Financial Independence can seem like a far distant dream that will never be reached — so how do you get there? Follow these 5 steps to become financially independent.
Financial independence can be defined in two ways. 1) the moment when your income from your investments covers your living expenses such as real estate income and dividends or 2) when you have 25x your annual living expenses saved up which will allow you to live off of 4% of your assets forever. For example, if you’re annual living expenses are $60,000 a year, having a portfolio of $1,500,000 will allow you to withdraw $60,000 per year.
What this will allow you to do is be free from having to work. Be free from worrying about how to cover your living expenses. And be free from a TON of financial obligations.
The question is how do you get there? I will let you in on the process that’s a simple concept but it can be extremely difficult to get there. More and more people are setting their goals and vision on financial independence but the truth is less than 1% of Americans are actually financially independent.
1. Set Goals Based on the 4% Rule
The four percent rule is a rule of thumb used to determine how much you could withdraw from a retirement account each year. You’ll be able to pull out a steady income stream while also maintaining an account balance because the withdrawals will primarily be from interest and dividends.
Basically, this is the percentage of money you could take from your investments each year and not have to worry (for the most part) about losing your principal balance.
Most people have no idea how much money they would need to retire or become financially independent. I’ve you’ve never calculated how much you need to completely stop working it’s pretty simple. Like mentioned above, how much you need is entirely driven by your expenses. If you spend $40,000 a year, based on the four percent rule you will need a portfolio balance of $1,000,000. This can seem so far out for most people. But it is possible! The hardest part is the beginning and getting started.
If you didn’t have to work and you knew all of your basic living expenses would be taken care of, what would you do with your time? Would you help people, travel, or finally pursue your passion? Too many people get caught up in the 9 to 5 grind and forget about what they are living for. You need step one locked in before you can truly be successful with the next steps on your journey to financial independence.
2. Increase Your Income
Almost everyone that I’ve worked with would like to learn ways to increase their income. I myself for the past couple of years have been looking for all sorts of different ways to increase my income. It all comes down to finding a skill and becoming really good at that skill. This is why I believe education is important because it will allow you to deepen your knowledge, increase your skills, and hopefully allow you to demand a higher wage from it. School is not everything and you shouldn’t expect that just because you went to college that you’re going to have a bunch of employers waiting to hire you when you finish.
Be careful when you look for ways to increase your income because you could very easily spin your wheel wasting your time on things that aren’t going to move the needle very much. The purpose is to help you make more money in less time so you can spend time with your friends and family while getting to financial independence quicker. I recommend you check out the Side Hustle Show podcast. I met Nick Loper last year at FinCon and he does such a great job delivering a ton of content on how you can start making money on the side.
For more specific ways to learn how to earn side income, I put together a huge list of ideas earlier this year.
3. Decrease Your Expenses
The biggest thing that will slow down your journey to financial independence is how you spend your money. Do you spend more than you make? If so, you will need to cut out unnecessary monthly expenses and learn to say no to things you don’t need.
|”It’s not your salary that makes you rich, it’s your spending habits.”
If you don’t track your expenses you won’t have any idea where your money is going. Set up a system that works for you that makes it easy to track the dollars going out of your bank. Once you’re clear about where your expenses are going, then you can start to analyze and cut back on things you don’t want. Most people spend 70% of their expenses on these three categories: house, car, and food. Tackling these areas are going to have the biggest impact on your finances than anything else.
Decide what is a need vs. a want. Today, you need a phone, but is having the newest iPhone X more of a want than a need? We tend to needify our wants. If you’re spending more than you make, you will never achieve financial independence. It’s simple – spend less than you make.
For ways to crush some of these big expenses, read this article I wrote last year.
4. Optimize Your Investments
What you do with the difference between what you earn and what you spend will determine your success of reaching financial independence. When it comes to investing, we’re looking for low-cost, broad-based, high-risk, and boring investments. Keep your fees as low as possible and only invest in something if you understand it. If you can’t understand it, don’t do it.
Let’s say you have $20,000 to invest now and you can save $600 a month going forward, but you’re unsure where to start investing. Let’s take a look at two options. One investment charges 2% in fees for someone to actively manage it. Another option is a low-cost index fund that mimics the market that charges 0.04% in fees invested passively. Which one is better if they earn the same rate of return?
Let’s say it’s invested for 25 years and returns 10% annually. In the first example, $20,000 and $600 a month will grow to be $594,847. In the second example, it would grow to $811,219. How do you get a $216,372 difference when the investment earns the same rate of return?
It’s one of the only things you can control. A simple 1.96% difference over 25 years could be the difference in reaching financial independence and having to work another 3 to 5 years.
|”Compounding interest is the 8th wonder of the world. He who understands it earns it, he who doesn’t pays it.” – Albert Einstein
5. Don’t Give Up
Once you decide to live this type of lifestyle you’re committing to live life differently. It will be hard at times. I’ve shared with you five simple ways to reach financial independence. But just because it’s simple doesn’t mean it will be easy.
The beginning is the hardest. Once you’ve built up a decent amount of assets they will start working harder than you and will do more to increase your net worth than you actually going to work every day.
It is possible to reach financial independence. It takes a little bit of clarity and a lot of motivation. It’s easy to give up on goals after a few months, but it’s really hard to stick to one goal for an entire decade. But if you do stick to it, you CAN have the life you’ve dreamed of having!
You get to decide the life you want to live.
Now go make it happen.