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12 Steps to Financial Freedom and Personal Finance Success

Welcome to Moolanomy. You’ve just found a road map to help you improve your finances and change your life!

I have been managing my own finances since I gradated from college in 1995. Through the course of the years, I have done many things right and I also made plenty of mistakes. I have learned a lot along the way, and my goal with this blog is to distill and organize best financial practices into an easy to follow road map that will help you improve your finances and achieve your financial goal.

But why should you listen to me? What credentials do I have to deserve your time and attention?

Without going into too much detail…here’s my story. I graduated…well almost failed to graduate…in 1995 with over $20,000 in student loan debt and another $20,000+ in credit card debt. I struggled through job search until I found a decent job that got me on my feet. I practiced extreme frugality early on, managed to pay off all debt, and bought my first house in 1998. Over the years, I have risen up the corporate ladder, worked as an executive in a small company, started my own business, bought several rental properties, and managed several investment portfolios.

It is nothing to brag about, but I feel it is enough for me to use what I have learned and Pay It Forward.

A journey of a thousand miles begins with a single step.

Laozi

12 Steps to Financial Freedom and Personal Finance Success

  1. Make a Commitment to Improve Your Finances
  2. Start Tracking Your Income and Expenses
  3. Reduce Your Expenses
  4. Set Up a $1,000 Mini Emergency Fund
  5. Pay Down Your Debt
  6. Increase Your Income and Begin Investing
  7. Set Up an Emergency Fund
  8. Invest Your Money
  9. Buy a House
  10. Manage Your Risks
  11. Plan for the Future
  12. Pay It Forward

First, don’t let all these steps intimidate you. Second, the list shows a natural progression toward financial success, but that doesn’t mean you have to complete one step at a time or in this strict order. Some steps are going to take longer than others and some are ongoing activities you will continue to work on for as long as you choose to (or need to). 

Now, let’s go into each step in more details.

1. Make a Commitment to Improve Your Finances

I think everyone agrees that the most important thing that you must do before you start on this journey is to make a commitment to change. Some people get into financial trouble due to bad luck. But most get there because they make bad decisions and have bad money habits — as such, the very first step is to change and make a commitment to turn things around.

Tip: It helps to find an Accountability Partner to help you stay on track and encourage you along the way.

2. Start Tracking Your Income and Expenses

The second step on your journey is to become self-aware. Most people only have one source of income, so you are going to be focusing mostly on your expenses for now. You can track your expenses manually, on a spreadsheet, or using automated software like Personal Capital or Mint.com. I personally use Personal Capital to track my expenses…and a whole lot more (it’s my financial dashboard).

Track Your Expenses

Your goal is to track where you’re spending money and group them into categories so you can start reducing your expenses in a methodical way. Here are the steps you can take.

  • Make a list of all of your accounts (e.g., banks, investments, mortgages, credit cards, etc.)
  • Enter information into your tracking system (again, Personal Capital will make this so much easier than doing it manually)
  • Categorize your expenses

12 Steps to Financial Freedom and Personal Finance Success 1

Calculate Your Cash Flow

Once you have have everything tracked, you will be able to calculate your cash flow. The formula is very simple.

Cash Flow = Income minus Expenses

If you are cash flow positive, then you’re adding to your savings and building wealth (congratulations!). On the other hand, if you are cash flow negative, you’re accruing debt…and we will work on this.

Your goal is to have a positive cash flow and keep increasing that cash flow so you can build wealth faster.

Action Items:

3. Reduce Your Expenses

Reducing your expenses is the easiest and fastest way to improve your cash flow, and that’s why it is our third step. Overall, you will be taking these steps 

  • Review your expenses starting from the biggest category and work your way down — use the Pareto Principle to help you cut expenses quickly!
  • Review your recurring expenses (anything that you get billed monthly — especially, subscription services like cable TV, telephone, gym membership, associations, etc.) and cut whatever you can. Saving money on recurring expenses mean that you will enjoy the saving over and over again!
  • Decide what is important and what is not.
  • Cut back or eliminate the things that are no longer important to you.

Depending on how bad your cash flow is, you might have to make some sacrifices and practice extreme frugality.

Action Items:

4. Set Up a $1,000 Mini Emergency Fund

By this time, you’ll be making good progress, and hopefully, have a positive cash flow to show for your effort. To reduce the risk of sliding back when you hit a bump, you are going to set aside $1,000 and put that into a savings account. Here is a list of high-yield savings account — keep your money in one of these accounts so that you can make some money with your money.  

Don’t worry about putting in all $1,000 at once. Open an account today and start putting in money that you save in Step 3 into this account.

Action Items:

5. Pay Down Your Debt

Debt costs you money, so your next step is to pay down your debt as much and as fast as you can.

First, you have to consider the different types of debt:

  • Consumer Debt. Debt such as credit card debt, payday loan, or personal loans are among the most expensive debt you can have. These are the first you need to tackle.
  • Car Loan. Depending on the interest rate, this is the second one you need to pay down.
  • Student Loan. Student loan cannot be discharged easily, but you could become eligible for deferment or forbearance that allows you to temporarily stop making your federal student loan payments. You might even be eligible for forgiveness. Also, you can deduct interest paid on qualifying student loan debt. Therefore, this is a lower priority debt to pay down.
  • Home Loan. This is a good debt, and in my opinion, is the last debt you need to pay off. If your interest rate is higher than current market rate, you might consider refinancing to reduce your overall expenses and/or monthly payment amount (whichever works better for your situation).

Second, follow a plan to pay down your debt. The two popular methods are

  • Debt Snowball (pay lowest balance debt first) — less efficient, but more psychologically powerful.
  • Debt Avalanche (pay highest interest debt first) — more efficient mathematically, but might be harder to follow through.

Here is our 7 Steps Debt Reduction Guide which is a variation of the Debt Avalanche.

Action Items:

  • Make a list of all your debts.
  • Pick a method that you like best and use it.

6. Increase Your Income and Begin Investing

Step six focuses on increasing your income and getting you started on investing your money.

Increase Your Income

There are several high level objectives that you’ll be working on.

You goal is to make more money with your primary job, and build multiple income streams (both passive and active). Basically, you’re trying to increase your cash flow (Step 2) even further because cutting your expenses can only take you so far once you cut everything down to the bare minimum.

Begin Investing

Before we even start building up your full Emergency Fund, there are two important investing actions you need to get going as soon as possible. Why? Because there might be some free money for you here and start investing early is really important.

  • Start Investing in 401(k). Contribute part of your salary to your 401(k). Definitely do this first if your company offer a 401(k) match. A matching contribution is basically free money…which you don’t want to miss out on. The secondary benefit is you will be saving some money on your income taxes. The contributions will be going into your 401(k) from each pay check which automatically let you take advantage of Dollar Cost Averaging. Usually, your 401(k) investment choices will be limiting — for now, just invest in a US Broad Market fund with the lowest expense ratio as possible. 
  • Start a Roth IRA. If your company doesn’t offer a 401(k) match, you’ll want to contribute to your Roth IRA first (otherwise, do this second). As of 2019, you can contribute up to $6,000 per year to a Roth IRA. You pay income taxes on your contributions, but you money grow tax-free. For your IRA, simply invest a low cost S&P 500 Index ETF. 

Also worth considering is whether or not you want to contribute to FSA and HSA if you have access to these options.

  • Flexible Spending Account (FSA) – You can contribute pre-tax money toward your eligible healthcare expenses and your dependent care expenses. Contributing just the right amount is the key to maximizing your saving here.
  • Health Savings Account (HSA) – If you have access to an HSA, you can contribute pre-tax money and use it to pay for qualified healthcare expenses.

I recommend that you sit down with your HR Manager and see if these options are right for you.

7. Set Up an Emergency Fund

At this point, you should start to see your savings grow bigger and faster every month. What should you do with all that money?

First, you need to have a real Emergency Fund (not just $1,000 from Step 4) in your savings. A good target is to have 3 to 6 months worth of living expenses in your emergency fund. Since you have been tracking your expenses (Step 2), you just need to look up your expenses for the past 3-6 months and have that in your savings account.

8. Invest Your Money

So you filled your Emergency Fund and you still have extra money going into your bank every month — good job! What next?

Since you already laid out a good foundation, you should go back to Step 5 and see if there is any more debt that you can pay off (but don’t be in a hurry to pay down your student loan or mortgage just yet). Next, go back to Step 6 and see if you can and should increase your 401(k), Roth IRA, HSA, and FSA contributions.

At this point, you should consider if you’re planning to buy a house or keep renting. If you plan to buy, you might consider setting aside a portion of your money toward down payment in a savings account rather than investing all of your money.

If all you do is to max out your 401(k)/IRA, and investing in low cost broad market index fund, you will do very well. However, there are some important investing concepts that you should familiarize yourself with.:

  • Dollar Cost Averaging
  • Reducing Investment Expenses
  • Diversification
  • Asset Allocation and Rebalancing
  • Timing the Market
  • Tax-Loss Harvesting

9. Buy a House

Next, the American Dream. Homeownership is one of the greatest ways to build wealth. When you own a home, you are taking advantage of the four pillars of wealth building.

  • Cash Flow. Long-term, owing is cheaper than renting, so you owning a home is a plus to your overall net cash flow.  You can further enhance this by renting out unused parts of your home, e.g., a room, your basement, your garage, etc. 
  • Appreciation. Real estate appreciate over time given a long enough time horizon. Yes, you could lose money if you make a bad buying decision and sell too soon; or if you just have terrible luck (like buying just before the 2008 crisis).
  • Equity Growth. Like most people, you’ll be buying your first home with a mortgage — especially, with low interest rates, there is no reason to buy with cash. As you make your monthly payments, you are paying down part of your Principal Balance. Basically, it’s a way of forced savings that help you grow your equity.
  • Tax Saving. Lastly, your mortgage interest and your property tax are tax deductible. For most people, this is additional savings that you will enjoy year after year.

As a general advice:

  • Buy your primary home before you think about buying an investment property.
  • Buy a home that is just good enough for your and your family for the next 7-10 years, i.e., don’t buy a home that you’ll outgrow too soon and don’t buy too much house that will become a financial burden.

10. Manage Your Risks

Step 10, takes you beyond your basic insurances that you should already have in place:

  • Health Insurance
  • Auto Insurance
  • Homeowner’s or Renter’s Insurance

As you build wealth, you need to start build layers of protection to shield yourself, your family, and your businesses. Some of these include:

  • Umbrella Insurance
  • Life Insurance
  • Disability Insurance
  • Limited Liability Company and other legal entities

11. Plan for the Future

What’s next? Now that you have reach your goal of personal financial success, it is time to think about the future. Here are some of the things to consider:

  • Long-term Care Insurance
  • Retirement Planning
  • Estate Planing

12. Pay It Forward

Last but not least, it is time to Pay It Forward. You probably have been giving back and paying forward along the way. There are many things you can do like:

  • Give to charities
  • Start wealth building for the next generation
  • Teach others to be financially successful

The activities in this list are not meant to be completed in a day, rather, they are activities that you can do daily ( or weekly or at whatever pace you choose) to improve your finances and help you on your way toward financial success. My recommendation is to pick an item or two each day and implement the activity. With each of these mini-steps, you will slowly but surely move toward a better financial live.

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