Clearly define your own goals and needs

The path to financial freedom requires a long-term approach

What is the meaning of financial freedom? There isn’t a universal answer to this question. One suggestion would be having enough savings and resources to be able live your life in accordance with your own desires and needs, while getting your money to work for you. This last point means generating interest, dividends, rental or copyright income with your money.

The most important thing on the road to financial freedom is to spend and invest wisely. This requires hard work, a lot of discipline and years – or sometimes even decades – of patience. Unfortunately, there is no magic formula. What’s more, it’s essential to know what you are aiming for, before you set out to achieve it. Once you have defined your goals, you can establish short and longer-term interim goals.

Keep debt levels under control

The first step towards financial freedom is to successfully manage the means you have at your disposal. To get an overview of your financial situation and manage your expenditure on a rational basis, the first step is to define your household budget. The first goal is for income to exceed total expenditure. In this context, it is particularly important to keep an eye on your debt levels and not just your outgoings. If you hope to one day achieve financial freedom, you will need to monitor and, in as far as possible, restrict your borrowing.

When planning your household budget, the first step is to make a list of all essential costs. This includes fixed costs (rent, water, electricity) and expenditure to cover basic needs (food, personal hygiene, etc.). If you deduct these costs from your income, you are left with the amount available for savings, debt repayment and leisure expenditure. A tip in this context: avoid impulse purchases and ensure that bills are always paid on time.

Draw up a budget for the year

To get a more accurate overview of your finances, try to think about your budget in yearly terms rather than using countless monthly categories. Why not open a specific account for leisure activities (including meals out and holidays in the next six months), extraordinary events (tax refunds, unexpected outgoings) and other large future expenses?

There is one golden rule to achieving financial freedom – pay yourself first.

You could even set up a standing order from your current account to this separate account and watch the balance build up over time. Then if any unexpected bills arrive or the time comes for some renovation work on your home, you’ll have the money ready in the account. And transferring any tax rebates or other bonuses to this account will mean you can afford that dream family holiday, or even enough for a good deposit on a new home.

Writing down your household spending is not old-fashioned – on the contrary, it is a brilliant way to manage your personal finances. But don’t worry. This doesn’t necessarily mean “writing down” in the traditional sense: nowadays there are various mobile apps and tools available to help, most of which come with a categorisation function. You can set spending limits and are sent notifications if you go beyond them.

Set your savings rate

Sticking to your budget is the first step towards financial freedom. And if you manage to remain under budget, this will provide a boost to your assets. Whatever your income level, you will make good progress towards achieving financial freedom if your keep a tight rein on your outgoings. Small changes are often enough to tip the balance, for example, distinguish between essentials (things you really need) and non-essentials (things you want) when shopping.

There is one golden rule to achieving financial freedom – pay yourself first. This means setting aside an amount from your budget each month for a savings plan, investment portfolio or similar, in order to build yourself a nest egg. This prioritises how you deal with any money technically available in your budget once you have covered your basic needs. Ideally this sum should be at least 15-20% of your income, if not more. If this level of savings is too high, you can of course start off with an appropriate amount. The important thing is to systematically set aside a part of your income for achieving longer term goals. Any debts should generally be settled at the start of the month. You should also budget for a specific amount to cover any unexpected costs.

Invest instead of saving

It’s advisable to invest your money, as pure savings accounts have not been worthwhile for a number of years. You have the choice of equities, real estate and many other products. To find an approach that matches your own investor profile and the goals you have set yourself, your best option is to take advice from professionals in the fields of finance, law, taxation or real estate.

Choosing professional assistance with investing simply means engaging an expert to advise or manage on your behalf some or all of the financial assets you intend to invest. Depending on your investment profile, there are two main options available:

• • an advisory contract, which means delegating responsibility to an expert to keep you informed and help with decisions; or
  • a discretionary management mandate, which means you hand over the responsibility to an expert for making investments that correspond to an investment strategy you have defined together in advance.

“A portion of income should be systematically used for longer term objectives.”

Most major banks in Luxembourg offer both of these alternatives, which – contrary to popular belief – are not solely reserved for private banking clients.

Follow the 50/30/20 rule

Managing your own budget isn’t always straightforward. It’s easy to lose track of the big picture among the bills, purchases, debt repayments, expenditure on the children, leisure spending, etc. And often, that’s when your savings suffer. Opting for the 50/30/20 rule will help optimise and simplify the way you manage your finances. This type of budgeting is based on the 2005 book “All Your Worth: The Ultimate Lifetime Money Plan”, by US politician and financial expert Elizabeth Warren. It is easy to implement and will help you create a sensible and balanced household budget. Of course there are other methods. The key is to find one that suits you.

50% of your income goes to covering basic needs and financial obligations. 30% is reserved for pleasure and leisure spending, although you can also create some room for basic needs here too. The remaining 20% is for savings and investments. There are decisive advantages with the 50/30/20 rule when properly applied: it ensures that your basic needs are covered, you can enjoy life, and still start to build a nest egg.

An example

Olivia is in her early thirties, and recently had a little boy called Mathéo. Previously she never paid much attention to how she spent her salary. If there was any money left over at the end of the month, she invested it in a savings account. But her expenses have risen since the birth of her son, and she wants to keep tighter control over her finances.

With the 50/30/20 rule, savings and investments are an integral part of the budget.

The 50/30/20 rule may help Olivia to achieve her objectives. How should she go about this?

1. Calculate her income: Olivia should first make a list of her monthly sources of income (after tax) and add these together: salary, child benefits, rental income, support, etc.

2. Define her outgoings: She should then make a note of her outgoings over recent months: direct debits, bank card payments, cash payments, etc. Everything should be included, even the most modest purchases. She should calculate the equivalent monthly cost of any quarterly or annual payments. The goal is to get an overview of all of her incomings and outgoings on a monthly basis.

3. Allocate her outgoings to different categories: The next step is to allocate her total outgoings to various categories: fixed costs and basic needs, optional and discretionary spending (leisure and pleasure), or savings and investment. At this point, Olivia may realise that her spending on basic needs accounts for more than 50% of her budget.

4. Adjust her budget: Olivia should now try to adapt her spending to the 50/30/20 rule.

Note that savings and investment opportunities are often ignored until other items have been paid for. With the 50/30/20 rule, savings and investments are an integral part of the budget. To ensure that 20% of income actually goes on saving, it is possible to set up a standing order out of the current account and into a separate account at the beginning of each month, and use this account to manage savings and investments.

A few figures in conclusion: According to Statec data, Luxembourg residents saved over EUR 6 billion in 2021. However, indebtedness continues to climb, primarily due to rising real estate prices. According to the CSSF, on average, repayments for housing alone represented around 39% of annual disposable income.