Financial independence is having the means to spend your time and energy how you want, on your terms. To that end, we define financial freedom as the point where you are generating enough passive income from your investments to comfortably cover all of your expenses.
So how do we get there?
In the spirit of simplification a la Harold Pollack's "Index Card" and "One Page Financial Plan" by Carl Richard, to achieve financial independence, we share our core wealth management principles with investors. We keep it simple: have a plan, get organized, and start today. Create a formal, written financial and investment plan that prioritizes your goals; then implement an automatic savings program specific to achieving each objective. After all, a goal without a plan is just a wish.
Spend less than you make. A core tenet of financial planning is having more money coming in than is going out every month, with the difference being your savings. No matter how much money you make, if this basic tenet is not followed, the rest of your financial plan completely falls apart as your savings rate would be zero or negative.
There is a direct correlation between the length of your journey to financial independence and your savings rate as a percentage of your take-home pay. It's all about increasing your savings and cutting material expenses. In fact, there are those out there aggressively saving 50 to 75 percent of their take-home pay to reach their goals. While this may seem extreme, conscientiously reducing your spending means you now have this additional sum of money to direct towards growing your (passive) income-generating investments.
As an added benefit, because you now have lower annual expense habits, it ultimately requires less passive income (and therefore less in income-generating investments) to achieve financial freedom sooner.
Five key factors to shorten your journey towards financial freedom: Increase your income by investing in your career development and advancement. Work diligently to improve your skill set and become more valuable. Never stop learning and if you are passionate about starting your own business, be bold enough to take the leap. Reduce your expenses by proactively monitoring monthly cash flows, tracking spending and cutting extraneous "luxuries and conveniences" that are not really improving your happiness and quality of life. For a husband and wife, a weekly 5-minute money communication chat and overall accountability to one another (and your financial planner) are effective methods for enhancing spending awareness.
Automate your monthly savings plan to pay yourself first and make saving easy and convenient. Save a minimum of 20 percent of your take home pay automatically via electronic transfer from your checking account into your savings and investment accounts each pay period. Work with your financial planner to increase your savings percentage each year. Keep in mind, there are those out there who have achieved financial freedom and are retired in their 30s after happily embracing a frugal lifestyle, cutting expenses, shunning consumerism and automatically saving 50 to 75 percent of their take-home pay.
In this context, saving 20 percent automatically is certainly doable. Do you want stuff or do you seek financial freedom?
Pay credit card balances 100 percent in full each month. Paying double-digit interest to a credit card company is not in your best interest.
Strategically and aggressively pay back outstanding loans and debts by ranking and then attacking your highest interest rate debt first until it is gone, then move on to the next highest rate debt (note: there are variations of this strategy, which may include paying off a small debt balance first to gain momentum, pending your specific situation).
Save for a rainy day. Build up a rainy day emergency savings fund, so that you have a year's worth of expenses set aside. Having a savings buffer serves to reduce stress over short-term money concerns and also helps to mentally and emotionally weather short-term market volatility. It's important to be able to say, "If I did not work for a year, my family would still be OK financially."
Financially protect your children. To protect and provide for your children, consider annually contributing toward a tax-advantaged college funding plan for their education, owning an appropriate amount of life insurance per your financial situation and working with an estate planning attorney to execute estate planning documents (living trust, will, health care powers, etc.).
Save meaningfully for retirement. Save meaningfully for retirement, tantamount to financial freedom, by maxing out tax-advantaged retirement accounts each year. This ensures taking full advantage of your company match to bolster your retirement savings. For W-2 workers, max out your 401(k)/Roth 401(k) and your Roth IRA or traditional IRA. If you cannot afford to max out, increase your savings percentage by 1 to 2 percent each year until you do. For 1099 contractors, you may max out a SEP IRA while business owners may consider maxing out both a defined benefit pension as well as 401(k) profit sharing plan.
Talk to your financial planner about an ongoing Roth IRA/Roth 401(k) conversion strategy to allow for 100 percent tax-free growth for retirement.
Joe O'Boyle is a financial advisor and offers securities and investment advisory services through Voya Financial Advisors Inc., member SIPC.
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