There are two types of freedom in this world. One is financial and the other is societal. You need to accomplish both of them to a certain degree to be truly free. We’ll talk about financial freedom in this post and talk about societal freedom in my next post.
Being financially free basically means if you stop working today, you can maintain your current lifestyle. It means you can work on whatever you like, whenever you like or even have the freedom to not work at all. You have the freedom to spend your time in any way you desire. You can travel, work from anywhere you want, spend time on your hobby, your passion or even spend it on building a business that you have always desired. More importantly, you have time to focus on kids, your spouse and be at home every day for dinner.
There are few simple steps which let you calculate the magic number you need in order to not work at all, forever.
Step 1: Figure out how much you burn.
Figure out how much you spend in a year. This includes rent, groceries, utilities, travel, holidays, child support, and all other expenses that you might have. If you’re living with your partner, this should be your total household expenses.
For example, let’s say — your household expenses annually is $50,000.
This is how much you’ll be spending every year to maintain your current lifestyle, so it’s important that you not be conservative with this number, and take into account everything. You should use a personal accounting system. There are many free accounting systems online which gives you a complete picture on how much you spend a year and where do you actually spend it.
Step 2: Add a buffer
Add a 25% buffer to the number you calculated in Step 1. We do this to see any expenses you might have that you might have not expected, and even account for inflation long term.
So, $50,000 + 25% of $50,000 = $62,500.
Step 3: Calculate how much do you need to have in assets.
So, now the next question is how much do you need to save or invest in order to generate an interest such that if you withdraw ~$50,000 every year, you should be able to maintain your current lifestyle.
4% Rule: So, the number we have in Step 2 is $62,500. That’s the 4% of your assets that you should be able to withdraw every year and still stay afloat, forever. I highly recommend that you do not withdraw $62,500 but $50,000 as you originally planned. There will be some years that you might go over that budget, but that’s completely okay.
So, here’s the formula to calculate how much you need in total assets:
(100 x Number you calculated from Step 2) / 4.
For example, (100 x 62,500) / 4 = $1,562,500 or roughly $1.5 Million.
This single number is your financial goal. That number looks huge, but trust me. It’s not. You can save and invest that money if you’re disciplined financially.
How do I get there?
The next natural question is — How do I save or make that kind of money? There are two ways you can do it — cut spending AND make more. You need to do both of these at the same time to achieve your financial goal.
Here’s what I personally do to cut my spending every month:
- Pay debt: This is very important. You need to get out of the hole you dug and put yourself into. Pay the debt with the highest interest first. Usually, this means credit card debt. Pay it off in full. All of it. Always pay your credit card bill in full every single month. Never pay minimums. This will help you build credit score which will make credit/loans cheaper for you in the future.
- Decrease expense streams: Every bill you have is an expense stream. Money gets deducted from your account and never comes back. Here are some of the ways to cut expense streams — Borrow Netflix password from friends, Use ebooks instead of physical books and use an e-reader. If you’re in the US — use Google Fi or some other equivalent service to cut your cellular bill. Cook at home and dine out once or twice a week. Reuse waste (for example, empty jelly jars can be used to store groceries or even as glasses for drinking water).
- Do not buy anything unless absolutely necessary. Most people ignore this. They fall for marketing which is targeted at them. Corporations want you to spend more, and you eventually do. Strive to be a minimalist. Never buy branded apparels. There are cheaper and better options out there.
Making More Money
- Know your job ceiling: There are two kinds of jobs in this world. One of them is creative and the other is laborious. If you’re working as an engineer who designs and invents systems and new products- you are in the creative job, and the best thing about this creative job is your pay increases every year and as you get better. The other type of job is laborious (an example of this would be — working as a maid). If you are someone who is working in this type then you have a very low job ceiling and you your income will NOT increase substantially as years go along. If you are working in this type of job. You should switch. Here’s a thought experiment — Where do you see yourself 5 years from now? If you continue your current job, how much would you be making in 5 years? If the answer is not much. You should switch to something else. You can literally switch your line of work. There are many free resources online where you can learn literally anything for free. Use the internet to your advantage.
- Add revenue streams: Your place of work is your primary revenue stream. Money is deposited every month into your account. Your goal should be to add more revenue streams — so even if one of these dry u, you have others to rely on. Here are a few ways to increase the revenue streams — start writing a book, write a blog, make money off by uploading videos on youtube, start a side business, and more.
- Grow revenues: Once you have added these revenue streams the next step is how do you grow these. For example, writing a book does not automatically mean you will make money. Nothing ever sells by itself. You should work on marketing and sales strategies for the book you actually wrote. Your goal now is to maximize out on each of the revenue streams that you have created and currently have.
- Build equity: You will not be financially free unless you own pieces of businesses. Owning a business or a piece of it is one of the best things you can do. Businesses pay a cut of profits every month/quarter or a year (and that’s called a dividend). Money gets deposited in your bank account without you having to ever work for it.
How do I invest?
If you’re someone who saves money in your bank account every month. You shouldn’t. You’re losing your money in inflation. Here are some of the ways to invest your funds.
- Index Funds: 90% of your savings should be invested into something called Index Funds. Index funds are a collection of stocks of the biggest companies in the world. (For example, S&P500 is a collection of stocks of 500 biggest companies in the US). Index funds return 8% on average every year. This has been happening from the last 100 years and this will happen for the next 100.
- Bonds: 10% of your savings should be invested in Bonds. Bonds are fixed-income instruments — what I mean by this is, you loan your money to the state (for example, US Federal Government) and they pay you interest every month, quarter, year. They are usually very low risk and provide a stable income.
- Emergency fund: You should have 6 months worth of expenses in your bank account as an emergency fund. Save this in a fixed deposit, so you can make interest of it and not lose it in inflation. This fund can be used in any number of circumstances — when you have been laid off and are looking for a new job, are hit by a truck, need to get a new dishwasher, or fix a roof.
What about investing in Real Estate?
Personally, real estate is not my preferred choice of investment. They are not liquid. The deal size is large. Transaction fees are too high and you’re locked into one specific location. You pay property taxes, and you’re responsible for upkeep.
However, this is just my personal opinion. I would not invest in real estate. On the other hand, I know few who have made their living by investing only in real estate, but this requires a lot of effort — You need to learn how to invest in Real Estate, You need to spend time looking at many properties, you’re responsible for tenants, and more.
So, here’s how to be truly financially free. In the next part of the post- We will talk about societal freedom which is equally important.
- Never spend capital, only the interest.
- Invest in Index funds. They give you a stable income on average (if you look at a 10 year period or more. ). You don’t need to manage it. When you invest in this type of security — Forget that you have actually invested and not look into this account ever. Make a habit to invest 40% of your income (after tax) every month.
- Compounding is powerful, and we humans are not evolved to understand how powerful this is. Suppose you invest $10,000 into X company stock. The first year, the shares rise 20%. Your investment is now worth $12,000. Based on good performance, you hold the stock. In Year 2, the shares appreciate another 20%. Therefore, your $12,000 grows to $14,400. Rather than your shares appreciating an additional $2,000 (20%) as they did in the first year, they appreciate an additional $2,400, because the $2,000 you gained in the first year grew by 20% too. If you extrapolate the process out, the numbers can start to get very big as your previous earnings start to provide returns. In fact, $10,000 invested at 20% annually for 25 years would grow to nearly $1,000,000 — and that’s without adding any money to the investment!
In the next story, we’ll talk about societal freedom which is more phycological and is as important as financial freedom.