FOOL'S EYE VIEW
Seven Steps To Financial Freedom

By Cliff D'Arcy
February 1, 2005

"Now there are three steps to Heaven,
Just listen and you will plainly see,
And as life travels on,
And things do go wrong,
Just follow steps one, two and three."

In 1960, Eddie Cochran sang that there were three steps to Heaven. Sadly, in a cruel twist of fate, he was killed in a car accident just a few months later, aged just 21.

I believe that there are seven steps to financial freedom. Follow these and "as life travels on and things do go wrong", your personal finances should be strong enough to cope.

Step one: live below your means

This is the most important lesson in life, often expressed as "spend less than you earn". However, not enough people learn this crucial lesson in life, mainly because they aren't taught it by their parents or teachers. The end result is that we Brits spend 110p for every pound we earn, which is a recipe for financial tragedy.

However, learning to budget doesn't have to be a grind. All you need to do is to go through your paperwork to establish how much you have coming in and how much is going out in essential household bills (completing a Statement of Affairs can help). What's left is your disposable income – and the more carefully you dispose of it, the longer it will last!

Some people find that using a limited amount of cash for discretionary spending works better than spending on plastic. Still, it's up to you as to how you control your cash flow – but over-spending isn't an option!

Step two: watch out for swindles

Financial scams have been around since money was invented. And no matter how little or how much money you have, there'll always be people hoping to trick you out of it. You don't have to be daft to be duped by financial tricksters – every year, millions of people fall victim to fake lotteries, boiler rooms, Nigerian 419 frauds and dodgy pyramid schemes.

Schemes that promise to double your money overnight are guaranteed to empty your pockets. Remember if it sounds too good to be true, it almost always is. So, if you don't understand what you're getting into, simply walk away. Your wallet or purse will thank you further down the line!

Learn more in Ten Ways To Get Ripped Off.

Step three: steer clear of credit

Lending money is a great way to get rich. The UK's biggest banks made record profits last year, making tens of billions of pounds for their shareholders. However, being caught on the wrong side of the lending equation is one easy way to be permanently broke.

By the end of 2004, we owed a whopping £875 billion to mortgage lenders and another £184bn in other debts. I reckon that the annual interest bill on this debt mountain comes to £70 billion, which would buy a lot of essentials and luxuries! Getting a mortgage to buy a home is fine, but using loans, overdrafts, credit and store cards to cover excess spending is madness, especially with annual interest rates of up to 30%!

Last year, I had the pleasure of speaking to a 94-year-old man during a radio phone-in. By always saving up for everything he wanted (except when it came to buying his home), he managed to avoid paying interest throughout his long life. Instead, sensible saving and investing really paid off for him, as he had a good income and owned several properties. What a role model!

Step four: laugh in the face of fate

If you're going to dodge disaster, you need to minimise the effect of the fickle finger of fate. My advice is to create an emergency fund that's big enough to cope with minor setbacks, but take care of the big stuff with insurance. So, armed with a suitably sized nest egg, you can take broken down boilers, short periods of unemployment and so on in your stride.

However, insurance is the best protection against catastrophes. Make sure that you, your family and your prized possessions are covered. You can start shopping around for cheaper life, health, motor, home and travel insurance by surfing over to our Insurance centre.

Step five: start saving for a rainy day

So, you've trimmed your expenses, avoided being ripped off (both legally and illegally) and protected what's important to you. Now the fun starts: you can begin to use your spare cash to make serious money.

First of all, you need a top-notch savings account to safeguard your savings. Aim to have between three and twelve months' expenses in this account to pay for unexpected outgoings. (By doing this, you won't need to buy hugely expensive extended warranties, so you can dodge yet another rip-off.) Of course, you can use this account to save for life's little luxuries, too, unless you prefer to keep your "dreams pot" separate. Here are five tips to help you to find a better savings account.

Track down a superior savings account in our Savings centre.

Step six: pump up your pension pot

Unless you pop your clogs first, there'll come a day when you stop working and settle down to retired life. However, for the majority of today's workers, retirement will be a dull and miserable time, largely because they didn't plan for their big day (and if you fail to plan, you plan to fail).

It's possible that your retirement savings may have to support you for ten, twenty, even thirty years. Unless you want to spend these years at the mercy of the State, or living a hand-to-mouth existence, you need to start saving sensibly. Here are five reasons to get a pension and five things to watch out for.

Visit our Pensions centre.

Step seven: start investing in the stock market

Don't worry, this isn't as scary as it sounds! The stock market does go up and down, sometimes wildly so but, over long periods, it has delivered handsome returns. Since the end of World War One, the UK stock market has produced an average annual return of 11%, with income reinvested. Growing at 11% a year, £1,000 turns into almost £23,000 over thirty years (but the value of this money will be reduced by rising prices, i.e. inflation).

If you can't be bothered to do you own research and pick your own shares, try investing in a cheap, simple, flexible index tracker (You can invest in the UK's biggest index tracker here.) This simply tracks a particular stock-market index up and down and, as there are no highly paid fund managers running it, it has far lower charges. Hence, with an index tracker, more of your money goes to work on day one.

An index tracker is ideal for learners and patient investors but, with a little experience, you may decide to create your own portfolio. You can open an online broking account via the Fool and get a free thirty-day trial to our popular Value Investor newsletter, where you can benefit from the wisdom of two experienced stockpickers.

Good luck with climbing those steps to financial freedom!

More: Check out the deals on offer in our Insurance, Savings, Pensions and Investing centres.