The importance of financial independence hit Americans hard when the economy headed south in late 2008. The dangers of living beyond our means became very real as many people lost jobs and homes. Whether you managed to stay on your feet or are in the process of pulling yourself back up, everyone wants to make sure they're protected next time.
So how do you do it?
Understand Wealth and Set Goals
In order to be truly financially independent, you need to be able to weather the unexpected. "Independent" means not dependent on someone or something else, including your job. Sure, you get a paycheck every couple of weeks that covers everything you need, but if that paycheck stops, then what?
That's where wealth comes in. Joshua Kennon, financial expert and author of The Complete Idiot's Guide to Investing, 3rd Edition, defines wealth as "the part of your net worth (assets minus liabilities) that generates capital gains, income, and dividends without your labor." Kennon points out that you can measure wealth by the length of time you can maintain your standard of living without an additional paycheck.
But you don't have to be rich and have a huge investment portfolio to build wealth. Savings accounts, 401k's, IRAs, and real estate all fit the definition of wealth. Of course some investments multiply more quickly than others; the key is that there's a wealth-building entry point to fit any budget. Just putting a few dollars a month into a savings account will get you started generating wealth.
Set goals that you can manage (even if they're small!) and start there. Once your few dollars a month have become something more substantial, you can explore wealth-builders with higher returns. The important thing is getting started, not where you start.
Check Your Budget for Spare Wealth
Financial security comes from a surplus of money. But how to achieve a surplus? Even if you're starting small, you have to have that extra few dollars to put in your savings account. So you can either make more money or you can cut expenses. And it's usually easier to cut expenses, especially in a down economy.
First, document every dollar you spend for a few months. Add up the total dollar amount spent on each item and divide that by the number of months to figure out what your average monthly spending is for each item. Divide your monthly expenses into two columns: wants and needs. Reassess anything that is in the wants column. Where can you cut back on expenses and start building wealth? Once you decide what you can cut, make a budget and stick to it.
Beyond the Savings Account
When you get a bit of extra cash, invest your money in brokerage and tax-deferred retirement accounts. And keep investing. Soon, your money will build interest and compounding will start to take effect. According to Kennon, this is "when the interest, dividends, and capital gains your money has earned begin to generate their own interest, dividends, and capital gains, and on and on in a virtuous cycle."
Your wealth can also create tax savings when you put it in retirement investments like a Roth IRA or a 401k.
Protecting Your Financial Independence
Once you accumulate your wealth, make sure you have an estate plan in place so that your assets are distributed according to your wishes.
A living trust can help avoid probate and estate taxes, thus protecting the wealth you've built. Probate can eat up thousands of dollars from your estate and tie up your assets, meaning it may be years before your beneficiaries have access to their inheritance. With a living trust, you can be assured that your property will be distributed as you intend, enabling you to pass the security of financial independence on to your loved ones.
It's Not All About Money
Finally, while accumulating your wealth, don't forget to enjoy your non-material riches. Take inventory of all the great things in your life that have nothing to do with money. Loved ones, good memories, and doing what you love are all important parts of being truly wealthy.