“Financial independence” is one of those goals that most people say they want, but few people actually pursue with any real zeal.
What is financial independence, besides a phrase that finance nerds like me throw around? It means having enough income from your investments that you can live on them alone, without any help from your 9-5 job.
But that little one-sentence definition fails to capture just how life-changing financial independence is.
It means spending more time with your family. It means spending more time on your passions, interests, hobbies. It means being able to continue working, or quitting and taking your dream job that doesn’t pay well. It means being able to go volunteer full-time if that’s what you’d rather do.
So how do you get there?
1. Track Your Spending
It’s hard to know how to get somewhere if you don’t know where you are now.
Start by drawing up a detailed tally of where every penny went over the last month. The big expenses are obvious enough: your rent or mortgage, your car payment. But you might find that you spent more than you thought on entertainment, or on groceries, or utilities. Understand how much money you spend on a monthly basis, and where all of the money goes.
Spreadsheets are great for this – be as detailed as you possibly can.
2. Create a New Target Budget
You probably noticed some low-hanging fruit in your current budget. What can you trim down? Start with the obvious discretionary spending.
Next, look at every cost you think you “need.” Could you live without cable TV? Perhaps you could stream your TV shows instead? Could you set your thermostat at 65 instead of 72 in the winter time, and leave your sweater on when you walk in the front door?
When you’ve reached the point where you don’t want to make any further compromises, pick up the phone. Call each service provider, and explain you need to tighten your budget and may need to cancel the service… unless they have any discounts available? This works far more often than you’d think.
Most people don’t get their budget right the first time around. The most commonly overlooked line items? Occasional but recurring expenses. For example, annual costs such as memberships, property taxes, insurance bills. Real estate costs money to maintain: last year it was the AC condenser, this year it’s the roof, next year it’s the furnace. Include a monthly line item in your expenses for property repairs if you’re a homeowner or landlord, and move that money into a separate savings account specifically for property repairs.
Likewise, be sure to set aside money each month for irregular but obligatory items like gifts for family and friends.
3. Bring Your Family Onboard
If your spouse is like most Americans, he/she likes spending money. When the average American gets a 10% raise, does that mean they suddenly put 10% more money into savings? Of course not. It almost always means they spend 10% more.
Your kids like spending money too, or at least they like you spending money on them.
Start by sitting down to have a heart-to-heart with your spouse, and explain that you’d really like to invest more money and become financially independent. Frame it in whatever terms will reach your spouse best; perhaps talk about retirement savings, perhaps talk about financial security for the family, perhaps talk about diminishing job security. Get them excited about the prospect of a richer future.
When your spouse is onboard, look for ways you can spend more time with your family without spending more money with them. After all, what your children want most from you is to spend time with you. Camping, hiking, cookouts with friends, game nights; the possibilities are endless.
4. Start by Paying Off Unsecured Debt
Credit cards are wealth killers. Most credit cards charge 18-24% interest, which is not a recipe for financial success.
Start a spreadsheet (yay, another spreadsheet!), listing all of your unsecured debts, including balance and interest rate. Sort the list by interest rate, and start aggressively paying off the highest interest debt first. Make only the minimum payments on your other debts, until you’ve paid off the highest interest debt.
As a nice perk, with each debt you pay off, it frees up more money to put towards paying off the next debt. But that means you need to stay disciplined, and not spend any of the savings!
Continue this cycle of funneling money toward your most expensive debts, until you reach debts with interest rates around 5%. From here, it’s a judgment call – can you earn a higher return on your investments, or by paying off your remaining debts? Keep in mind the risk factor of your investments. Paying off your debts will provide a guaranteed return on investment in avoided interest costs, whereas other investments may well lose money rather than earn a return.
5. Set Up an Emergency Fund
What would happen if you had a sudden bill for $1,000? Could you cover it without stress? Most people can’t – 69% of Americans have less than $1,000 in savings.
Before you can be financially independent, you need to be financially secure. That means having an emergency fund that can cover three months’ expenses. Emergencies do happen; people lose jobs, fall ill, have car trouble, suffer sudden divorces, have family health problems… be prepared for the unexpected.
Now that you’ve paid off most of your debts, funnel the money instead toward your emergency savings fund. When you reach three months’ worth of expenses, start using your monthly savings to…
6. Build Retirement Funds
The beautiful thing about retirement funds is that they’re tax-free. That means an instant return of 25-50%, on top of whatever returns your investment actually earn.
And then there are the matching contributions many employers make. This is free money, in the most literal sense. Whether or not you max out your retirement accounts each year depends on your finances and priorities, but you should always, always max out on employer contributions.
Like sugar and spice and all things nice, retirement accounts have limits. This year those limits are $5,500 for IRAs and $18,000 for 401(k)s, but that doesn’t mean you have to hit those limits. After all, retirement accounts won’t let you live off the money until you’re nearly 60, and you want financial independence now, right?
7. Invest in Cash-Flowing Rental Properties
Rental properties can never be 100% passive, but they can provide mostly hands-off income. The math also changes, helping you retire earlier with rental properties than you could using just stocks and bonds.
New rental investors usually fail to calculate cash flow properly. Many simply deduct the mortgage payment from the rent, and think they can simply enjoy the difference.
But what about vacancies? Most properties should assume a vacancy rate of at least 10%.
And don’t forget repairs. Real estate, unlike stocks, needs to be maintained. Assume at least $1,000/year for repairs, and often more. CapEx, in particular, can be a ROI killer.
Property taxes? Insurance? Accounting?
If you really want a more passive experience you’ll want to hire a property management firm – tack on another 10% of the rent in expenses. Even then, you’ll still have bookkeeping and accounting costs.
8. Diversify Passive Income
If rental properties aren’t 100% passive income, what is?
The standard answer is bonds. But bonds’ returns have been deplorable over the last fifteen years, given how low interest rates have been.
A better answer? Stocks, mutual funds, ETFs and REITs with strong dividends. If you don’t feel comfortable choosing these yourself, talk to a financial advisor about helping you reach your financial independence goals.
But passive income investments don’t stop there. Today there are more opportunities than ever to invest money for a decent return; there are peer-to-peer lending websites, crowdfunding platforms, note lending and many others. Don’t feel pressure to invest in any of these though, they are merely more options on the table.
If all of those steps sound like a lot of work, you’ll understand why so few people actually achieve financial independence. But if you’re committed to a life of your choosing, where money is no longer the dominant limitation, you can get there one step at a time. It just requires discipline, which costs only as much as your determination.♦
How is your financial journey coming along? Any tips or tricks to share with other travelers on the journey to financial independence?
Awesome website with some great material! Quick question concerning house hacking, I currently own a house in Tennessee and have been looking to be more active in the real estate investing business, I am considering utilizing the house hacking method to purchase a 4 plex, but would I be able to technically “keep” my current house by listing it on AirBnB as a rental and merely move to the fourplex for the first year?
I ask because I’m currently in an occupation as a security consultant that usually keeps me out of the States most of the year with infrequent visits to my home of record…. hence why I think the house hacking method would be a perfect way for me to accelerate my investing portfolio. Thoughts and criticisms??
Hi Nathan, the answer is “probably.” Where you might run into trouble is with your financing.
The first question is how long you’ve been in your current residence – if it’s less than a year, the lender will consider it fraud if you change legal residences and start renting out the property. If it’s been your legal residence for over a year then you’re probably fine.
The second question is whether a new lender will give you owner-occupied financing, with you being physically out of the country for most of the year. Owner-occupied financing is 1) cheaper and 2) requires a much smaller down payment, so if you can find a lender who’s willing to give you owner-occ financing for the fourplex, it sounds like a solid plan.
Just make sure that you list it as your primary residence for at least a year, and don’t rent out your unit in that time, if you want to stay in compliance with your loan terms.
Keep us posted! Drop us a line on our Facebook page, we’d love to hear how it unfolds for you. I’ve actually been meaning to run a case study on this exact situation, so stay in touch!
Thanks for sharing this. I am starting to save money and be more concerned about my financial independence.
It is great to hear! We are glad that this information can help or assist with tips to prompt everyone to take some type of action.
I have a 1979 mobile home that is on it’s own lot. The current market value is about $140,000. I am unsure if I should continue to rent this property after the lease is up with my current renters next spring. The basis of the property is $48,000, so capital gains after selling would be a little. My dilemma is that this property is a mobile home that will depreciate with time and may be subject to changing lending rules as time passes. Currently it would qualify for FHA financing. It is paid off and I have an 18% cap rate of return. The expenses are very low including the taxes and insurance.
Would I be better off selling while the market is high and pay my capital gains taxes but loose the income ($7,000-$8,000 after expenses) annually? Or keep the property and continue to receive the income stream over the long term even though the property will decrease in value? I am 53 now, disabled and do have other rentals.
Thank you for your advice.
Hi TK, that’s a personal investing decision, but one option worth considering is selling it and putting the proceeds toward a 1031 exchange on a new rental property. That way, you avoid capital gains tax, and put your money into an appreciating asset rather than a depreciating asset.
Keep us posted!
Investing in cryptocurrency is another way to reach financial independence. I think it’s going to be the new trend in the next few years.
I hear you Danica. Just make sure you don’t put too much of your asset allocation in crypto – it’s speculation, not investment, since there’s no underlying revenue stream or inherent value.
I will take your advice. I only put almost half of over budget in crypto and make it grow. Thank you Brian!
I’ve been following your guide for few years and it has been a fulfilling journey!
So glad to hear it Ivan!