The news is rife with stories of bright-eyed thirty-year-olds who have retired early and sailed off into the sunset to live as an expat on a tropical wonderland. These stories cause many to take a hard look at your own finances only to say, “My ancestors dream was not for me to spend 40 hours a week toiling, only to spend my entire check at Amazon to send Jeff Bezos to space again.” Congratulations fam, you’ve taken the first step to living the good life.
Next, you start thinking of all the details of financial freedom, and try to figure out what your next step is. If you’ve been attempting to put together what path you are going to take by listening to all the “experts” on the internet you might feel a little bit like a cartoon character who has come to a fork in the road and looks up to see a post with signs pointing in twenty different directions. Overwhelming, right?
Relax and take a deep breath. People just like you reach their financial goals all the time. And, if you’re willing to put some important systems into place, you’ll be next. These 6 guideposts will show you how to reach your goals by creating a powerful financial foundation.
How to Reach Your Financial Goals by Using These 6 Guideposts
We’re going to look at 6 guideposts to reaching financial freedom:
- Create a vision of where you are going
- Total debt should be no more than 36% of your gross income
- Fund your emergency fund
- Insurance, insurance, insurance
- Plan for the future by investing today
- Living will & estate planning
- Create a vision of where you are going
Before we get into the nitty-gritty of achieving financial freedom, you need to figure out what you want the end result to look like. This is highly personal, and each individual (or couple) needs to answer the question, why am I doing this? For some people the goal is to retire early to travel the world, for others the goal is to have enough money to take care of family members, and others simply want the luxury of spending their time in the way they choose without having to answer to a boss.
So, what separates those who successfully reach their financial goals and those who don’t? Creating a vision.
Bottom line: Creating financial freedom is a roller-coaster ride. You need to create a positive vision of the future that makes you feel good in order to stick with the ups and downs that you will inevitably encounter on the journey. I recommend that everyone creates a financial vision board. For couples, a joint financial vision board is a powerful tool for getting on the same page.
- Total debt and expenses should be no more than 36% of your gross income
Debt is quite literally a four-letter word. And, it can be one of the biggest obstacles between you and your financial goals. Debt is divided into two categories. High interest debt and low interest debt. High interest debt is what we want to focus on eradicating. I consider any interest rate above 6% as high interest. Credit cards, payday loans, and subprime car loans fall under this heading. Low interest rate loans, include most mortgages (current rates not included), and student loans.
In an ideal scenario your living expenses (mortgage or rent, utilities, home or rental insurance, taxes) do not exceed 28% of your gross income. Let’s use my imaginary home girl Iyesha as an example. Iyesha makes $100,000 at her job. Using the 28% rule she should be spending no more than $2,333 a month to keep a roof over her head. For many people, especially for those living in big cities – this could be a tough one to pull off because the cost of housing is so high and has outpaced wage increases. However, keeping your housing under 28% of your gross income is a major key to wealth building because it ensures you aren’t over-leveraged in your housing and that you have free cash for investing. There are many ways to get creative about housing depending on your circumstances. This includes cost sharing with roommates, house hacking or even renting your primary home out on certain occasions.
In terms of your total debt and expenses, you want to keep that below 36% of your gross income. For Iyesha, that means she shouldn’t be paying more than $3,000 a month in total bills including housing. Don’t panic if this sounds like something you could never achieve. We call it a financial journey, because this is a step-by-step process of learning, adjusting and improving. All, I want you to do now is understand the guideposts. For, those of you who already have achieved the 28% and 36% rule – congrats, let’s keep it going.
- Fund your emergency fund
Depending on your situation you should have between 3 to 6 months of living expenses set aside in a high yield savings account. If your household has one form of income then you should have 6 months of emergency savings, and if you have two or more forms of income than you can have 3 months of savings. Because Iyesha’s bills and living expenses come to about $3,000 a month – her emergency fund needs to have at least $18,000. This is because Iyesha is single and does not have a secondary form of income like a side business, alimony, or investment income.
Let’s incorporate another example. Iyesha has a sister named Alisha, who is married. Together, Alisha and her husband’s household income is also $100,000, however they only need $9,000 in their emergency fund because they have two sources of income in their household. Some people prefer to hold more cash in their emergency funds but 3 to 6 months is the minimum.
Emergency fund money should not be invested. This is money for when “ish hits the fan” like your car breaks down, or your apartment catches on fire three weeks before your wedding because the neighbor wasn’t paying attention while BBQing baby back ribs, or your uncle’s second wife suddenly dies and you need to catch a flight home to be with your family. The reason emergency funds are so important is because first, they give us a way to prepare for whatever life throws at us and second, they prevent us from reaching for our credit card when it happens.
- Insurance, insurance, insurance
Almost everyone knows the basics about life insurance. Mainly, that almost everyone should have it. In addition to life insurance, there are many other types of insurance products that can help you in achieving your financial goals and provide liability protection. I’ll make another post the various types of life insurance (term, universal and whole life), but for most people reading this post, term-life insurance will be the best option for your needs. Other insurance you absolutely need is home or renter’s insurance, auto insurance, and a personal liability umbrella policy (PLUP) on your home and auto. The PLUP provides extra coverage – starting at $1 million in liability coverage. This is important should your cousin’s trifling friend Larry get too drunk at your holiday party and miss the last step of the stairs and decide to sue you. Other important insurance to have is disability insurance, which will pay if you are unable to work. And, depending on your age, long-term care insurance to assist with elder care needs.
- Plan for the future by investing today
In a perfect world, when you started your first job, you began investing at least 12% of your income towards retirement. However, for most people this isn’t the case. That’s absolutely okay, and depending on your age, goals and lifestyle you may have to set aside a bit more, delay retirement or get creative about what retirement looks like. For some people this may mean having a small business or rental property after they’ve stopped working in more traditional ways. Those are things to think about down the line, but for now you need to be investing a minimum of 12% of your income in your company sponsored retirement plan. If they offer a match you should be investing whatever percentage they require to obtain that match.
For many people, investing for the future means planning for their children’s education. One of the best vehicles to do this is within a 529 plan. Even if you do not have children at this time, some people start a 529 plan for themselves (for undergrad, master’s or certificate programs), or with the intention of saving now for future children. Yes, you can do that too! One of the biggest benefits of investing in a 529 plan is the potential tax savings. While you won’t receive any federal income tax deductions from investing in a 529, all of your earnings will grow tax-free and you won’t have to pay taxes when you withdraw the money. 529 plans can be used for qualified education expenses which include tuition, books, room & board, computers and repayment of student loans.
- Living Will & Estate Planning
Who makes medical decisions for you if you are unable? Life support or no? Does your car go to your favorite niece or your estranged brother when you pass? What happens to your minor children if you and their other parent die? All of these are living will and estate planning questions.
A living will, sometimes called an advance directive, dictates the medical care you wish to receive if you become incapacitated or otherwise unable to communicate your wishes. A last will details what you want to happen to your children, as well as your property after your death. This type of estate planning includes the bequest of assets to heirs, which is just a fancy way of saying what property goes to who. Estate plans must be set up with the help of an attorney experienced in estate law. However, in creating a comprehensive financial plan you should receive information on what parts of the estate plan you need created and strengthened.
For more information on how to reach your financial goals, set up a complimentary 1:1 session with Tamara.
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