Steps to Financial Freedom

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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.

These financial checkpoints in chronological order are:

1. Have an Emergency Fund
2. Pay off Your Consumer Debt.
3. Build a Savings Buffer.
4. Insurance.
5. Buying a House.
6. Investment - Retirement Fund.
7. College Education Fund.
8. Pay off Your Mortgage.

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.

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.

Read more:
• Types of consumer debt
• Ways to Minimize Credit Card Interest

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.

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