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12 Steps to Financial Freedom and Personal Finance Success

12 Steps to Financial Freedom and Personal Finance Success

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

I have been managing my own finances since I graduated 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 the best financial practices into an easy to follow roadmap that will help you improve your finances and achieve your financial goal.

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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 probably about $10,000 in credit card debt. I struggled to find my first real job until I found an opportunity that got me on my feet. I practiced extreme frugality early on, managed to pay off all debts, 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

The Basics: 4 Pillars of Financial Success

12 Steps to Financial Freedom and Personal Finance Success 2

Our 12 Steps Financial Success Plan below is built on four elementary building blocks.

  1. Income Management – Earn more through your job, passive income, business, and investing.
  2. Debt Management – Pay off your bad debts. Leverage good debts wisely.
  3. Expense Management – Spend less and make smart spending decisions.
  4. Asset Management – Invest your money, manage risks, and build wealth.
Read More About IDEA: How to Become Rich

12 Steps Financial Success Plan

Here is a summary of the 12 steps with a side-by-side comparison to a more popular Dave Ramsey’s 7 Baby Steps. Although I like Dave Ramsey’s Plan, I feel my plan is more flexible and comprehensive. Ultimately, it doesn’t matter which plan you choose, but more important that you choose a plan and take steps to improve your finances.

12 Steps Financial Success Plan Dave Ramsey’s 7 Baby Steps
#1 – Commit to a Plan

#2 – Track Your Income and Expenses

#3 – Score Financial Quick Wins

  • Reduce Your Expenses
  • Implement Easy Passive Income Ideas
  • Complete Easy Money Hacks
  • Contribute to 401(k) to Get All the Employer’s Match
#4 – Set Up a $1,000 Mini Emergency Fund #1 – Save $1,000 for Your Starter Emergency Fund
#5 – Pay Off All Debt, Except the House #2 – Pay Off All Debt (Except the House) Using the Debt Snowball
#6 – Increase Your Income and Begin Investing

  • Invest in a Roth IRA
  • Contribute to Health Savings Account (HSA)
  • Contribute to Flexible Spending Account (FSA)
#7 – Complete Your Emergency Fund and Personal Financial Plan #3 – Save 3-6 Months of Expenses in a Fully Funded Emergency Fund
#8 – Invest Your Money #4 – Invest 15% of Your Household Income in Retirement
#9 – Buy a House

#10 – Manage Your Risks

#11 – Plan for the Future

  • Save for Your Children’s College Education
  • Retirement Planning
  • Long-Term Care Insurance
  • Estate Planning
#5 – Save for Your Children’s College Fund

#6 – Pay Off Your Home Early

#12 – Pay It Forward #7 – Build Wealth and Give

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 detail.

1. Commit to a Plan

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

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

Action Items

  • Choose a plan (or create one)
  • Make the commitment to change
  • Start working on the steps 2 to 7
  • Start putting together your Personal Financial Plan. Your first plan can be as simple as completing Step 2 to 7 in a specific amount of time.

2. Track Your Income and Expenses

The second step on your journey is to become self-aware. Most people only have one significant source of income (i.e., your job), 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.

Track Your Expenses

Your goal is to track where you’re spending money and group them into categories so you can start systematically reducing your expenses.

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

Calculate Your Cash Flow

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

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.

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

Action Items:

3. Score Financial Quick Wins

Before digging in to do the heavy lifting stuff, let’s put some quick wins under your belt.

Reduce Your Expenses

Reducing your expenses is the easiest and fastest way to improve your cash flow, and that’s how you will score your first few Quick Wins.

Overall, you will be taking these steps

  • Review your expenses starting from the biggest category and work your way down — use the 80/20 Rule 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 means 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.
  • Start reducing your expenses one by one using these money-saving ideas.

Implement Easy Passive Income Ideas

In our list of passive income ideas, we listed Easy Passive Income Ideas for Beginners. Take some time to set those up now.

Complete Easy Money Hacks

We also have a list of ideas that are not directly related to expense reduction on passive income. You can take a look at our list of money hacks and ideas to improve your finances to score a few more quick wins.

Contribute to  401(k) to Get All the Employer’s Match

If your company offers a 401(k) match, do whatever it takes to get all of the matching money — even over paying down your debt!

401(k) matching is the only time you have an opportunity to get free money. This is an instant 50%-100% return on investment, and you get a tax deduction on your contributions as well. Let’s assume you have $250 extra a month to put toward credit card debt or 401(k); this is how the math works out.

  • Paying Credit Card: $250 x 20% saves you $50. On average, you have to earn $1.55 to get a dollar after taxes; this means the $50 saved is equivalent to about $77 earned.
  • 401(k) Match: $250 invested results in a $250 match (assuming $1 for $1 matching). At 22% federal and 5% state, you’re saving $67.50 in the form of tax deduction, which is equivalent to $105 earned (e.g., $67.50 x $1.55). The two add up to $355 value!

You can adjust the match to fit your exact situation, and you’ll find in most cases, taking the company match wins!

Usually, your 401(k) investment choices will be limited — for now, invest in a US Broad Market fund with the lowest expense ratio possible.

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

By this time, you should be making good progress, and hopefully, start seeing some money left over from each paycheck.

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 accounts — keep your money in one of these accounts so that your money can help you make some 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.

Why a $1,000?

A $1,000 should be enough to cover your home and auto insurance deductibles in case you need it, and it should also cover your small emergencies.

Action Items:

5. Pay Off All Debt, Except the House

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

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

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

Here is our guide on How to Get Out of Debt Fast.

Action Items:

  • Make a list of all your debts.
  • Pick a method that you like best and use it to pay down your debts.
  • Review and update your Personal Financial Plan.

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.

Your 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 (FSP#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 is one more investing action you need to get going as soon as possible — you need to start investing in a Roth IRA.

Hopefully, you already took all the company’s match in FSP#3. Now, you’ll want to contribute to your Roth IRA. As of 2019, you can contribute up to $6,000 per year to a Roth IRA. You pay income taxes on your contributions, but your money grows 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 savings 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.

Action Items:

7. Complete Your Emergency Fund and Personal Financial Plan

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

Complete Your Emergency Fund

First, you need to have a fully-funded 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 need to look up your expenses for the past 3-6 months and have that in your savings account.

Complete Your Personal Financial Plan

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

This is where your Personal Financial Plan comes into play big time as your unique financial situation, wants, and needs become a more important factor.  You will start to see many goals that you want to work on at the same time, and it is good to have your thoughts organized.

For example:

  • Is there any more debt that you can pay off?
  • Do you want to save more for retirement? Maybe consider increasing your 401(k) and Roth IRA contributions.
  • Are you planning to buy a house or keep renting? If you plan to buy, you might consider setting aside a portion of your money toward the down payment in a savings account rather than investing all of your money.
  • Do you want to increase your HSA, and FSA contributions?

Action Items:

8. Invest Your Money

Many of your financial goals will require you to invest your money. If you start investing in your 20s and 30s, you will do very well if all you do is to contribute just enough to get your company’s 401(k) match (FSP#3) and max out your Roth IRA (FSP#6).

However, you should try to do more. The next most logical thing is to Max Out Your 401(k). After you max out your Roth IRA ($6,000 maximum contribution as of 2019), you should try to max out your 401(k) ($19,000 maximum contribution as of 2019). Each time you deduct money from your paycheck and deposit into your 401(k) plan, you’re automatically taking advantage of Dollar Cost Averaging.

Here are some additional investing concepts that you should learn:

9. Buy a House

This is the ultimate 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 real estate 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 appreciates 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 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 Savings. 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 you 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.
  • Consider house hacking to accelerate your real estate wealth.

10. Manage Your Risks

Step 10, takes you beyond the 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 building 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 reached your goal of personal financial success, it is time to think about the future. Here are some of the things to consider:

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
  • Build generational wealth
  • Teach others to be financially successful

The activities in this list are not meant to be completed in a day; instead, 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 life.

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Anne
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Great article! A stepwise approach always makes it easier to tackle your finances. Do you think it is wise to own have loans for two rental properties at a time in (real estate investment)? Or is it safer to pay one apartment off first before buying another?

12 Steps to Financial Freedom and Personal Finance Success

by Pinyo Bhulipongsanon time to read: 13 min
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