How To Become Financially Independent

If you’ve ever wanted to quit your job or just sleep in, you’ve probably considered what it would be like to be financially free. You wouldn’t work for a living, but somehow would still have enough income to cover your expenses.

Specifically, financial independence means having sufficient investment income to cover your living expenses.

But how do you get there? Some of us are lucky enough to be given a head-start in life by our parents. For example, financial assistance during college or with the purchase of a first home can launch a young person far ahead of their peers. But even if you’re starting with student debt and no savings, financial independence is achievable. How do you do it? Read on.

Save, Save, Save: The First Steps Toward Financial Independence

How do you eat an elephant? One spoon at a time. How do you eat it quickly? With the help of others. That’s the concept of leverage.

How do you achieve financial independence? One thousand dollars a time for most of us. But the first hundred thousand dollars are the most important. Let me explain.

We don’t need to earn and then save the whole investment portfolio dollar by dollar. We’re planning to invest into the stock market, which will boost our portfolio year over year. But until there’s a substantial amount of money in our brokerage account, our efforts saving are building the portfolio more than investment activity.

One more time, for clarity: early in your investment career, saving is more important than investment returns. Let’s look at this with real numbers.

Example: Beginning Saving

Suppose you start with $100 today in your brokerage account and save $1,000 monthly. You’ve invested into S&P 500 index funds which return 8.5% on average annually.

You faithfully contribute $1,000 over ten years. Unfortunately, your SAVING will have to do the heavy lifting to build up your nest egg over this period to its ending balance of $188,000.

Here’s how the numbers play out, contributing $12,000 per year:

• Year 1: $12,100 portfolio balance, earned $488 gains
• Year 2: $26,179 balance, $1,591 gains
• Year 3: $40,972 balance, $2,793 gains
• Year 4: $57,072 balance, $4,100 gains
• Year 5: $74,595 balance, $5,523 gains
• Year 6: $93,667 balance, $7,072 gains
• Year 7: $114,425 balance, $8,758 gains
• Year 8: $137,018 balance, $10,593 gains
• Year 9: $161,608 balance, $12,590 gains
• Year 10: $188,372 balance, $14,763 gains

There’s a point at which your annual investment returns outpace your individual contributions. This happens in year 9, when you’ve contributed $108,000 (or 9 years x $12,000 per year). Now your portfolio is contributing at least as much money to its own growth as you are. But you wouldn’t have gotten there without the first years of saving.

Create A Vision Of Financial Independence

This isn’t as hokey-hippie as it sounds. Pursuing financial independence can sometimes mean self-denial and sacrifice. It means making choices every day that align with that goal. Now isn’t that easier if you know why you’re making those choices?

Sleeping in and sipping fruity drinks on the beach isn’t the vision for most of us, though it may be part of it.

Having financial independence can mean having the flexibility to care for a loved one who is ill. It means being able to visit your kids often when they’re in college. It means reducing daily stress and improving your health.

Creating a thoughtful, multi-faceted vision for financial independence will make the goal self-evident. Write it down. You don’t have to post it on your fridge, but make sure you can turn back and read it again if you need to. Having a clear vision will make choices that favor saving and investing feel right because you will be acting in service of your goals.

Asset Allocation Matters Later

We’ve shown that asset allocation matters far less than actual contributions in the earlier years of investing. But once you have saved over $100,000 and have clarified what your vision for financial independence is, it’s worth considering how you will achieve that vision. Make a decision regarding how much income you are shooting to achieve. I think this is different but related to your vision for financial independence.

For example, I have shown before that investing in real estate will create wealth and income quicker than many stock or equities portfolios.

Real estate investing isn’t easy – but nowadays there are avenues that lower the barrier to entry. There’s turnkey real estate companies Doorvest, a startup that seeks to connect professionals with cash-flowing, appreciating rentals. Then there’s large funds like Fundrise which offer passive investments in both income and growth portfolios. And there’s always traditionally purchased and managed physical properties.

Beginning to have concrete numbers as goals is important. For example, many people choose a goal of $100,000 annually from their investments. How could you achieve that? With real estate, you could plan to purchase five homes for $300,000 which each produce $2,000 cashflow. With a stock portfolio, you might plan to have $2.5 million in index funds to achieve this goal. You can choose more than one investment vehicle to get there. You can even choose to have a leaner financial independence or a more luxurious one.

It’s possible to save enough that you don’t need to save any more, even if you’re not planning to live on your investment income for many years. This has been called Coast FIRE.

Take Action: Even Inaction is a Decision

The earlier years of investing and saving are grueling on their own. The portfolio growing from $29,000 to $30,000 isn’t all that exciting. But contributing isn’t all that hard. The harder things sometimes mean working against inertia.

A hard step is choosing to take $50,000 to invest in real estate for the first time.

Or changing jobs to get a new sign-on bonus and higher salary.

Or increasing your investable assets by selling an old home.

Financial independence is uncommon among young people because it requires a difficult to achieve combination: either high income with moderate discipline or high discipline/creativity with moderate income.

Wouldn’t you rather be among the few who are free?

Thanks for reading.