How to Become Financially Independent
Congratulations! You have made the single most important step in the entire process – searching out how to become financially independent. In my book, I explain how I made several money mistakes over and over before finally making the decision that enough is enough.
If Only I Became Financially Indepedenent by Winning The Lottery
One of the ideas I often had, was “if only I won the lottery”. Or, “if only I made more money” then I could someday free myself of a day to day job. Unfortunately, the “If only” idea just doesn’t work without action. Surely, if there were a magic ball that would tell me the next week’s lotto numbers, it might make things easy. Just as getting a new job, or a raise might come with a higher salary.
The fact is, I’m here to tell you that it isn’t so. You don’t need to win the lottery or get a raise to become financially independent. Yes, it would certainly help, but unless you know how to build a monthly surplus, and maintain it, there’s no way you can every achieve financial freedom.
If Winning the Lottery Won’t Work, Then What?
So if winning the lottery or getting a raise isn’t the key, then what is? Simple! Reduce your monthly expenses, and start building a monthly surplus. Sound easy? It is! But habit is hard to change. Luckily, money is its own motivator. Having more money month after month frees your mind to think about more important things, rather than what needs to be paid.
Choosing to become financially independent and follow this course is the first step in achieving the life you always wanted to live.
Read on as we will cover the essential points to achieving financial independence (FI). Examples of topics will be cash flow management, debt reduction strategies, and knowing (roughly) how much you’ll need to become financially independent.
The very first step, however, has already been done. You got this far. Then, the next step is to introduce yourself in our private, members-only Surplus Academy Facebook Group. Here, in the group, you can discuss what you are learning, ask questions, and learn more from each other’s specific perspective.
What Is Financial Independence?
In my book, The Financially Independent Millennial, I define financial independence as having more PASSIVE INCOME than you have monthly expenses. Simple huh?
It’s essential to know the distinction between passive income and active income. Active income is income earned from the occupation in which you are “actively involved.” For example, if you go to work every day, the income you make from that is considered “Active.” Unfortunately, you are limited with how much you can make with active income, as there are only “so many hours in the day.”
Passive income, however, is the income you earn without being actively involved. Being Financially Independent requires that you have a passive income! Passive income is the income you want to have!
Examples of passive income include:
- Pension income
- Dividends from businesses, stocks, etc.
- Rental Income
- Interest from CD’s/GIC’s/Bonds
So you see, the key is to focus on having more passive income than you NEED. Passive income is the key to Financial Independence.
Taking Back Control of your Cash Flow And Become Financially Independent
Let me tell you a SECRET (but seriously, don’t tell anyone) Becoming FI is not about earning more money. It’s about spending less. Write this down and REMEMBER it!
So how do I get on top of my financial house? Simple, it starts with simply knowing your monthly surplus.
But how? The easiest way to find out your monthly surplus is to have a look at your income and expenses for the last 2-3 months on paper. Or better yet, by putting it all on a spreadsheet. Categorize your expenses. Include any/all income.
Your surplus is simply your income minus expenses! It is essential to become Financially Independent
Sounds like a lot of work? Nope. I set up a pre-filled spreadsheet for you. You can download my example cash flow spreadsheet here and follow along.
As you can see, I pre-filled two months of Income & Expenses.
Now it’s your turn to download your income + expenses from your online banking and put them all here in the spreadsheet.
*Tip: If you use a credit card, do not include the payments TO the credit card. Instead, set up categories for the credit cards as makes sense to you. For instance, if you paid $480 from your checking account to your credit card, don’t count this $480 in your expenses. Instead, add up each category of costs in your credit card and insert them on the spreadsheet. So if you spent $300 on clothes and $180 on restaurants – those are the figures you’ll use. Interest charges are also an expense.
Do this for the past two complete months. Ideally 3. By the end, you will start to see a pattern.
At the bottom of the spreadsheet, you will find your surplus. As I said earlier, this is the most critical part of this lesson. Know your surplus. Tomorrow, we will discuss cutting expenses.
Identifying Areas to Cut Expenses On Your Way to Financial Independence
If you’ve made it this far, give yourself a big pat on the back. Seriously, you’ve done more than most – I believe you can truly help yourself get to a better place financially.
In the last email, you filled in the cashflow spreadsheet. At least one month of expenses and income, right? Great!
And you know your surplus (or deficit), right?
Your monthly surplus is important stuff!
Now we need to figure out how to increase that surplus. If you have a deficit, you’ll want to work to turn it into a surplus ASAP. While your instinct might be that you have to get a better job (i.e., a higher paying one) or work more, the simple fact is:
“It doesn’t matter if you earn $50,000 a year or $150,000 a year. Unless you spend less than you make, you’ll never get ahead.” –Rick Orford
It’s kind of like the old chicken an egg story. But, how do you start? You need to be cutting the budget. This is going to be fun. Keep telling yourself that, and it will!
Cutting the budget. Yep, that’s right. Cutting the budget is all that’s needed to generate extra money at the end of every month. You see, Money that you can use to pay down debt, build an emergency fund, earmarked for a large purchase, or invest. Eventually, the last two will be your monthly goals. But how?
Now that you have a spreadsheet set up with at least two months’ expenses detailed, now we need to look at where we can cut out some expenses. Let’s look at an example spreadsheet might look like:
|December 2018||January 2019|
|Working Salary (Fixed)||$5,618.09||$5,618.09|
|Rentals Income (Duplex)||$1,300.00||$1,300.00|
|EXPENSES (Fixed Monthly)|
|Rent / Insurance||$1,750.00||$1,750.00|
|Mortgage for Duplex, Taxes||$604.82||$604.82|
|Electricity – Primary Residence||$104.51||$104.51|
|Cable TV & Internet||$144.39||$144.39|
|Credit Card A+B+C||$180.00||$220.00|
|Surplus (Deficit)||$ (886.84)||$ (84.32)|
In this budget example, we see that at the end of both months, there is a deficit (in other words, the person spent more than they earned). If you look carefully though, the lions share of the expenses is “shopping”. This alone is killing any possibility of having money left over at the end of the month. Without knowing the whole story, the first thing I’d suggest to someone in this situation might be to start by cutting down on shopping and use the surplus to pay off the credit card debt.
Determine your NEEDS and WANTS
The first thing you need to think about when cutting expenses is to determine your NEEDS and WANTS.
Needs are things like food, rent/mortgage, utilities (like Electricity).
Wants are all the things that make us feel like we’re keeping up with the jones, for example, like fancy restaurants, clothing, expensive holidays, etc. Wants are what I call financial independence killers!
SECRET: If you want to retire at 65 or 67, and are in your 30’s – you can save & invest 10-15% of your income, and you’ll probably be ok. But if you want to retire earlier, much earlier, you’re going to have to ratchet up your savings to 50% – 60% of income.
Don’t think it’s achievable? Think again! In the coming days, I’ll show you exactly how to do it – and I know you can do it!
Here’s how you start. Organize the expenses section of your spreadsheet into needs and wants. And for the next month, stick to just your needs as much as you can.
Now that you have some data on your financial house, tomorrow, we will talk about setting goals.
Mini Goals on Your Way to Financial Independence
By now, you’ve hit the mid-point of the course. You should have a good handle on your financial house, your income & expenses, and a good idea of what needs to be cut.
Now, let’s work on something a little lighter: your goals, dreams, and aspirations. It’s not fluff, but rather, it will become the REASON for your desire to be Financially Independent. So let’s break this down.
Ask yourself: what do you want in life?
It’s not a million dollars. No, the amount is what you’ll need to get to that point, eventually. And it will be different for everyone.
Instead, write down your wants/and desires.
- Is it to pay off your debts?
- Put your kids through school?
- Perhaps retire early?
- Maybe be able to travel once a year, or twice?
- Or ???
Strategies for Paying Down Debt To Become Financially Independent
Debt reduction is the natural next step in the program. Generating a healthy surplus is essential to eliminate monthly debt payments.
The first step in debt reduction is to identify what is good debt vs. bad debt.
Good debt is anything that has an asset attached and, ideally, has equity and can be sold. Good debt can be seen as a secured loan with a reasonable (nonpredatory) interest rate. Types of loans that often match these criteria are mortgages and to some degree, car loans. Many who are financially independent continue to maintain good debt. For example, a clever investor might have a mortgage on a rental property and pay 4% interest to the bank, while earning 10% from the rental income.
Bad debt is a loan account that carries high-interest rates (i.e., over 15%), is unsecured (i.e., does not have any asset attached that you can sell), and can often feel like is never-ending. Credit cards (due to their high-interest rate), and student loans (due to their high, unsecured balances) often come to mind. They can seem like endless obstacles that can’t be overcome. Further, bad debt will certainly play a role in preventing someone from becoming financially independent.
Debt Snowball Method is a Good Step in Becoming Financially Independent
There are a few ways to attack household debt, and my absolute favorite is the Debt Snowball (My preferred way) Method.
How does it work?
Start by listing all your debts (everyone) in order. Eg. Mortgage, car loans, student loans, lines of credit, credit cards, etc. Organize them by the balance outstanding. Typically, the mortgage, for example, will have the highest balance. Your current level of financial independence will certainly pop!
Your list might look something like this:
- Mortgage – $240,000
- Car Loan – $18,000
- Credit Card A – $6,000
- Credit Card B – $2,000
With the snowball method, my recommendation is to start attacking credit card B. It has the lowest balance and, therefore, can be paid off the quickest. Once you have that one knocked out, you’ll have an instant feeling of accomplishment – and a monthly payment that you can then put toward the next debt – Credit Card A. And so on.
Strategies to Improve your Income
Now that you learned about the first method to increase your surplus (paying down debt), we need to focus on the other part of the equation – increasing your income, and one quick way to do it is to start a side hustle. Side hustles are crucial to paying off debt and becoming financially independent.
I suggest side hustles as a temporary means of achieving a goal. You see, goals can be paying off debt, or reaching your Financial Independence Number (The topic of the next email). To be sure, the side hustle is just a temporary lever you can use on your path to becoming financially independent. You don’t have to rely on it forever. When you are financially independent, you want to rely on your PASSIVE INCOME.
What’s a side hustle?
Side hustles are a part-time job. Ideally, these can be done from home, but others require that you “go out and work.” For example, side hustles can be driving or a ride-sharing company or teaching something online.
Entrepreneur magazine recently released a fantastic article entitled “50 Ideas for a Lucrative Side Hustle“. Whatever it is that you do, make sure you turn a profit and apply 100% of it to your goal (I.e., debt reduction, etc.). Then, in no time, you can reduce debt and create a passive income stream. In the end, financial independence will start to become a reality.
Have you ever wanted to start something on the side? Reply, as I’d love to hear about your ideas!
Financial Independence Number
So by now, you’ve learned about the different types of income, different types of debt, and methods to pay it off quickly.
Today, we look at what it takes to become financially independent. To be sure, while there is no exact science, experts (and I) agree that your passive income needs to exceed your minimum monthly expenses.
Need to know: The 4% Rule is the conservative withdrawal rate that experts agree can be withdrawn from your investments in “retirement” without touching the principal.
How do you calculate it? Assuming the most conservative estimates, to get your financial independence number, multiply your minimum annual expenses by 25.
For example, your minimum expenses look like this:
Mortgage/Rent/Insurance/Maintenance: $2000/mo Food/Restaurants/Shopping $1000/mo Car/Gas/Insurance: $600/mo Misc/Travel/Discretionary $400/mo
In this (albeit minimal) budget, you would add up the monthly expenses ($4000), and multiply by 12 to get the annual figure, and then 25. In this example, financial independence can be achieved with $1,200,000 invested.
With this amount of money invested, it should generate enough income to sustain a 4% withdrawal rate.
Investing is a Key in Becoming Financially Independent
You can invest in many different things. For instance, you can invest in a rental home, stocks that pay dividends, CD/GIC’s, and so on. Also, I recommend consulting with an investment professional who has some form of fiduciary duty to best assist you further with investments.
Congrats, by the way! I hope you liked it – and if you did, perhaps you might share this article with your friends!
P.S> BONUS! If you sincerely read through all this information, click here to book a one-on-one chit-chat with me personally. We can cover anything related to financial independence.