Step to Financial Freedom

The path to financial freedom is certainly not a short journey. There are “financial checkpoints” you have to reach before you before you can achieve financial freedom.

1. Emergency Fund

An emergency fund is a stash of money kept for emergency use. It must be readily accessible and you should be able to get hold of this money within 24 hours or less when you need it.

You need to have an emergency fund because unfortunate events may happen. Your emergency fund could help you fix this problem so you could get back to your normal life as fast as possible. Note that this “emergency fund” is different from the “savings buffer” which will be discussed later.

Why do you need an emergency fund? Because you can get the money without any delay and you save on interest and processing fees. If you didn’t have an emergency fund, you might get a cash advance on your credit cards which will incur high interest and processing fees.

How much emergency fund do you need? Ask yourself what emergencies could happen to you and how much would you need to address these emergencies.

Car breakdown.
An emergency fund comes in handy when emergency strikes.Assume the emergencies are (1) car breakdown, (2) household repair, and (3) theft or robbery. In these 3 scenarios you need money to fix your car, repair your house and money for everyday use to replace what was stolen or robbed from you.

Which scenario would cost you the most money? Assume you estimate you car breakdown is $200, household repair is $500 and money in your wallet is $100. Therefore you should aim to have an emergency fund of at least $500. It is recommended that your emergency fund be higher because there will always be other costs involved. For example, when your car breaks down you need to send it for repair plus you will need to incur additional traveling costs until your car is fixed.

Once you have your emergency fund in place, the next step is to eliminate all your consumer debt.

2. Pay off Your Consumer Debt

Not all debt is good. Neither all debt is bad. Whether the debt is a good debt or bad debt depends on the reason you incur the debt. In most cases, a mortgage is considered a good debt while putting an expensive vacation on credit card is considered a bad debt.

Consumer debt is debt that accumulates by spending on daily expenses. Common types of consumer debt are credit card, overdraft and personal loan. The interest rates on consumer debt are the highest. The purpose of consumer debt is to earn money off you. This is different from mortgage or education loan which aim to help you.

The high interest rate on your debt will slow you down in building your net worth. It could also eat into your net worth if you are not careful in managing this debt.

It is therefore your priority to get rid of this unhealthy debt before it is too late.

3. Build a Savings Buffer

Spending less than you earn is the foundation of wealth building.A savings buffer is a stash of money different from the “emergency fund”. While the emergency fund is used to fix problems immediately, the savings buffer aims to help you through the unfortunate period.

Examples of these events include losing your job, being sick and unable to work for a short period of time, incur unexpectedly high medical or repair bill and so on.

Though there is no fixed rule of how much your savings buffer should be, in general it is advisable to have a buffer of between 3 to 6 months worth of living expenses.

With a savings buffer, you avoid from borrowing from your credit cards to pay your daily expenses.

4. Insurance

Once you’ve got the savings buffer setup, you could consider buying a life insurance. This is to protect your loved ones.

Think about this. You worked so hard to setup your emergency fund, cleared off your debt so your family wouldn’t be burdened by it and setup a savings buffer to ease the financial impact on your family day-to-day living.

If you are the sole income earner in your family and if anything unfortunate should happen to you and you leave this world for a better place, then who is going to pay for the food and shelter? Your savings buffer could help your family for maybe up to 6 months. What happens after that?

If you have a life insurance, then the income from the life insurance will help your family take care of the living expenses for a long time to come.

Therefore, by buying a life insurance, you take away this financial risk from your loved ones. As long as you live, you will provide for them. If you are no longer here, the insurance will provide for them.

However, if you have no dependent and no financial commitment then you could shelve the thought of buying a life insurance until a time in the future when the needs arise.

5. Buying a house

When you rent, you are building net worth for your landlord. When own the place you live, you are building net worth for yourself.

Aggressively save money towards a down payment for a house. Research on the property you intend to buy.

If you’ve bought a good property in an up and coming neighborhood with high demand, then chances are your property will rise in value and this helps in building your net worth.

The monthly mortgage payments you make out to your bank also build your net worth. Part of the mortgage payments goes to paying interest while a portion goes to paying down the principal of the mortgage.

6. Investment - Retirement fund

Eventually there will come a time when you retire from working. How well you live during retirement depends on how well prepared you are for this day. It is never too early to setup and build your retirement fund.

7. College Education Fund

After you have your retirement fund in place, you could also start a college education fund for your children. If you can only afford either a retirement fund or a college education fund, then priority should go to investing in your retirement fund because there are other ways to raise the funding needed for your child’s college education, such as scholarship, student loan and others.

8. Pay off Your Mortgage

Finally, pay off your mortgage. You will have peace of mind knowing that even if you lose your income, nobody will take away the roof over your head.

However, if you are already reaching retirement age, then priority should be paying off your mortgage, then invest your surplus money.

Source: www.financemind.com