How to go From Broke to Financial Independence: 12 Steps that Anyone Can Follow

This is a post for those of you who do not want to work until traditional retirement age making somebody else rich. It is a post for those of you who want to retake control of your life and it is a post for those of you who want to know the exact simple steps that can take you to Financial Independence (FI).

Nothing in this post will be complex but the fundamentals will be backed up with some incredibly simple maths before we dive into the 12 steps of how to achieve this and my summary of the most important points.

For those of you who are still unaware financial independence is the achievement of becoming wealthy enough that your investments can generate you enough of a passive income that you no longer have to work. From here whether you choose to retire early (FIRE) is up to you.

How achievable and straightforward (but not easy) this is will likely surprise you so please read on.

• How much do you need?
• How Long until I Reach Financial Independence?
• How to Increase Your Savings Rate
• Step 1 – Review Financial Health
• Step 2 – Understand Your Spending
• Step 3 – Create a Budget
• Step 4 – Pay Off High Interest Debt
• Step 5 – Build an Emergency Fund
• Step 6 – Enroll in Workplace Pension
• Step 7 – Pay Remaining Short Term Debts
• Step 8 – Enlarge your Emergency Fund
• Step 9 – Review Your Budget
• Step 10 – Define your Financial Goals
• Step 11 – Save for Short Term Goals
• Step 12 – Invest for Long Term Goals
• Conclusion

How much do you need?

If you read newspapers, journals or other “financial blogs” you may be told that you need X amount of money to retire. Expect to often hear:

“You can’t retire with just a million pounds these days”

“Two million is my target, any less and you’ll run out”

Others will tell you how much you need to save:

“Half of your age as a percentage”

HSBC

Unsurprisingly all of these are wrong and the simple math’s states that you simply need 25 times your spending as long as you are willing to be flexible in retirement. This is known as The 4% Rule.

Simply calculate how much you spend each year and multiply by 25. Poof and you have your target figure. If you do not know how much you spend then read on as step 2 will walk you through determining this.

Yearly Spend* X 25 = Financial Independence Figure

E.g. £25,000 X 25 = £625,000

*Remember not to include expenses you would not have in retirement… like monthly savings for retirement.

How Long until I Reach Financial Independence?

Tell someone the above information and expect to get the following response:

“It doesn’t matter, it’s impossible for me to save 25 times my spending”

On the surface it is completely understandable as this seems like an extremely daunting figure but again if we dive into the math’s behind this then it becomes much easier to grasp and become excited about.

It turns out that in reality the only important metric when determining how long it will take you to become financially independent (and therefore be able to live off just your investments) is:

Your savings rate, as a percentage of your take home pay

This essentially means that if you know what percentage of your income you save each year then you can easily calculate exactly how long it will take you to reach financial independence and if you so choose, early retirement.

It may seem obvious that the more you save the quicker you will reach retirement. What is not so obvious is that only by calculating as a percentage will you get an accurate timeframe. Plucking a figure like £1,000,000 out of the air just simply gives you an arbitrary number, which will likely not reflect your needs as proved earlier by the 4% rule.

Think of it like this:

If you save 0% of your income, you will never have enough to retire (ignoring government benefits)

If you can save 100% of your income and maintain this, then you can retire right now

Now if you are sensible (and have at least half a brain) you probably do not need me to tell that the majority of people fall between these extremes and therefore a bit more information is needed.

Thankfully the guys and gals at networthify.com have already done the hard work so use their table to calculate exactly how long it will take you to reach financial independence.

Let’s pick out some percentages and discuss:

10% – “The 10% savings rule often recommended by experts” = 51.4 Years… Thanks “experts” at The Balance

20% – The 50/30/20 rule (50% needs, 30% wants & 20% Savings) = 36.7 Years. Thanks HSBC

30% – Now we’re starting to get somewhere = 28 Years

50% – A number a lot of people following FIRE try to reach = 16.6 Years

66% – Okay if you reach savings 2/3s of your income you’re killing it = 10.2 Years

80% – Find a way to reach this sustainably and you’ll be there in moments = 5.6 Years.

So what can we take away from this?

• If you listen to a lot of “experts” you can expect to work until you’re too old and too feeble to really enjoy your retirement
• It doesn’t matter how much you earn if you spend all of your money

Some important points to note:

• Time to Financial Independence was calculated by assuming your investments grow by 5% each year
• You implement the 4% rule with your investment pot (E.g. this is how long it will take your net worth to reach 25 x your spending).
• You only spend the income generated by your portfolio which will make it last indefinitely – An important safety net if you plan to retire early and have to rely on it for 50 years.

How to Increase Your Savings Rate

After reading the above you may be about to start searching hungrily for ways to go about improving it. There are two real methods:

Spend Less

Earn More

Each of these have their benefits and drawbacks so we will speak about each one in turn.

Cut Spending

This is almost certainly where you will start and is the more powerful because it has three huge benefits:

You can save more

You need less to reach FI

Additional taxes (for earning more) do not affected you

Before cutting spending it is important to work out exactly what it is that you value spending your money on. This is completely personal and what others value should not affect your decisions.

• If you take home £40,000 a year (singularly or as a household) then it is just as effective to save £20,000 of that than it is to earn an additional £40,000 and save it all.
• Take home pay is the pay you receive after taxes have been paid
• The table does not account for the additional taxes you would need to pay for earning more money. This will likely be 20% or 40% depending if it was split between a couple or not.

Earn More

The second part of the wealth building/financial independence pathway is to look at way to earn more money. This should be tackled after spending less because if you do not learn to manage your money and put it to work for you then earning more money will not help you on your path to financial independence.

We will discuss ways to improve your income in a later post which will be linked here.

12 Steps to Reach Financial Independence

As stated at the beginning of this article we will be outlining a 12 step plan that anybody can use to set them on their way and turbocharge their path to financial independence and freedom. These steps are best taken in order but as always, personal circumstances may require flexibility.

Step 1 – Review Financial Health

The easiest way to complete this step is to collate all the below information into a simple easy to understand excel/google sheet. Complete this yourself instead of relying on apps as it will force you to look into and understand your personal circumstances.

• Bank Account Balance
• Savings Account Balance
• Investment Account Balance
• Credit Card Debt and Interest Rate
• Loan Debt and Interest Rate
• Other

Complete the above and you should end up with something similar to the below (all examples in this post are not personal to me):

Tip – Make it simple and make it easy but get all of the above information.

Step 2 – Understand Your Spending

Before you begin to budget and change your spending habits you need to understand how you spend your money at the present moment. To help you with this step there are various apps that can help such as Yolt, Mint, Money Dashboard or through your banking app (especially easy if you have a bank like Starling or Monzo). You can check out the best UK banks here.

The first step to creating your own budget is to understand and outline your past spending. Categorise this into:

• Essential spending (mortgage/rent, utilities, groceries, council tax, fuel etc.)
• Discretionary spending (subscriptions, gadgets, eating out, drinks with friends, holidays etc.)

Do not beat yourself up as you evaluate your spending and go back for as many months as you can and preferably up to a full year. You may also wish to group spending (all house related etc.) You should end up with something like the below:

Step 3 – Create a Budget

Creating (and sticking to) a budget is possibly the most important step for those of you at the beginning of the path to financial independence. Do not underestimate this; it will allow you to multiply your savings rate and potentially remove decades from your working life.

The most important thing about a budget is that it needs to be personal and it needs to reflect what you want and value in life. There’s no point reaching financial independence if the years leading up to it are barren and mind numbingly dull. The only exception to this is if you have high interest debt – in this case you need to take sacrifices in the short term to eliminate this (more in step 4).

The best way I have found to start your budget is to reorganise the list of ‘discretionary spending’ into an ordered list of what brings you the most value; regardless of how much you spend. Rank each one out of 10 and highlight any areas where you think the cost does not represent the value it brings to your life. It should look something like this:

From here work through each spending type and give yourself a new budget for each section. If this were my budget, I would do the following:

• Flights/Holiday Accommodation/Spending – This brings me the most value of all my expenses. I have a girlfriend who lives abroad and without this, I would struggle to see her. Therefore I would not plan to reduce this if it was affordable to me.
• Gym/Exercise – No change required. Large value and minimal cost
• Nights Out/Drinks/Pub – This requires modifying as the cost outweighs the value to me. I would look to reduce this by 50%
• Eating out – Minimal value and large costs – I would look to reduce this to a max of 1 meal per month (£30 a month).
• Netflix/Spotify – No amendment required – Decent value for cost. Would look to split the costs with someone else though.
• Computer Games – Try to reduce minimally. Buy second hand/older games and sell when used. Reduce by 50%.
• Gadgets/Toys – Probably the worst cost to value comparison in this chart. Give myself a budget of £20 a month and use as gift ideas for me at Christmas/birthday
• Sofa – Needed and minimal cost. No real issue
• Takeaways – Don’t bring value so remove
• Clothes – Don’t bring value but required. Cut by 50%
• Amazon Prime – Doesn’t bring value to me. Remove.
• Other – No Concern

Remember that this is how I would adjust the above if it was my spending habits but your wants may differ completely and that is absolutely fine. You may choose to cut from holidays and use the money for nights out.

Once complete you should look for ways to minimise your essential spending. This could be:

• Remortgaging
• Changing electricity/gas supplier
• Renewing internet/phone deals
• Using discount supermarkets

Points to note:

• This is assuming that you have no high interest debt. If this is the case then you need to cut out as much of your spernding as possible to focus on repaying it. The higher the interest the more you need to cut until you only have the bare essentials
• This is assuming you earn enough to afford the above example. If you are still going into debt or still have a low savings rate after the above remediation’s then unfortunately you need to remove more or when this becomes unfeasible look to earn more.
• You can test and reassess your budget as often as you choose.

Step 4 – Pay Off High Interest Debt

High interest debt will quickly and brutally kill off any plan of financial independence that you have. The longer you remain a slave to high interest debt the further and further you will spiral away from financial independence and control of your life.

Definitions of ‘high interest’ debt will differ depending on who you speak to but personally I would class anything above 8% as high interest. Due to the actions you have already taken by following this guide you should now be in a position to take action. If you need to take this step then you should minimise your budget as far as possible until the debts are repaid. Do the following:

1. Using your financial health review (step 1) order your debts by interest rate.
2. Using excess money you now have available (because of sticking to your budget – step 2) direct it all at your highest interest debt until it is completely repaid.
3. Rinse and repeat at the next source of high income debt until you are free.

Points to note:

• Continue to pay for essentials you need to survive – don’t just put them on another credit card
• Pay the minimum balance of your other debts to ensure you do not encounter any penalty fees
• Check if you are eligible for state financial support
• Look into potential ability to refinance debt to a lower interest date but do not use this as an excuse to not repay debt or to spend more

Step 5 – Build an Emergency Fund

If you have made it this far then you’ll be happy to know you’ve now put in a lot of the hard yards and it should be smoother sailing from here. Now that high interest debt is repaid you should:

Build your first emergency fund of 1 to 3 months expenses

This emergency fund will allows you to cope with any unexpected issues without having to resort to debt. Common uses of an emergency fund would be:

• Loss of income
• Car broken down
• Boiler breakdown
• Roof leak etc.

Points to note:

When choosing between 1 to 3 months think about factors like:

• Stability of job (employed, self-employed or contractor)
• Different streams of income (the more the better)
• Help around you (parents, friends etc.)
• Dependents (children or wife/husband)

Step 6 – Enroll in Workplace Pension

The law states that now you must be automatically enrolled in your company’s pension scheme but despite this many still are not. If you are currently not a member then join and contribute enough to receive the employer’s maximum contribution (if you can afford to).

Many employer pension will match your contribution up to X percent (or even above). It may look something like:

Your Contribution + Employers Contribution = Total Pension Contribution

7% (£225)          +          7% (£225)          =          14% (£450)

Congratulations – You just earned £225 of free income every single month!

Points to note:

• Your contribution comes out before your salary is taxed so you will see less than an X percent drop in your take home pay (A £225 contribution may result in between a £180 – £135 drop depending on your tax bracket).
• Self-employed workers can invest themselves through a SIPP
• If you cannot afford to contribute the maximum then contribute whatever you can afford and work towards the maximum

Step 7 – Pay Remaining Short Term Debts

You have already paid off high interest debt in step 4 but now it is time to get even closer to being debt free. Following the same methods as step 4 you should now focus on repaying any short term debt that you currently have.

As before it may be possible to refinance debt to lower monthly payments.

Points to note:

• A mortgage is not considered short term debt
• No real need to pay off any very low interest debt (below 3%) unless it will benefit you physiologically (e.g. I have a sofa at a 0% interest rate).

Step 8 – Enlarge your Emergency Fund

Build up your emergency fund so it can now support you for between 3-12 months depending on:

• Stability of job (employed, self-employed or contractor)
• Different streams of income (the more the better)
• Help around you (parents, friends etc.)
• Dependents (children or wife/husband)

This will give you a much greater degree of control over your life and because you are no longer living pay check to pay check expect your boss to no longer be able to dictate your future as he may once have.

Points to note:

• An emergency fund should allow you to sleep easily at night and therefore if you feel your situation dictates that you need 2 years’ worth of expenses then do this.
• Personally I am comfortable holding 3 months’ worth of expenses due to
  • Extremely stable job
  • Multiple sources of income (buy to let and renting a bedroom)
  • No dependents

Step 9 – Review Your Budget

Go back (now in a position of strength) to the budget you created in step 3 and review your spending habits. Depending on your income you are potentially now in a position to increase your budget in areas that you now know bring you a lot of value.

Do not increase your spending for the sake of it or risk seeing the good work you’ve now completed undone and wasted.

Step 10 – Define your Financial Goals

Unless you define and create a plan to get what you want it will be very difficult to achieve your dreams. You should plan short and long term goals and some examples of common goals are:

Short Term

• Buy a home (deposit) – within next 5 years
• Wedding – 3 years
• Holiday to Spain – 1 year
• Laptop – 6 months
• Remodel kitchen – 2 years
• Second hand car – 3 years – see blog post
• Parental leave – within 5 years

Long Term

• Buy to let property
• Holiday home
• Retire early – at 50
• Mortgage repaid – at 50
• Sabbatical year from work – before 35
• Inheritance for children

Where possible put figures next to these goals:

Points to Note

• I do not include goals like ‘reach FI’ in the table because this is determined by your savings rate and various things will affect it like:
  • If your spending habits change
  • Whether you sell your home when you reach FI
  • If you will still earn passive income (BTL)
  • If you choose to move to a lower income country (see geoabitrage).
• It is important to be realistic with your short term goals – in the example above if it is not feasible to save £1,194 a month then re-evaluate your goals and remove those which are not important to you
• You do not need to focus on long term goals initially as they will seem daunting and may change as you grow older. What will be important is investing regularly (discussed in step 12).

Step 11 – Save for Short Term Goals

It may have taken 11 steps but it’s finally time to start saving for what you actually want instead of planning and repaying debt.

You should keep savings for your short term goals in the following accounts:

• House – Lifetime ISA (LISA). You can contribute a maximum of £4,000 each year and the government will top it up by 25% if you use it to buy a home.
• Savings Accounts
• Premium Bonds
• Investment Account – Interest rates (savings and bonds) are extremely poor at the moment so if you have a higher tolerance to risk you could invest a small percentage (no more than 25%) of your savings into a stocks and shares ISA or a general investment account. You should not invest a higher percentage because returns are volatile in the short term. See Step 12.

Step 12 – Invest for Long Term Goals

All money that is not required for short term goals should now be invested for long term goals and financial independence. It is of utmost importance that this money is invested in the stock market instead of held within a savings account because compound interest is what will launch you towards financial independence.

How to Invest:

• Investments to be made within a stocks and shares ISA
  • No tax on growth of money
  • £20,000 limit each tax year
• Investments should be low cost index funds – See Should I Invest in the Stock Market
• Any additional money (above ISA limit) should be invested in a general investment account.
• If you pay 40% tax additional contributions can be made to your pension but be aware:
  • You will not have access this until after age 58
  • There is a lifetime pension allowance of £1,073,100 (anything above this and you will lose tax benefits. See more information here.

If you invest £1,000 every month in an index fund like the S&P 500, history would suggest that your returns would look like the below (this is inflation adjusted – so has todays spending power):

10 Years – £173,084

20 Years – £520,927

30 Years – £1,219,971

40 Years – £2,624,813

For more information regarding investing go here.

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Conclusion

This has been one of the largest and most detailed posts I’ve written to date but hopefully it has been of huge use to you. I wrote it particularly for those who are new to the scene and find that all of the above information is scattered across various articles.

I believe my biggest takeaways are:

• The path to financial independence (FI) should be about optimising and enjoying what you value instead of deprivation
• Use the 4% rule to determine how much you need to reach FI
• Use the savings rate calculator to determine your time to reach FI
• Cutting spending is more important than earning more (especially at the beginning)
• Cutting spending of what does not bring you value will give you extra years of freedom without negatively affecting your life
• If you want to retire early you need to save a minimum of 30% of your income – preferably more
• High interest debt is your biggest enemy and should be avoided as much as possible

Step 1 – Understanding your finances will give you clear areas on which to focus.

Step 2 – Understanding your spending will likely open your eyes to waste and inefficiencies

Step 3 – Creating a budget is extremely important and will give you the ability to initially repay debts and then save towards your goals

Step 4 – Paying off high interest debt will give you freedom and open doors of opportunity

Step 5 – Building a small emergency fund will stop you from being de-railed by a small but unexpected difficulty

Step 6 – Enrolling in a workplace pension will essentially give you a free pay rise and force you to save for retirement. It will likely give you the best return on investment you can find.

Step 7 – Pay remaining short term debts to give you greater freedom and a ‘guaranteed return’ (the interest rate). The only exception is extremely low interest debt (< 3%).

Step 8 – Enlarge your emergency fund to stop you being de-railed by a large and unexpected issue.

Step 9 – Review your previous budget and amend to suit your new spending habits. As you should now be bad debt free you can increase spending in areas you value if you desire.

Step 10 – Define short and long term financial goals

Step 11 – Save for your short term goals

Step 12 – Invest for your long term goals

Do all of the above and I guarantee that your life will change for the better. To maintain progression on this path do the below:

• Setup automatic payments on all credit cards to pay as soon as possible (to pay the full balance)
• Update your budget monthly to notice trends and changes
• Unless you are trying to pay down high interest debt don’t cut out what brings you the most joy. If you can find a way to minimise the cost then great.
• If you have already minimised spending and the only way to save more is to cut out what you enjoy – it’s time to earn more instead.

Who do you know who could benefit from this post?

Please share it with them and you will make my day :).

Also want to do a quick shout out to UK Personal Finance who have an easy to follow flowchart containing a lot of this info.