What Is Financial Independence? A 9-Step Guide to Financial Freedom

Financial independence, or FI, is one of those rare goals many people hope to accomplish – someday. But few ever do. Most of the time, the problem isn’t a lack of desire, but the absence of a plan or willingness to commit. 

(or a lack of commitment because you don’t understand the FIRE Movement)

The good news is that you can start working towards financial independence now, no matter where you’re at in life.

The following guide includes a nine-step plan to help you reach FI. Each step is crucial, but it can be customized to fit your circumstances.

Let’s start with some basic concepts.

Table of Contents
  1. What Is Financial Independence?
  2. How Can You Achieve FI?
  3. 1. Define Your Version of Financial Independence
  4. 2. Get Family and Friends on Board
  5. 3. Prepare to Cut Your Living Expenses
  6. 4. Create a Plan to Earn More Money
  7. 5. Save, Save, and Save Some More
  8. 6. Create a Long-term Investment Plan
    1. The 4% Rule Explained
  9. 7. Get Out of Debt as Soon as Possible
  10. 8. Assess Your Progress and Make Adjustments as Needed
  11. 9. Dig in for the Long Haul
  12. Final Thoughts on Financial Independence

What Is Financial Independence?

There is no single definition of financial independence. For one person, it could mean getting out of debt and having $50,000 in the bank. For another, it may mean having a $5 million investment portfolio that generates enough passive income never to have to work again. (but don’t fall into the trap of thinking passive income doesn’t require work!)

To illustrate, here are three loose definitions of financial independence circulating on the internet that describe both forms of financial independence in more poetic terms: Barista FIRE, Coast FIRE, and Fat FIRE. (there are plenty more)

Barista FIRE: The word barista refers to a person who brews coffee for a living and is most closely associated with Starbucks. (“FIRE” is an abbreviation for Financial Independence, Retire Early.) The person pursuing Barista FIRE plans to continue generating part-time income after reaching financial independence. This includes a regular job or side hustle.

Part-time work is meant as a way to supplement income once FI is achieved, or just to keep busy and engaged.

Coast FIRE: A person achieves Coast FI when they have accumulated enough in their retirement accounts to be able to retire at the traditional age without any further contributions. For example, let’s say you’re 45 years old and you plan to retire at age 60.

Assuming standard market returns, if the current balances in your retirement savings (pension, 401K) will grow to be enough to fund your retirement without any further contributions, you’ve reached Coast FI.

In other words, if you wanted to, you could coast your way to retirement.

Fat FIRE: Finally, there’s Fat FIRE where you accumulate a larger nest egg and live life to the fullest (in terms of financial outlay). It’s more about building an investment balance that can fund your living expenses without the need to cut back simply because you’ve stopped working.

Whereas someone looking to retirement early as soon as possible may wish to cut back on their post-retirement living expenses, Fat FIRE is about building up far beyond the minimum. It’s less about retiring as early as possible and more about retiring earlier than traditional retirement age but with an investment account that can fund a lifestyle that has not been lowered.

How Can You Achieve FI?

To achieve financial independence you’ll need a concrete plan. That will include a series of strategies. Below are nine strategies that will help you reach financial independence. 

You may not need to use them all, but you will need to use most (and yes, all is better). Even more important, you’ll need to be fully committed to each strategy. If you’re not, the risk is real that you’ll fail to make progress and abandon the effort entirely.

Here are the nine strategies:

1. Define Your Version of Financial Independence

In the previous section, we described financial independence in the most general terms. But to make it a reality in your life, you’ll need to define exactly what it is – to you. Once you do, you’ll be in a better position to create and implement the needed strategies.

This isn’t a decision you need to make today.

It’s better to take as much time as you need before getting started. Consult with trusted friends and advisers, read books on the topic, and become a regular visitor to websites that cover the topic, like Wallethacks. 

Achieving financial independence is a long-term process, and you can and will change details along the way. But nothing will happen until you take that first step of creating the definition. 

Ask yourself the following questions:

  • What is my current financial situation? Be honest with where you are starting from.
  • Is my version of financial independence just having a certain amount of money?
  • Do I need to create an income stream for early retirement?
  • Am I trying to design an improved lifestyle for myself and my family that may not be centered on finances?

Your answers to those questions will give you a clearer picture of what you consider financial independence to be. Once you establish that image, you’ll be ready to implement the other eight strategies.

Recommendation: Once you define what financial independence is for you, put it in writing. Then display it someplace where you’re likely to see it every day. That will be your way of reminding yourself every day of the reason for your plan and your journey. 

2. Get Family and Friends on Board

This is an important step that many would-be financially independent people overlook.

The people in your life have a major impact on your finances. If most of the people you associate with tend to be spendthrifts, living on the financial edge, you may unconsciously live the same way in an effort to keep up. 

If that’s the case, it will need to change. You’ll need to make clear to family and friends that you’re embarking on a new course in life, one that will require certain sacrifices that may limit participation in activities that are on the high-cost side of the ledger.

If you’re married, it goes without saying that you’ll need to have your spouse on board. And if you have children, they should also be considered.

Because it takes such a long time to achieve financial independence, you’ll need to create a lifestyle that’s conducive to achieving that goal. That requires cooperation from the people closest to you.

3. Prepare to Cut Your Living Expenses

Most people find this step to be painful because they’re not used to following a budget. But you’ll need one if you hope to achieve FI.

Fortunately, there are plenty of budgeting apps that can help you implement a workable budget. With a budget in place, you’ll be able to see exactly where your money is going. That will help you to make the necessary adjustments to your living expenses.

There are more than 100 ways to reduce expenses. The more you can implement, the faster you’ll reach your goal.

If you’ve been unable to make much progress with your finances in the past, start with your major expenses. That includes housing and transportation, two expense categories that most people are unwilling to disturb. (you could also try to get free land if it makes sense for your finances!)

If those expenses are eating up a disproportionate percentage of your budget, you may need to consider moving to a less expensive home and driving a more modest car.

The upside of making such dramatic moves is that by reducing your major living expenses, you won’t need to cut the smaller ones.

4. Create a Plan to Earn More Money

In most cases, cutting living expenses alone won’t be enough for you to reach financial independence. After all, your income is limited, and you probably need most of it to survive. That puts a ceiling on the savings you can accumulate through expense reductions alone.

It will probably be necessary to increase your income. That may not be as tough as you think. It could mean taking a part-time job permanently or on a seasonal basis. But it can just as easily mean finding ways to get promoted into a higher paying position in your current job, or starting a side business.

Fortunately, there are plenty of ways you can earn extra money online. If you can get one or two up and running, you may be able to make enough additional income without needing to leave the house.

Just make sure any additional income you earn is directed into savings. It can be difficult to avoid lifestyle inflation or lifestyle creep when your income increases, but that’s exactly what you’ll need to do.

5. Save, Save, and Save Some More

Cutting living expenses and earning additional income is a two-pronged strategy with a single objective in mind: to direct extra cash flow into savings.

If your goal is to achieve financial independence, the oft-recommended strategy of saving 10% to 15% of your after-tax income won’t cut it. That might get you to a reasonably comfortable retirement when you’re 65, but you’ll mostly be tooling along, just keeping your head above water between now and then.

No, your savings goal needs to be loftier. You should plan to save 30%, 40%, or even 50% or more of your after-tax income. That’s the kind of savings commitment you’ll need to reach financial independence.

You don’t have to do that all at once either. You can start with a 20% savings allocation, then gradually increase it. For example, you may find 20% very workable in the first year. But in the second year, you’ll increase it to 25%. By the third year, you can upgrade to 30%, and so on.

By expanding your savings contributions gradually, you’ll be able to build the strategy into your overall budget and lifestyle more easily.

6. Create a Long-term Investment Plan

If the reason for cutting living expenses and earning more money is to build savings, then the purpose of building savings is to invest for future growth.

Start by putting enough money into an emergency fund to cover living expenses of between three to twelve months. Exactly how much should be in the fund will depend on the stability of your job and your income, your typical monthly expenses, and your anticipation of any likely emergencies.

Though your emergency fund should emphasize safety, you owe it to yourself to get the highest yield you can. A savings account at a local bank paying 0.10% isn’t ideal. Instead, there are several online banks currently paying 0.50%, and even higher.

The purpose of the emergency fund should be to provide you with enough cushion that you can invest the rest of your savings aggressively. That will be important because to build the kind of portfolio you’ll need to achieve financial independence will require an aggressive investment strategy, aka the stock market.

The argument for market investments like stocks or ETFs is that they provide superior returns compared with other investments. The average annual return on stocks for the past 50 years has been over 10%.

Let’s look at why this type of return is so important for financial independence.

The 4% Rule Explained

How much is enough? A popular guideline is 25X your current income, sometimes referred to as the “4% rule” or the safe withdrawal rate. (In theory, if you withdraw 4% per year, a balanced portfolio of stocks and bonds will last the rest of your life.)

With that in mind, let’s say that you project that you’ll need $60,000 per year to live without working. Using 25X $60,000, you’ll need a portfolio of $1.5 million to generate that income on an annual basis.

Assuming you’re broke now, how can you reach $1.5 million in, say, 20 years?

By saving $30,000 per year in each of the next 20 years ($600,000 total) and investing at an average annual return of 10% – which will require a portfolio comprised entirely of stocks – you’ll reach just over $1.5 million at the end that timeframe.

If your current after-tax income is $60,000 per year, that will require saving and investing 50% of your after-tax income each year. That level of savings is one of the biggest reasons few people achieve financial independence, at least early in life.

You may also have noticed that the example above makes no allowance for the impact of income taxes on investment income. For the strategy to work, most of your savings will need to go into tax-sheltered retirement accounts. 

If you participate in a 401(k) plan, you can contribute up to $19,500 per year (or $26,000 if you’re 50 or older), plus an employer match. You can also make an IRA contribution of up to $6,000 per year. Assuming an employer match of at least $4,500 per year will get you to the $30,000 annual contribution target.

The combination of investing in the stock market within a tax-sheltered plan is the closest thing to a “secret sauce” to achieving financial independence.

7. Get Out of Debt as Soon as Possible

This can be a real challenge if you’re already carrying a substantial amount of debt. You may need to concentrate your initial financial efforts on getting out of debt or at least reducing the amount you owe. That will make it easier for you to make the investment contributions needed to reach financial independence.

But creating extra room in your budget for savings and investing isn’t the only reason for getting out of debt.

Once you reach financial independence, and especially if you plan to retire early, debt will be an expense you probably won’t be able to carry.

Getting out of debt, and learning to live without, is another critical step on the ladder toward financial independence.

8. Assess Your Progress and Make Adjustments as Needed

There’s probably no such thing as a plan that will get you to financial independence without making significant changes along the way. After all, life gets in the way from time to time. 

There may be times when your income is interrupted, or you encounter a large, unexpected expense. When that happens, you’ll need to adjust.

Remember, disruptions don’t mean that you should abandon your financial independence goal. Think of them as challenges you’ll need to overcome.

If you find yourself unable to save as much money as you need in one year, plan to make it up the next. Alternatively, you can extend the target date of your financial independence by another year or two to compensate for the disruption.

9. Dig in for the Long Haul

As you can see, achieving financial independence is very much a long-term process. Some people may attain it in just a few years, perhaps because they receive a large windfall or build – then sell – a successful business.

But if that doesn’t describe your situation, you’ll need to prepare for the years and decades it will take.

In the investment example we presented above, we used a 20-year timeframe. You may be able to do it in 15 years, or you may not be able to do it for at least 25 years. Either timeframe will require a serious commitment.

When creating financial independence, you’ll need to be fully committed to earning extra money and reducing your living expenses. That may mean forgoing a nicer home, a better car, or taking the kinds of vacations your friends do.

Final Thoughts on Financial Independence

The purpose of this guide is to help you reach financial independence, not to discourage you from even attempting the journey.

It won’t be easy. But nothing worth doing ever is. In 20 years, you’re going to be 20 years older than you are now. You have no choice in the matter. But you do have a choice as to how you will live when that time comes.

If you achieve financial independence, you won’t have the financial stress and lack of choices you may be dealing with now.

It’s challenging but doable – and certainly worth the effort.

Other Posts You May Enjoy:

What Is Coast FIRE? Save Early, then Relax

Coast FIRE is one of the more interesting versions of FIRE, aka Financial Independence, Retire Early. With Coast FIRE, you build a portfolio early in life that can grow enough to fund your retirement, then live your life - or coast - until the big day arrives. That’s where this FIRE flavor gets its name.

What Is Lean FIRE? Early Retirement for the Frugal Crowd

Like the other FIRE versions, Lean FIRE relies heavily on the safe withdrawal rate and building an extensive portfolio. But the main difference is that this version of FIR has a much stronger emphasis on frugality. Lean FIRE works incredibly well for people who can live on less than the average person does.

What Is Fat FIRE? Living Large in Early Retirement

If you've been spending much time reading personal finance blogs, you're probably aware of something called the FIRE movement. FIRE, in this case, is a moniker for Financial Independence, Retire Early. There are different FIRE versions, but Fat FIRE is like early retirement on steroids. That is, it's full-blown FIRE and not one of the watered-down variations.

How to FI: How to Create a Path to Financial Independence

Financial independence is a shared desire of millions of people. There’s even a moniker for it – F.I.R.E., which stands for financial independence, retire early. But how does one achieve FI? After all, it’s just a theory unless you have a plan in place to get there. Let's find out.

About Kevin Mercadante

Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed "slash worker" – accountant/blogger/freelance blog writer – on OutofYourRut.com. He offers career strategies, from dealing with under-employment to transitioning into self-employment, and provides "Alt-retirement strategies" for the vast majority who won’t retire to the beach as millionaires.

He also frequently discusses the big-picture trends that are putting the squeeze on the bottom 90%, offering workarounds and expense cutting tips to help readers carve out more money to save in their budgets – a.k.a., breaking the "savings barrier" and transitioning from debtor to saver.

Kevin has a B.S. in Accounting and Finance from Montclair State University.

Opinions expressed here are the author's alone, not those of any bank or financial institution. This content has not been reviewed, approved or otherwise endorsed by any of these entities.

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  1. Libra says

    I love it–It (the FIRE system) describes Me.. I retired at age 60. Two streams of income–Tax free munis averaging normal rates of interest at least at the time I retired of 5 to7 %. Then Obama was elected and spent (borrowed money) during his 8 years more than all of the previous Presidents in the history of the USA combined. This forced interest rates into an abnormal low rate of interest due to the extremely high interest payments now needed to pay for the Obama “Shovel Ready Jobs” that somehow never materialized. The scandal of Solyndra and the bankruptcy that followed after his donors had received a government loan to purchase a known failing business and his donors were repaid but the taxpayers took one in the shorts. His protege’ Biden is driving the USA even deeper into debt. This affected me because I watched as my bonds were being called and new bonds written at much lower rates. I realized that I must increase my bond holdings to keep my income at a livable rate of return. The second stream of income is from stocks which I Dividend Re-invest for growth. The premise being that should I need more income, I can spend the dividends. So far this method has worked for me.

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