For far too many people, finances are an obstacle standing in the way of one’s goals. But done right, your finances give you the freedom to pursue your goals. This does not necessarily mean being wealthy, but wisely managing your financial situation—whatever it may be—to achieve financial health, giving you the means and opportunity to pursue your goals.
Here are five essential principles for achieving financial freedom:
1. Live below your means
Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.
—Charles Dickens, David Copperfield
The line between overspending and underspending is thin but critical. Get in the habit of spending less than you can afford, and the difference immediately becomes extra money in your pocket.
This often means living in a less luxurious apartment or house, cooking instead of going out, drinking the house wine instead of the $18 dollar Napa Valley cabernet, vacationing with an AirBNB instead of a 5-star hotel, canceling your $200 cable package in favor of Netflix and Amazon Prime, and IKEA or used furniture instead of that artsy piece from that SoHo boutique.
These cuts may feel tough at first, but they will pay long-term dividends as the savings amass over years of underspending and avoiding debt. More than any other, the habit of living below your means can drastically reshape your long-term financial landscape and set you up for financial freedom. (For a more in-depth dive, check out our article on The Why and How of Living Below Your Means.)
2. Maintain your lifestyle even as your income increases
When you get a raise or move to a higher-paying job, the natural response is to spend more on your lifestyle. After all, you’ve earned it!
But if a home-cooked meal and Netflix were good enough before, they’re good enough now. Reject lifestyle creep. Commit to maintaining the status quo even as your income increases, and you’ll build in a long-term strategy for living below your means.
This will yield not only extra savings but—perhaps more importantly—the financial flexibility that comes with a modest lifestyle. Many professionals find themselves trapped in careers they don’t want, unable to pursue more meaningful or riskier endeavors, because they feel they must earn enough to support the lifestyle to which they (and their family) have become accustomed. Don’t fall into that trap.
Remember: your long-term goals should trump a lavish lifestyle. Whatever your goals—buying a house, pursuing that career change, paying off student loans, or putting your kids through college without incurring debt—avoiding lifestyle creep will help you achieve those goals that much quicker. Sure, it’s good and appropriate to increase a few key areas of spending as income grow, but be incredibly thoughtful and slow about this. Expenses should increase at a slower rate than your income.
3. Follow the money: exercise awareness
Most people overspend not due to lack of discipline, but lack of awareness. In this age of credit cards, 1-click ordering, automated monthly billing, and ATMs on every block, most people have little to no idea how much they are spending and on what.
The more aware you are of your spending, the more control you’ll have of your money.
Use Mint to track spending and aggregate your accounts or review credit cards and bank statements. Review spending at least monthly, or even weekly in the beginning or for categories you are most prone to overspend. Take a big picture look at spending quarterly and annually (especially important for categories like travel, gifts, or home improvement that are more annual in nature). Check out my Mint tutorial videos for help getting started with Mint.
4. Keep investing boring
Karate’s a very boring sport, but when you know the technique you can go further and further.
—Jean-Claude Van Damme
Over the last fifteen years, over 80% of actively-managed funds performed worse than their respective market indices. That means that low-cost, passive index funds are the right investment choice for almost everyone.
If you don’t have an advisor helping you with your investments, I recommend a low-cost robo-advisor like Betterment or WealthFront to select the index funds for you and continually rebalance your portfolio.
Source: Carl Richard, Behavior Gap
5. Talk about money
Having a healthy relationship with money means being open to feedback and accountability.
Don’t manage your finances in isolation. Talk to your spouse, family, friends, or financial advisor about your financial goals, your spending, and your lifestyle. For couples this is particularly important, in order to avoid conflict and ensure a united front.
Things get wonky when we manage our finances alone. There’s no one to give objective feedback, remind you of your goals or tell you you’re about to do something stupid. Let’s change the norm in our culture and talk a little more freely about money. I don’t mean asking your colleague how they invest their 401k and copying their fund allocation or comparing their performance to yours. That’s entirely unhelpful and not advised. I’m talking about the vulnerable, qualitative aspects about money:
How you do decide how much is enough?
I’m really struggling to pay off my student loans. Do you ever stress about money?
How do you resolve disagreements about money with your spouse?
I’m really trying to pay off my credit card debt this year. Can you help remind me of this the next time we’re out shopping?
Choose a select group of close friends or family members and be humble, seek advice, give encouragement, and ask for accountability. You don’t have to share specifics about income, mortgage payments and the cost of your vacation for this to be helpful.
Up next, we’ll build on these principles with essential healthy habits for achieving financial freedom.