Hi everyone, Mr. B here. In our last post we explained WHY we are working to achieve financial independence. As the CFO (chief financial officer) of the family, I’m here to explain HOW it can be done. I’m more of the financial nuts and bolts guy while Mrs. B (CEO and sales manager of the family) is in charge of overall family operations and finding new ways to generate revenue/savings. In this post, I do not want to get into any in-depth financial strategies or how to invest, but want to convey the general concept of what we are doing.
As we mentioned, to us, financial independence is defined as having your savings/investments generate enough income to pay for all of your expenses.
So, imagine that you found a theoretical investment that could indefinitely generate a 5% annual return. If you were to invest $100 in that investment, it would pay you $5 per year, every year, forever. If you could live on $5 per year you could retire with one crisp $100 bill. If you have one in your wallet, then congratulations! You did it! You may stop reading right now and go enjoy the rest of your life free from financial woe! Unfortunately, I don’t think even someone from the poorest third world country can live on $5 per year, so you’re probably going to have to save a bit more than $100. I.e.:
- If you can live off of $5,000 per year you will need to accumulate $100,000;
- $20,000/year means saving $400,000;
- $50,000/year and you need $1,000,000;
- And so on…
You might be thinking: “Whoa, a million freaking dollars! How am I going to accumulate that much?” Yes, it’s a lot of money and, if you haven’t already been saving for a long time it’s not likely you will be able to hit that number in the next 12 months (unless you hit the lotto or inherit 7 figures from your long lost uncle or something like that). Financial independence is a long term commitment and usually takes years to achieve. If you are just starting on this journey and don’t see the path to full financial independence, start small.
Imagine becoming financially independent from something like your cable bill. At $150 per month or $1,800 per year, you will need to accumulate $36,000 (remember the hypothetical 5% investment) to generate enough income to pay that bill forever. Once you have the cable taken care of, move on to your $250 per month car lease which is $3,000 per year. You’ll need to accumulate another $60,000 to pay for that, for life. Then keep going and knock out all of your expenses one by one until they are all gone. This may also help you shift your mindset as to what is really important in your life. Is your cable TV really worth $36,000? That is for you to decide.
While this concept of financial independence may seem radical, it’s actually what everyone does. However, most don’t reach it until their 60’s. We are just aiming to hit our number a bit faster: in our 30’s, while we still have our health and our kids are young.
The key to financial independence is not becoming some kind of investment whiz, trying to outperform Warren Buffet year after year or obtaining your Masters degree in finance. In fact, achieving early financial independence has little to do with what investment returns you can achieve. The key is maintaining a very high savings rate.
Mrs. B and I have consistently achieved a savings rate of over 50% for the past few years. This means that when we receive our bi-weekly pay checks, at least half is kept for ourselves, while the other half goes into other people’s pockets.
In the U.S., the average savings rate is about 5%. That means that for every $1,000 paycheck earned, you keep a measly 50 bucks for yourself and send the remaining $950 to other people. While a 5% savings rate is better than not saving at all, or God forbid consistently spending more than you earn and using credit cards to make up the difference, this minimal rate will surely lock you into the rat race until age 67.
In order to achieve a high savings rate like ours you need to KNOW YOUR NUMBERS!! I can’t stress that enough. We know where every penny of our money goes every month. Most people have no idea where their paychecks end up. This may sound like such a chore and it would be if this were 15 years ago. Imagine recording every single Starbucks Latte or McDonalds cheeseburger purchased, by hand in your spending notebook. Thankfully in the age of the smart phone, there are numerous apps that will connect to your bank account and credit card and not only record and tabulate every purchase you make, but also automatically categorize each purchase so you can see where all of your money goes. Tracking your spending is THE MOST important first step in achieving financial independence. Do this before you think about anything else. Once you see where all the money is going, you can decide what is really important and where you can cut back to add to your savings plan. If you don’t track your spending, you can’t determine how large of a portfolio you need to accumulate.
As I mentioned, reaching early financial independence doesn’t really involve much in the way of study or some naturally endowed brain power. It’s more about commitment and sticking to the plan. Much like dieting or becoming physically fit, you can hire the greatest personal trainer and nutritionist that money can buy but if you don’t show up to the gym you will never see results.
Mrs. B and I have been on this journey together since we got married 5 years ago and are only a few short years from becoming financially independent. Stay tuned to track our progress and get tips on how you can reach your goals to live a happy and free life!