First of all, congratulations! Millions upon millions of Americans are in the game, without a solid understanding of what the object of the game even is. Many of them figure out the object of the game as the years go by, but they’re at a big disadvantage, because this game is much easier to win if you start making the right moves early.
But you already know, early in your adult life, that the object of the game is financial independence. (And if you’re not completely clear on that, check out this post). Now that you know the destination, how do you get there?
First comes the part that everybody already knows about: you need a steady income. For most people, that means finding a job. It might be one primary job, or multiple. You might work as an employee for a large, established organization, or as a solo, side-hustling freelancer - or both. You might love all, some, or none of what you do. But however you earn it, that steady, dependable income is the indispensable ingredient to getting started.
Because the income aspect is so obvious, many people figure that’s all there is to it. Get a job, work hard at it, stay more or less ahead of your bills, and you’ll be fine - right? That’s what most people do, so it must be an okay way to go - right?
Oh my goodness, no! Get a load of these sobering stats:
All this, at a time when unemployment rates are at or near generational lows. It’s clear that just getting a job, then doing what everybody else seems to be doing is not a recipe for financial independence!
Here’s the truth: It’s one thing to earn an income; it’s quite another to know what to do with it. Learning how to make wise decisions with the money that you earn, to get you on a solid, proven path to financial independence is what I Am Net Worthy is all about.
Back to the original question: You’ve chosen financial independence as your goal. You’ve established a steady income or are well on your way to it. Now what? You make literally hundreds of financial decisions in a year. Which ones do you focus on first to get the most traction?
The path begins as soon as you’re primarily responsible for your own financial condition, where it’s marked “Start.” Welcome to the red phase! But don’t make yourself at home here - as soon as you enter the red phase, your goal is to get out of it as fast as you can. You do that by building up an adequate emergency fund, and eliminating all debt, except the mortgage on a home that you live in.
Let’s look at these two one at a time:
Eliminate non-mortgage debt
Student loans, car loans, credit card debt, appliance loans, furniture loans, personal loans, payday advances - all of the above have to be completely paid off to exit the red phase. What about “zero interest financing” on TV’s, mattresses and the like? Or “rent with an option to buy” deals? If you’re making payments on something that somebody else still legally owns, it’s debt.
Some of you just read the above paragraph and are reeling in shock. You may have six figure student loan balances that you’ve barely made a dent in. You may have big credit card balances - maybe even on multiple credit cards. This might be the first time that it’s really sunk in that all of that debt is standing between you and financial independence. These aren’t the kinds of cold, hard facts that the credit card ads, or the friendly folks at the Financial Aid office, emphasize.
But it doesn’t do any good to sugarcoat the truth. When you’re in debt, the power of compound interest is working against you. So now that you’ve established an income, one of the very first orders of business is to start directing as many dollars per month towards eliminating all that debt as you can. The more dollars to send in that direction, the sooner you’ll be out of the red phase.
What if you have lots of debts, big and small, at all kinds of various rates of interest? Which do you pay off first? Great question! Later in the post, we’ll introduce some powerful red phase tools to help you wisely prioritize.
Build an adequate emergency fund
The concept of an emergency fund is easy to understand - it’s cash set aside to be readily available when bad financial news hits. Certain financial emergencies can be insured against, and that’s your first financial safety net. Your emergency fund is for financial hits that fall outside the bounds of, or exceed the limits of, your insurance coverage.
But even though emergency funds are easy to understand, few households have enough set aside. The reason why? In our financial lives - just like in other parts of our lives - we tend to react first to what’s urgent. You never get an intimidating “past due” notice from your emergency fund. It’s never urgent to build up your emergency fund before an emergency strikes. But as soon as one does, you’ll wish you had.
Keeping your fingers crossed, hoping nothing bad happens is no way to go through your financial life. To get out of the red phase, you need a nice big one. If you end up needing it, it will be a financial lifesaver. Even if you don’t, the peace of mind that comes from knowing you’re financially safe is huge.
How big does your emergency fund need to be? The answer to that is expressed in terms of average monthly expenses in your household. One month’s expenses is the bare minimum, but you’ll need much more than that to get out of the red phase - either 4, 6 or 9 months expenses. It depends on how much financial risk you face, and that’s different for each household. Want to find out how much financial risk you face? Sounds like a job for another red phase tool!
One more POSSIBLE red phase requirement
Have you ever heard of an “employer match” into a 401(k) (or similar) retirement investment account? For the most part, your long term investing program will take place in the yellow phase. But there’s one important exception, and that’s the employer match. It’s an exception because this is a deal so unbelievably, incredibly good, that you’d be crazy not to take advantage of it, as completely as you can, and as early as you can.
So what’s an employer match? It’s when the organization or union you work for offers to contribute money directly into your retirement account - above and beyond your normal pay - in proportion to how much you contribute into it. Employers aren’t required to do this, but many of them chose to because they want to encourage you to save and invest for your own retirement, and because they know that generous matching programs are a great way to attract the best employees.
An example of how a match might be defined would be: 50% match, up to 6% of pay. Let’s say your annual pay is $40,000 per year. The 50% means that for every dollar you contribute to your retirement account, your employer throws in fifty cents. But they’ll only do that up to a limit, and that’s where the 6% comes in. 6% of your annual pay is $2400 (6% x $40,000). So if you contribute $2400, your employer kicks in $1200. But once your contributions go beyond $2400, the matching stops.
This doesn’t apply to everyone earning an income. Freelancers, self employed, or employees of very small organizations don’t have employer matches because such employees don’t have have employer-provided retirement at all. But if you do have such a retirement account, and if it features an employer match, it’s in your best interest to find out all you can about how it works, and when/whether you’re eligible for it. Bottom line, if you’re eligible for an employer match, taking full advantage of it (at least up to the amount they’ll match each year) is a red phase requirement.
Household A is a two income couple with no dependents, each earning about the same amount in unrelated fields, and with lots of airbnb income on the side. Household B is a single parent, with seven dependents, working seasonal construction and no supplemental income. Does it make sense that Household A and B need the same size emergency fund? Of course not!
This calculator walks you through ten simple questions about your household financial risk, and then calculates the appropriate size emergency fund for you. It can be found at the bottom of this page.
This calculator is available here. You supply all your debt information, your emergency fund goal, and a few other pieces of key financial information about your household’s financial situation. The calculator lets you know, at your present rate, how long it will take you to get out of the red phase and into the yellow phase. If you don’t like the answer - or if you just wonder what a more aggressive strategy might look like for you - this calculator allows you to do some “what if” modeling, too. “If I sold my car and got rid of that loan, plus all the expenses like gas, parking and insurance - but I incurred higher public transportation expense - would I get out of the red phase faster?” Hint: you probably would, and you might be surprised at how much faster!
Once you’ve had a chance to get your feet wet with the Financial Dashboard, you’ll find that all roads lead to the app’s ultimate tool: The Networthy Monthly Gap Prioritizer.
To use this tool, make your way over to the Networthy Navigator, then select Integrated Tools and Calculators, then Monthly Gap Prioritizer. Details matter, and this calculator does all the heavy lifting for you. Now you know that debt elimination, emergency fund building, and (maybe) employer match participation are your big red phase priorities. But those are a lot of individual payments, and it can get confusing which ones to do first, and which ones have to wait until higher priorities are met first, or there's more money. No problem. You put all your bills and other red phase financial information in, and the Prioritizer tells you, very specifically, what to pay first to get you out of the red phase the fastest.
It’s heartbreaking how few people have achieved financial independence who could have - and how few are on track to achieve it, who could be. These people remain stuck in financial dependence - dependent on a job, on other people, or on various various forms of financial help to meet their living expenses. For the most part, it’s not really their fault - they’ve just never been taught the object of the game, let alone how to play it. So what do they do?
There are two very common profiles:
In today’s complex and challenging financial world, it can feel like a major accomplishment just to track down all of your bills and other obligations, and to somehow make all the ends meet, ideally without adding to your credit card balances. For these people, an unexpected expense is a genuine emergency, and financial life is a constant source of stress.
Many people are impatient to improve their financial position, so they begin doing long-term investing before they eliminate debt, and/or before they build up an adequate emergency fund. These people have one foot in the red phase, and the other foot in the yellow phase - simultaneously. “I still have student loans and credit card balances, but I’m also trying to put lots into my 401(k)!” It’s like stepping on the accelerator and the brakes at the same time - you’re just not going to make much progress (unless, as you learned earlier, you're just taking advantage of your employer's 401k match limits, of course).
If either of these sound like you - this post is your wake up call! Make a conscious, eyes-wide-open decision that your goal is to achieve financial independence. Whether you get there as fast as you possibly can or at more measured pace is completely up to you. The important thing is that the ultimate goal is very clear in your mind.
Now that you know your destination, break the task down into distinct phases, and then tackle one phase at a time - first red, then yellow, then green. No doubt about it, the red phase is a grind. Paying off your debts and building up an emergency fund takes sustained commitment and focus. Use the tools described above to help you. Many - most! - Americans never get completely out of the red phase. But once it’s done, it stays done, and you can move on.
The yellow phase is where you do most of your serious bathtub filling, through your long term investment program (If you aren’t yet familiar with the concept of the financial bathtub, or could use a refresher, see the object of the game). Compared to the red phase, it’s a lot less financially stressful. Instead of constantly worrying about the unforeseen, you’ll be reassured by charting your steady, inevitable progress towards your goal of financial independence.
The green phase - financial independence - is where you’re headed. That’s a life of freedom and boundless choices. You’ve got both the money, and the time, to pursue the things in life that are most important to you. That’s your goal, and now you know how to get there. The sooner you start your journey, the sooner you can arrive!
The financial world of the 21st century requires a long-range approach that begins early in your financial life.
The Net Worthy Path to financial independence includes three distinct phases: red (getting your financial basics in order and preparing to invest), yellow (earn/save/invest/repeat), and green (financial independence).
A bare minimum emergency fund of one month’s expenses is your initial, and high-priority, goal. Eventually, you’ll increase this to 4, 6, or 9 months’ expenses, depending on your household risk level.