grow exponentially thanks to compounding interest. So I think you should start saving for retirement. Start small, but start now.
Basically, we should ALWAYS be saving for retirement IN CONJUNCTION with all our other financial goals.
DEFINING ”FINANCIAL STABILITY”
To me, financial stability means:
- Not carrying consumer debt.
- Having a back-up plan if you lose your primary source of income (at least an emergency fund and maybe a second income stream).
- Regularly saving and investing money for the future.
I wrestled with what to call this post. In other words, what the ultimate outcome of these seven steps should be.
At first I was going to call them steps to financial independence, but that’s not right; financial independence means different things to different people. For many, it simply means not relying on mom and dad to pay some of your bills, so in that sense you could technically be financially independent but still have no savings and tons of debt. In the personal finance world, financial independence has another meaning: it’s when you can live off interest on your investments or other passive income. In other words, you no longer have to rely on working for your income. That’s a much bigger goal.
I settled on financial stability because I think it is a) something we all want, b) a milestone that will make you significantly happier, and c) it’s achievable for most people, regardless of income. To be clear, we’re not talking about getting filthy rich here. Somebody making $10 an hour can become financially secure just as much as somebody making $100 an hour. But once you achieve financial stability, you will:
- Worry about money less, if at all.
- Earn interest rather than pay it.
- Grow wealthier by the day, almost automatically.
Finally, you’ll be richer than most people. According to a Bankrate.com survey, less than 40% of Americans have enough savings to cover three months’ living expenses. Combine a rainy-day fund, no debt, and regular retirement savings, and you’re joining a rather exclusive club!
OK, let’s hear it. What do you think of these steps? Do you disagree with them? Have you followed a similar path? How have you deviated? Have you used Dave Ramsey’s steps or another plan to reach financial stability? What worked for you?