5 steps to financial independence

Uncle Sam hat

Financial independence is a goal well worth fighting for.

It means you can maintain your standard of living without running out of money, no matter what happens.

You might be surprised to learn this is less about how much you make and more about how much you save.

Follow our five steps and you'll be on your way to achieving financial independence.

Step 1. Take responsibility.

There's no doubt that for many Americans, the return to a growing economy hasn't resulted in sudden prosperity.

Income inequality has meant huge gains for the wealthy, while everyone else has been stuck in place.

When adjusted for inflation, median wages haven't budged since the 1970s. The same can't be said for housing and medical costs, for example.

This is the reality of today.

You may be doing everything right or you may be financially pinched because you're living beyond your means.

In any case, you can't rely on a financial fantasy to save you. You're not going to win the lottery or get a sympathy check from the federal government.

No one can help you but yourself. Accept that responsibility and commit to changing your own financial future now.

"It takes discipline to invest and save, and (it) all falls into the individual's hands when it comes to taking responsibility," says Dan Neiman, partner and portfolio manager at Neiman Funds, based in Williamsville, N.Y.

Step 2. Spend less than you make.

If your lifestyle outpaces your income, you will always be walking a financial tightrope.

It's a pretty simple concept, but most Americans struggle with it.

"Watching client behaviors for over 30 years, I'd say the power of living below your means is the single most important factor in creating a secure financial future," says Lynn Ballou of Ballou Plum Wealth Advisors in Lafayette, Calif.

It takes more than cutting out lattes at Starbucks. You'll have to take a hard look at your two biggest expenses — where you live and what you drive.

Maximum housing costs

We calculated how the 28% rule works out for various incomes. If you have one of these incomes, here's the maximum you should spend:

Annual income Monthly housing limit
$50,000 $1,167
$60,000 $1,400
$75,000 $1,750
$100,000 $2,333

Housing costs — that's everything from the monthly mortgage or rent payment to property taxes, insurance premiums and condo fees — should be 28% or less of your gross (pretax) income.

You should also spend no more than 10% of your gross income on a vehicle, including the monthly payment, insurance and maintenance costs.

So if you make $50,000 per year, aim to spend no more than $1,167 per month on housing and $416 per month on transportation.

If these numbers appear shocking, know that you'll never get ahead if you can't get these two expenses under control.

You may want to start with our calculator, which will help you create a monthly budget to see where your money is going.

The best way to ensure you're saving is to pay yourself first and make it automatic.

You can do this through a 401(k) at work or with an automatic draft at your bank. It will move a certain amount every month from your checking to savings account and force you to live on less.

Step 3. Manage your debt.

Debt, especially high-interest credit card debt, is the single biggest wealth killer and a barrier to achieving financial independence.

The average credit card debt per borrower stood at $5,164 at the beginning of 2014, according to an analysis by TransUnion, one of the three big credit bureaus.

It would take more than 10 years to pay off this balance if you make the minimum monthly payment.

With an average interest rate of 15%, you also would pay more than $2,200 in interest.

You can save money and erase your debt years sooner if you pay more than the minimum required.

Use this credit card repayment calculator to develop a plan to wipe out your debt as quickly, and cheaply, as possible.

It's hard to go through life without some debt, but the only things you should ever consider financing are a car, a good education and a home.

"A low-cost mortgage could be 'good' debt," says Nick Ventura, president and CEO of Ventura Wealth Management in Ewing, N.J. "It allows for the buildup of equity and, in most cases, tax savings."

If you need to finance a vehicle, use the 20/4/10 rule.

It says to finance a car for no more than four years, make a 20% down payment and not let the total costs, including insurance, exceed 10% of your income.

Borrowing money to pay for college assumes you’re going to a reasonably priced school and studying something that will earn you a decent living someday.

If you need to borrow money for anything else, chances are you can't afford it. If you can’t recognize and accept when you can’t afford something, you'll always be in debt.

How much car can you afford?How much car can you afford?Americans spend more than $30,000 on average when they purchase a new car or light truck. But our 2014 auto affordability study found that the median-income family in 24 of the nation's 25 largest cities can't afford to spend this much on a vehicle. See what kind of vehicle you should buy based on your income.

Step 4. Save and invest.

Most financial experts say you should save at least 10% of your income — preferably even more. If you're having a problem saving, see Step 2.

When you save money, you are buying and obtaining security. It's no surprise that, in general, the more money people have in the bank, the less they worry about their finances.

Your first place to save should be an emergency savings account. You should have about six months of living expenses socked away there.

Next, take advantage of any 401(k) matching contributions your employer may offer.

To build financial security, it's critical you start contributing to your retirement early in your adulthood.

"The sooner you get started, the greater the compounding effect will be later in life, and you'll be more likely to weather financial cycles," Ventura says.

Your emergency fund should be in an easily accessible savings account, but your retirement funds should be in stocks and bonds. CDs and money market accounts aren't going to provide the growth you need.

It's also important to invest for the long term.

"Growth is essential," says Bruce Helmer, founder of Wealth Enhancement Group in Chaska, Minn. "You need to take (some risk) and get a return that at least exceeds the rate of inflation. There is volatility in the short term, but long term, stocks produce (greater) returns."

If you don't know much about investing, start with a low-cost target date fund.

All you have to do is pick the year closest to your retirement date, and you'll get a portfolio with the appropriate mix of stocks and bonds that will adjust as you grow older.

It's an easy way to start investing.

See how quickly your nest egg can grow with this savings calculator.

penny on a fever line5 things to know about target date fundsTarget date funds can make investing easy. Rather than picking stocks and bonds on your own to create a diversified portfolio, you select a single fund designed to have the right combination of assets based on when you plan to retire — your "target date." Here's how to buy with confidence.

Step 5. Carry insurance.

No one likes paying insurance premiums.

You pay a company a bunch of money in case something bad happens. And when nothing happens, you don't get anything back.

Sometimes it seems like it's all for nothing.

But insurance isn't just to protect your vehicle, home or health; it's to protect your financial security and all the money you've saved.

Owning a home, driving around, even walking down the street without insurance is like walking a tightrope: One single incident or accident can wipe you out.

Carry enough homeowner's and auto insurance, and make sure you have health insurance.

At least start with a catastrophic policy to cover you in worst-case scenarios.

The new insurance marketplace instituted by the Affordable Care Act may not be perfect, but at least it offers some additional options.

Medical bills cause more than 60% of all personal bankruptcies and pose the single biggest threat to everything you're working to achieve.

Protecting yourself against lawsuits, accidents and medical issues is part of declaring your financial independence.

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  • Mark Stephenson

    Thank you, Captain Obvious! "If you want to make more money, find a job where you will make more money. If you want to save more money, put more money in the bank." What a great in insightful article!

  • Roena Wray

    And for those whose chosen careers cap out at 35K/ year? My guess would be rent a room instead of an apartment and risk job loss by having to rely on public transportation? These are not 5 steps to independence. These are 5 financial facts that everyone should be aware of very early in life. People need a hope and a plan, Not many of us out here working have money to buy a latte every day, even less use not buying one as a savings plan.

    In my mind, if you are under 25, there is still hope for you, Follow the above guidelines, and if no tragedies strike, you might have a chance. For the rest of us, don't try to become independent on your own. Once the mistakes have been made, it takes the support of friends and family to undo the damage. Set one small goal at a time. "When my car is paid off, I will resist the urge to buy a new one. I will instead use the car payment money to pay my student loans." Or, "I will start by rounding my credit card bill up to nearest $5, when I get my raise, I will round to the nearest $10". Change your lifestyle as a group. Take turns having potlucks at people's homes instead of meeting at a restaurant or bar. Don't worry about saving if you have credit card debt. Make sure you pay down your high interest balances first. A 401(k) often earns more interest than you pay out on your car loan or student loans, so by all means save in 401(k) before you pay extra on low interest loans, especially if you have company matching.

    Now... for those who aren't fortunate enough to have attended college or learned skills to get you out of the minimum wage job, it is never too late to start. However, the graduation rates for non-traditional students in 4 year programs is not great. There are trade schools, and community college certification programs and technical certification programs that might be a better option. Never ever take out the maximum allowable in student loans. Always search for and apply for scholarships and grants. If you can pay for a few classes at a time while working, it is better to just pay for them as they come instead of putting yourself into debt, at least for most programs. Highly technical programs are time sensitive and are worth reducing to a part time workload and taking out student loans to cover just any tuition and books not covered by grants. And DO consider learning a trade instead of pursuing a college education. Book smarts aren't everything.

  • Middleburybigdog

    Dave Ramsey books are gold. It's all spelled out simple. Then the choice is yours.

  • patpad

    how do you survive on $8,000 dollars a year? the guy writing this program 50,000 a year dream on. gas. electric, auto insurance, phone, and cable internet and still have something to buy groceries and gas GOOD LUCK!!! how do the people living on income below poverty level save on minimum wage or less? you big know it all got an answer for this one?

  • iLiner

    Here are the two secrets to growing wealth and doing just fine on a modest income:
    1) Only buy as little insurance as you are legally required to buy. It is a complete scam and rip-off. It is a product base on fear, no different from garbage peddled on talk radio. On No! I need to buy Food Insurance! On No! I better buy gold! On NO! I better buy cloud-based hard-drive back up! Because, you know, the way this country's going, I better protect myself by buying all this stuff!
    2) Stop thinking you are so cute. The biggest money sucks in your budget indulge your sense of being cute. Nobody needs a cell phone. Nobody needs cable TV. Nobody needs a $3 cup of coffee. Enjoy what you have, grow your mind, and stop wasting your money on industry-fed delusions about how cute you are. The result will be accumulating a huge amount of cash. Keep this cash in your house. Do not give it to some douche bag to lose in the stock market.

  • Steve Vinzinski

    The article covers plenty,like he says ACA may not be perfect find me any insurance that is perfect.I have been dealing with them for forty years I have met some great claim people.You have to adjust,hope you do not get sick,loose your job,etc.I do admit the older you get the sicker you become in general,insurance does not go down.I have been informed Medical,Px.,Dental and co-pays are going to move up with force when the December premiums come out.