The Complete Guide to Financial Independence
Anyone with income and smart investments can achieve financial independence. Here's our complete guide.
Financial Independence may sound like a trendy buzzword for wealthy people like doctors, lawyers, and Wall Street executives. But people from all income brackets have been saying farewell to their jobs and spending the rest of their lives doing whatever they want for decades.
The recent FIRE (financially independent retire early) movement has provided a glimpse of the good life and revealed the financial strategy for many young earners.
Regular middle-class people just like you and me - are retiring early with MILLIONS in the bank and passive income to cover their expenses – well before the ripe old age of retirement.
You don't need a high income (although it helps get you there faster).
You don't need to get lucky on an investment (also helps).
Financial independence comes down to just three simple things: earning, investing, and time.
The goal is to replace your earned income (your job) with passive income from assets and investments. Once your assets (investments) outpace your paycheck - you have achieved financial independence.
Easy peasy – Earn money. Invest money. Repeat.
However, building enough assets and investments to live off of takes time. The more you earn and the better investments you choose – the quicker you will reach financial independence.
Bottom line – anyone can achieve financial independence. The sooner you start earning and investing the sooner you can quit your job and live the life of your dreams.
Are you ready?
We've taken a deep dive into the world of Financial Independence to bring you the Complete Guide to Financial Independence.
In this guide you will learn the 3 steps to achieve Financial Independence (Income, Investing, and Time). We will also share some specific ideas in each step to get you started.
But first, let's learn what financial independence means and why it is not widely accepted or understood by Western culture….
The Broken System
For a majority of Americans - life after education looks like this:
Get a job you think you will like
Buy the biggest house you can afford
Buy the nicest car you can afford
Spend money on new toys and a yearly vacation
Put a small percentage of your paycheck into your employer’s retirement plan
The system is designed to keep you spending money and employed until you are 65 (or older). To be completely honest – this system is perfectly acceptable for many people. It works if you have a career you love and don't mind working for someone else for the rest of your life.
But as someone who ended up at a dead-end job – it was not for me.
And since you are reading this guide – I’d guess it's not for you either.
If you want to spend your life living - not working and keeping up with the neighbors –there is a better way.
What is financial independence?
Financial Independence is having enough money or assets that cover your living expenses.
If your monthly expenses are $5000 (rent, utilities, groceries, etc.) and you have assets (stocks, funds) or passive income (real estate, dividends) that earn more than $5000 a month - there is no need to work or earn income. You are financially independent.
But how do you get all these assets and passive income?
If you continue to earn and consistently invest your money, eventually your investments will earn more than your day job.
Work hard now, invest your money today, and then quit your job and retire in your 50's, 40's, or even 30's!
Let's dive in.
The Math Behind Financial Independence
Let's start with the end goal: You will need a lot of money.
Financial independence requires a lot of money. Cash in the bank, real estate, stock, and/or streams of income that will cover the expenses for the rest of your life.
There are two main drivers to achieve financial independence: passive income and appreciating assets. Some focus on one, some use a combination of both.
Passive income is any income that is generated with minimal effort (making money in your sleep). Dividends from investments, real estate rentals, or businesses you own (but don’t work at) are all passive income.
Appreciating assets are investments that increase in value over time. The goal is to collect enough assets that are appreciated at a rate greater than the amount you need to withdraw.
The amount needed to achieve financial independence will be different for everyone. There is no magic number and you can’t predict the future. However, we can use historic returns (in the stock market and real estate) and use our desired lifestyle to make a good guess. Many use the 4% rule
The 4% Rule
A common figure amongst the financially independent and retire early (FIRE) crowd is "the 4% rule". This is a highly debated topic - but let's take a look at the math so we can better understand the logic behind it.
The 4% rule refers to the amount of money you should be able to safely withdraw from your entire portfolio and never run out of money. The thinking is that your assets will increase at a rate greater than 4% per year (on average).
Example: If you have $1,000,000 invested into a diversified portfolio you should be able to safely withdraw 4% or 40,000 per year and your portfolio will grow at a rate of (at least) 4% per year. The average return rate of a balance stock fund is 8%. Theoretically, you should never run out of cash.
There has been much debate over whether 4% is enough. Some say 2%. The truth is that no one can predict the future, and everyone has different needs. There is no perfect answer - but the 4% rule at least gives you a number to strive for.
OK, so now you know you need to save a TON of money. But how the heck do you get to millions of dollars?!
Let's start with step 1... Income
STEP 1: INCOME
Let's take a look at what income means, what you've been taught, and how you should start thinking about income if you want to achieve financial independence.
The Problem with Income
Our culture has deceived us about income. We've been taught that we can afford everything we want up to our income limit. And when we can't afford what we want we simply use debt to pay for it.
We buy the big house, the nice cars, all the toys, and then if there's any money left over we put it into a savings or retirement account. We've been taught to prioritize spending over saving (or investing).
Some people will live a great life on their income. They will make more money and buy nicer things. The problem with income is that unless you have an NBA contract - it's not guaranteed. What happens if you lose your job or you become unable to work? Your income goes to ZERO, but your expenses remain the same.
Over the course of a 40-year working career, you have a pretty good chance of losing your income at least once. Companies go out of business, recessions happen, accidents happen. Life... happens.
By the age of 40, I had lost my job three times. None of which was due to my own performance.
Many people will argue that self-employment or investing money in the stock market is "risky". I would argue that being employed is the greater risk.
The other problem with income is that we tend to let it become a level at which we live our lives. As our income grows, so does our need to spend it. This is not a sustainable lifestyle.
A Better Way to Think About Income
Instead of thinking of your income as how much money you can afford to spend on things – think of your income as a way to buy more income.
The more fuel you can contribute to your investments – the faster they will grow.
Some are fortunate to have a high income. Others may work multiple jobs. The important part is how much you have left after expenses - this is the amount you can invest to make more money.
When people realize this two things happen: you spend less and you find ways to earn more.
Some high-income earners can do this in 10 years. But this does not mean those earning $40k a year are not able to reach their goals - it simply takes more time and more effort to choose the right investments.
Many people today are creating multiple sources of income to get wealthy. Side hustles, blogs, real estate, teaching, etc. are all easy ways to earn an extra income.
Start a side hustle
Starting a side hustle or small business is a great way to increase your income. There are endless choices when it comes to finding a way to make a little extra cash. Start a blog, create a brand, freelance your skills, and resell items.
Move up the ladder
Sometimes the best path is the one you are already on. If you have the ability to work your way up the company ladder - learn everything you can and work your ass off. If you reach a stumbling block, find another company that values your skills and make the move.
Ask for a raise
One of the best ways to make more money is to simply ask for more of it. Create a list of your assets and achievements. Ask your boss for a meeting and pitch why you would like to be considered for an increase. It never hurts to ask.
Keep track of your expenses
Keeping track of your expenses is an important part of any small business or side hustle. You will need to report your extra income on your taxes and you will be able to deduct any expenses related to your business. Use an app like Quickbooks or FreshBooks for accounting.
STEP 2: INVESTING
Investing your money means placing it into an asset that appreciates over time and/or generates income. Investing is putting your money to work. Investing is where the magic of compound interest happens.
There are an endless amount of ways to invest your money. The stock market, real estate, and businesses are a few of the most common investment options.
Ultimately choosing investments will be up to you. Each investment will require a different amount of money, knowledge, and sweat equity to get started.
Choose your own investments depending on your individual:
• investment goals
• risk tolerance
Let's take a look at 3 common ways to invest your money...
Buying shares of publicly traded stock is one of the most accessible and time-tested ways to make money - it's also one of my favorites.
Making money in stock can be as easy as choosing a well-known company or finding the next big trend.
I enjoy finding new trends and buying shares in the companies that are supplying them.
You can invest in the latest tech stocks like Google and Apple, invest in dividend-paying blue ships such as Exon Mobile and 3M, or find the next unicorn such as Tesla or Amazon.
The stock market is how some of the world's greatest wealth is made.
Index Funds and ETFs
Index funds and ETFs (exchange-traded funds) are a great way to invest in the stock market without choosing individual stocks.
Funds and ETFs are much less volatile than individual companies and allow you to simply choose a fund and add it on a regular basis.
These investments are best for those who want a more hands-off approach to their investments. Many investors have done very well by simply owning and holding a fund like the S&P 500.
Buying index funds and ETFs is one of the most recommended investments for young investors.
Real Estate has a long history of creating generational wealth. Real Estate is a great way to invest your money if you have enough for a down payment and the interest in either home repair (flipping) or being a landlord.
The best part about real estate investing is the ability to use leverage. Leverage is using other people’s money (loans) and paying it down over time.
If you are looking for a more "hands-off" approach to real estate investing take a look at REITs. REITs are purchased and traded just like index funds and you get paid a percentage of the rent into your account.
Owning a business is a great way to earn income and have an asset that can appreciate over time. Business owners also enjoy tax benefits and the ability to hire others to run the business while they focus on other things.
Today, there are many ways to own a business. You can open up a local coffee shop, launch an e-commerce brand online, or even perform a service such as photography or lawn mowing on the weekends.
Take advantage of company-sponsored plans such as 401(k)
If you have the ability to contribute money to a company-sponsored plan such as a 401(k), this should be your first investment... especially if your employer offers a company match (free money). Plus, any money contributed to a 401(k) will reduce your taxes (less money owed to Uncle Sam). The more money you can contribute to a tax-free account, the less you will pay in taxes today and the greater compound interest you can earn in the long term.
Roth IRAs are one of the best tools to invest your money
A Roth IRA is an individual retirement account where you can put after-tax money (up to $6500k as of 2023). The magic of the Roth is that your investment will grow tax-free to withdraw starting at age 59.5. Plus, any contributions you make can also be withdrawn at any time without penalty.
Automate your investments
Automate your investments to simplify your life and be consistent with investing. This removes the element of excuses from the equation and puts your money (and life) on auto-pilot. You can easily have your employer or brokerage account automatically deposit an amount or percentage for each paycheck. Every couple of weeks, log into your account to buy new investments.
Talk to pro
Before you make any major moves with your money or invest in new assets, it’s best to speak with a financial advisor or accountant. The advisor will help you make smart decisions and avoid any costly mistakes.
STEP 3: TIME & MANAGEMENT
Financial Independence does not happen overnight - unless you hit the lottery. It takes time (compound interest) and good management (making smart decisions).
When you start adding new money to your investments and let them grow over time, you will start to experience compound interest. Some call it the eighth wonder of the world - we totally agree.
Compound interest is when the interest you earn on your investments is earning you even more interest. Compound interest accelerates the growth of your savings and investments over time. The greater the time, the greater the growth.
Here's an example with investments in a Roth IRA
If you open a Roth IRA at the age of 20 and contribute $6000 per year into a S&P 500 index fund (average return of 8%) you will have...
$38,000 by 25
$94,000 by 30
$300k by 40
and $1 Million by the age of 54
On that $1 Million in 34 years, you would have only contributed $200k (of earned income) - that's $800,000 in compound interest!
Of course, compound interest only happens if you make smart investments with your money. For some the smartest investment is simply a boring diversified index fund (or ETF). For others – Real Estate, small business, growth stocks, crowdfunding, or cryptocurrency may be the right move.
There are endless ways you can use your money to compound over time. The important part is that you invest your money in what is RIGHT FOR YOU – and let TIME do the rest.
How to Achieve Financial Independence – LET'S REVIEW
Financial Independence requires assets that appreciate and/or provide income to cover your expenses without the need to exchange time for money (aka a job).
• Increase your income
• Reduce/limit your expenses
• Invest the difference
Financial Independence requires a commitment to a way of living where you spend less than your assets return.
Create a budget and stick to it.
Review your assets and investments regularly.
Add to your investments regularly
Talk to a professional about any big-picture items such as new investments, large purchases, and taxes.
Financial Independence is something anyone can achieve with income and smart investing – you got this.