If you are following me and have been reading all my articles, you will note that I’ve written about how to change your lifestyle, and I also described the process to change a lifestyle. More recently I also shared with you the EFILYM definition of Financial Independence. I’ve had some feedback that even if these articles have been useful, that certain of you would like me to go into more detail about how actually to build a plan to achieve a financially independent lifestyle (effectively combining all 3 of these notions.
Wait no more, here you are 😊!
I look forward to your feedback as usual – don’t hesitate to contact me via the Get in Touch button at the top of the page, or by adding a comment at the bottom of this article.
Everyone should plan to reach financial independence
I firmly believe that everyone should plan to reach financial independence. Not many of us want to (or are able to, even if we want to) work until we die 😲. This means that we need to be able to support ourselves financially when we stop working. Most people wait until ‘traditional’ retirement for that to happen when hopefully they receive a well-earned retirement pension. More and more, however, are choosing to plan to be able to take an early retirement (or at least being financially independent before the retirement age).
If you are one of the people that chose to take control of your destiny (and as you are reading this, there is a good chance that you are one of those people 👍), then there are additional benefits in striving for financial independence early.
- You provide yourself with security and freedom of choice
- The world’s population is growing at an ever-faster rate. It’s not sure or even clear if governments are going to be able to ensure that all future generations of retirees will receive a substantial retirement pension. By being financially independent you remove any possible constraints and stress that this might bring.
- Making your money work for you, rather than you having to work to get money
- Time and our health are the 2 most important resources we have. If you can use money as a tool to get the maximum benefit from your time and health, then you can make the most of the time you have on this planet.
Starting from scratch
I chose the photo at the top of this article as I think it sums up pretty much how we feel when we sit down for the first time to think about building a plan for a financially independent lifestyle. We are not even sure to have a foundation upon which to build, and for the moment we have a few ideas rising up, but nothing really solid. The future we desire is far off into the distance and it’s difficult to get our heads around the task at hand. My assumption is that you have at least thought about your priorities in life and are able to write down what your future desired lifestyle looks like from a financial point of view. ie; you are able to estimate expenses that you will have to support your ideal lifestyle. These expenses could be the same ones you have today, or for a completely different lifestyle, living somewhere else, and doing completely different things with your time. Of course the higher the expenses, the longer you will need to achieve a state of financial independence.
Recapping the Financial Independence definition
As I explained in an earlier article, you have achieved a situation of financial independence when your wealth supports your lifestyle. You have organized your life (over time) so that you have sufficient savings or sources of income that allow you to give up that day job at some point to focus solely on the activities that bring you happiness (which could still include a form of work).
I also remind you of the 4% rule (based on the Trinity Study) which states, that if you can save 25 times your annual expenses, you should be able to live for at least 30 years by drawing down 4% of the total savings annually. This gives you the basis for the plan that you can build to achieve financial independence.
The foundation for your plan
With your expenses defined for your ideal future lifestyle, you need to make sure that you take into account any inflationary effects. The cost of living increases every year and you need to factor this into your expense estimations. The EFILYM application does this automatically and you can adjust the inflation rate and see the impacts instantly which is really helpful to see if your plan is highly sensitive to inflation or not. With the inflation rate applied, you will have a good estimate for your future expenses, for any year in the future. Now you can apply the 4% rule. By multiplying your future expenses for each year by 25, this will give you your target savings value that you should aim for to be financially independent for that year. Of course, the further away the year, the higher the accumulated inflation so the bigger the number you have to achieve, BUT also it gives you more time to save and accumulate that net worth value.
Build your net worth value
So now you have an idea on how much money you need to save to be financially independent, how do you actually go about doing it?
It’s not rocket science. I define 3 key habits that have to be part of your daily life to achieve in order to be able to build your net worth to the required value.
- Earn the money:
- For most people, this means getting a job and doing your best to earn as much as possible (through promotions, salary increases over time, etc). You can also establish or undertake side activities/hustles to bring in additional income.
- Live below your means and save:
- No matter how much you earn, make sure you save some. Start with 10%, move to 15%, then 20% etc. The more you save this quicker you get to financial independence. For example, if you can save 50% of your income, then for each year worked, you have earned enough money for 2 years’ expenses (1 year that goes into savings and the 1 year you just worked). In an extreme case (Yes, there are some people that can do this) by saving 75% of your income, you earn enough money for 4 years living expenses in one year).
- Look to reduce your expenses in order to boost your savings rate. There are millions of ideas out there to save money on daily expenses. Start with your biggest expenses (normally Housing, Travel, & Food) first. Generally starting to track your expenses and knowing where your money goes is already a big step forward to be able to master your financial situation and improve it.
- Invest and grow your money:
- Just putting your saved money in the bank will not increase its value much over time (even if it’s still better than nothing). Look for investments that suit your personality to help you generate passive income sources. It could be rental properties, shares & stocks, Index Funds. Make sure you seek advice from a professional as each type of investment carries its possible gains, but also an associated risk. You need to fully understand what you are getting into before making any decisions about what type of investments will support your plan.
If your starting position is one of having debt then whether you pay off your debt first, or invest your savings as the first priority, will depend not only on the growth rate you could get from your investments but also how much interest you are paying on your debt. If your debt includes a mortgage (which it does for most people) then paying this back as quickly as possible is a way of eliminating debt and investing at the same time.
My personal preference would be to pay off all debt first before investing too much, as psychologically having no debt can be a big confidence booster, but each person should do what suits them best.
As you project into the future your possible direct incomes, and your passive incomes associated with your investments (done automatically by the EFILYM application) you will be able to determine how long it will take you to reach your net worth value target number for financial independence.
The first time you run the numbers I’m guessing that you will be like me. Completely depressed and demoralized in seeing that I was going to have to work many years (probably decades) to be able to be financially independent. There is no magic wand or miracle act to be able to become financially independent overnight. Hard work is required and there is no escaping that. By taking the time however to run the simulation as described here, is an incredibly powerful act. You have taken a big step to master your finances, which most people don’t do until they start to get close to the retirement years. Based on this initial simulation, you will now be able to evolve and improve your plan going forward. This plan you have built becomes the basis from which you should define any short term budget for each year, month, etc during the course of you deploying (and living) your plan.
An iterative approach
Taking conscious control of your financial situation allows you to be aware of the levers you have to play with to be able to fine-tune your plan. If you are anything like me, the first simulation you will run will play in your mind over the following days and weeks. You will start to have ideas on how to improve the simulation results.
The obvious things you can do are:
- Look at reducing your expenses:
- Each reduction in expenses means a 25 multi-factor reduction in your net worth value required (based on the 4% rule cited above). Think about that for a moment! A $1,000 per year savings in expenses means $25,000 less you need to save to reach financial independence.
- Maximize your current income sources:
- Go for that promotion or pay rise. Take advantage of any bonuses or employer-funded saving schemes (Like the 401K in the US or Kiwisaver in New Zealand) that allow you to accelerate your savings rate. The company I was in previously, gave us 1800€ in shares if we invested at least the same amount in the company share program, a 100% return! There are many examples around, you just need to look for them.
- Investigate other sources of income:
- Can you turn your activities and passions whilst living in a state of financial independence into revenue-generating activities? (For example, If you love gardening, why not offer your services to others, as well as making your sure your garden is the most beautiful, prolific, etc 🍅🍆🥒🥕🥔)?
- A good strategy would be to start this in a part-time mode well before you reach financial independence so you can test your plan, and also evolve your lifestyle over time (also known as SlowFI or slow financial independence – more later on that).
- Optimize your investments not just for a capital gain, but also for passive income:
- You can invest in any number of things today. I’d suggest ensuring that at least some of your investment portfolio provides passive income (such as rental properties 🏠 , etc). The more passive income you can generate the less overall savings 💰 you will need to support you whilst living in financial independence.
- Vary the timing of events:
- Bringing forward ➡ or pushing back ⬅ certain investments, or projects may have a significant impact on the overall plan to achieve financial independence.
- Consider future financial events:
- Have you included your retirement pension in your simulation? Will there be some probable inheritances that may make your plan more robust at some stage?
As you evolve your plan, you will find that certain combinations of actions and decisions will allow you to optimize your plan. This process will also in parallel you to prepare yourself mentally for the things you will need to do to make your plan a reality. For example; If you have decided that buying one or two rental properties would be a good plan for you, then as you go about investigating the property markets around you, you will acquire more accurate and up to date information that you can feedback into your simulations, making them more robust. Once you use that information to make decisions and make your property purchases, you will be just going through the act of securitizing and formalizing the plan you have been working on and evolving.
A quick or slow Financial Independence
Let’s face it, some people are more patient than others.
Some will want to achieve financial independence as quickly as possible. These people will look at optimizing expenses, finding the best performing investments, working hard to earn every last dollar (or whatever currency you prefer 😊) in order to get to that financial independence nirvana as fast as possible. This, of course, takes strong sacrifice and discipline!
Then there are other people who will want to make the most out of life while driving for financial independence. These people accept that even though it will take longer to be able to walk away from the 9-5 job, they know that they will get there at some point and they are secure that they have become the masters of their own lives, as opposed to letting their lives mastering them.
Personalize your plan for you!
I’d suggest that there is no hard and fast rule for anyone to apply to achieve financial independence. Each person (or couple) should build their plan based on their preferences, personalities, and willingness to take a risk. There are literally millions of things that you can invest in to support your financial plan, and you (with the support of a financial professional) should decide what is right for you. No one else can and should do that for you. Avoid comparing to others. What is important for you, is what you want to get out of life and how you want to do it. Your objective is to live YOUR life to the max, and not someone else’s.
Consuming your accumulated net worth
Nearly everyone I speak to on this subject thinks that once you have planned to build your net worth value for financial independence, then its just a matter of getting on with it. Here I think that a big part of the picture is still missing to be fully comfortable with your plan. Saving and investing are all well and good, but also how you plan to consume your network over time may also have a significant impact on whether your plan is solid enough. One of my previous articles explains why relying solely on the 4% rule to estimate your spending behavior whilst living in financial independence may not be so wise. We all have projects, whether it be travel, or buying or doing up a boat, or whatever. These projects mean that consuming the accumulated net worth value will not be linear over time.
This is the one and only reason why for me its important not only to simulate the creation of the net worth over time, but also the consumption of it during the period of financial independence. The biggest fear one can have about transitioning to a lifestyle of financial independence is quite simply not having enough money at some point to support the lifestyle. The reason I built the EFILYM application was to be able to simulate not only the creation of wealth but also the consumption of it. I recommend strongly that before you take the step to walk away from your day job into blissful financial independence, that you run a number of simulations where you consume your wealth. Do this based on the projects you have in mind so that when you launch into them, you have peace of mind that you are not putting yourself in a perilous situation.
Striving for financial independence is a noble act. Not only are you taking control of your destiny, but also you are ensuring the best utilization of the money at your disposal. This by default means that you are making a strong effort not to waste it on unnecessary items, activities. Ultimately this is better for the planet, which is why I consider it noble.
In any case, I wish you all the best in developing and living your financially independent plans.
There are many points of view out there describing how to become financially independent. I’ve lived it and fully believe in what I write here. Perhaps for you, I have missed something, or maybe you want to challenge something. Go ahead and tell me, I’d love to get your feedback.
Feel free to let me know by leaving me a message below. ⬇
Credit Photo: Photo by Dewang Gupta on Unsplash
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5 thoughts on “How to build a plan for financial independence”
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