Editor’s note: This is a guest post from Pauline of InvestmentZen.com. The point Pauline makes here is simple: to achieve financial independence you need to master three things: spending less, earning more and investing wisely the rest.
Financial independence is the stage of your financial journey where your passive income from investments covers all your living expenses. That means you never have to work another day in your life if you don’t want to. Pretty sweet, right? But that sweet reward comes after a few years of saving and dedication that not everyone is able to accomplish.
Know where you stand
When you embark on a journey towards financial independence and early retirement, you need to review your entire finances to know where you stand.
- If you have high interest debt, paying it off is your number one priority. Try to get a 0% balance transfer or at least refinance for a cheaper rate, so it doesn’t take forever.
- Then look for a refinance of your student loans and mortgage, that can also save you thousands
- Send every extra cent you have to pay off your debt.
Once your high interest debt is wiped off, time to plan for financial independence.
Your financial independence number
How much do you need to live comfortably for the rest of your life? Right now, there are expenses that are related to work, like buying suits, commuting or having lunch with your colleagues, that will be eliminated once you are financially independent. If your income is lower once you stop working, you might also be paying less taxes. And if you are living off your nest egg, you will not be making retirement contributions anymore.
On the other hand, as you get older, you might need a bigger house for your growing family, money to send your kids to college, and medical care in old age. The last thing you want is having to go back to work at age 65 because you didn’t plan properly!
So, determine your financial independence annual budget, and multiply that by 25. Using a safe withdrawal rate of 4%, your nest egg should outlive you if you have 25 years of expenses saved.
Financial independence is achieved by a combination of
- Spending less
- Earning more
- Investing and compounding
Spending less is easy when you know the reward that is expecting you: independence from a cubicle and freedom to do what you please with your days, decades before your peers. But if it becomes a frustration, you might give up and go back to your old spending ways. Try to determine what is really important to you, so that doesn’t happen. If you want to buy something, wonder how long you would have to pay for it, and whether it is worth delaying financial independence by that much.
Earning more is the real key to financial independence. While you can certainly cut your expenses here and there, you still need to eat and put a roof over your head. You can’t achieve a 100% saving rate. In order to become financially independent earlier, you need to make more.
You can start by asking for a raise at your current job, if you haven’t had one in a while. A one time $10,000 raise means $200,000 more over the next 20 years! If you were already able to live off your current salary, invest 100% of your raise for a year or two. Living on last year’s salary is a great way to boost your saving rate. If your boss won’t give you a raise, look for a better paying job elsewhere. Or a job that pays the same but would give you more free time, less commuting expenses, etc. Try to find an hour or two in the evening to work on a side project. It could be something that pays you right now, like teaching a yoga class or dog walking, or a side business you enjoy, so it doesn’t feel like work and might provide an additional source of income in retirement.
Finally, investing is the secret that will take your financial independence plan to the next level. It will take much, much longer to save 25 years of expenses if you are getting 1% interest from your saving account, compared to getting 8% from the markets. 8% is a realistic rate of return over a long period of time (30+ years) for index funds like the S&P500. Open a brokerage account and start sending every amount you can spare, taking first advantage of tax free accounts and your company match for an extra boost. No need to be an expert in investing or spend hours researching a company, just select a few low fee index funds and keep going. Ignore the market crashes, the craze about this or that stock, do your boring little thing and watch your nest egg grow. Invest only money you can afford to leave untouched until financial independence. Reinvest the dividends and watch compound interest work its magic.
You can also look for other types of investments, like real estate, but remember that managing a rental property is not exactly what you call passive income, so take that into account when you picture your retirement. Will you be active, and willing to do that? Will you even be around, or traveling the world? Will a manager still make the investment worth your while?
Financial independence does not happen overnight. But following these steps, even on an average salary, you can get there in just a few years. If you save 50% of your income, which is easy with a partner since many households make it work on one income, financial independence is just 17 years away.
What is your game plan?
photo credit: Lapse of the Shutter Tree Avenue via photopin (license)
Over the last several months my mind has been drifting towards thinking about whether I’m ready to retire.
Okay. Not really pondering whether I’m ready to retire; more like trying to decide when I’m going to be ready.
For me the matter of retirement – be it early or not – is not mixed with longing for twisty, ribbed stockings, bubbly cardigans and watching daytime TV. I can’t stand daytime TV.
For me, the matter of retirement is tangled with the lust for independence, the desire to create without restrictions and contribute to people’s lives with no limitations. While I’m employed this is not possible.
‘Oh, but you are a university professor.’ – I hear you say. ‘If you are not able to create and contribute value to people’s life, who can.’
You’d be surprised. In the past, I have made some positive contributions through my research; like contributing to a very substantial increase of the science budget in the UK in mid-1990s. I have touched the destinies of generations of Doctoral, Masters and undergraduate students…reputedly. Still the changes in Higher Education and the universities over the last decade or so, have been consistently robbing my life of meaning.
I want the meaning back. After all, we are all mortal and we are not born to make money, spend money and die with regrets.
So I’ve been trying to decide whether I’m ready to retire – and when I’ll be ready if I’m not there yet – and have had a big problem.
This problem is called ‘enough money to last me for life’. I am not looking to stop being employed so that I could put my feet up and do b*gger all, that’s true. Still, leaving the security of a full professorship and having to make a living is scary. I’d like to know that I have enough at a very basic level so I don’t need to obsess and panic about earning.
So, I played around a bit with our retirement calculator. It is fun but…I had to make too many assumptions that are highly problematic. Like my annual spending in ten years’ time.
While looking for something else, I came across an easy formula that helps you decide whether you are ready to retire; it was introduced by Quora reader Doug Massey and is known as F*ck That Index (or FTI).
Are you ready to retire: what is FTI?
FTI, or your readiness to retire, is calculated using the following:
Your Age * Your Net worth/Annual spending
The index should be greater than 1,000 for you to be ready to retire.
I love this one! I love it not only because it is the kind of thing that tells you ‘yes’ or ‘no’ but also because it allows you to play with the conditions for readiness. For instance, you may be closer if you reduce your annual spending; or you need to wait several more years.
Where do I stand in all this retirement lark?
Remember when I was telling you how important it is to know your net worth and that you should follow it religiously. Hope you did! I do know my net worth exactly and update it every month so calculating my FTI is easy.
…my index is 1,705.
(Had to correct this one up after carefully calculating my net worth. What am I waiting for, I wonder.)
Which is over 1,000 anyway and this means that I can jack my job tomorrow is I want to. And this makes me feel all warm and glowing inside. This is without changing our current level of spending at all.
(Just for the record, John’s FTI is well over 1,000 as well. I haven’t factored keeping a teenage son through university but this may be why I have to make a lot of money some other way.)
What is your FTI value? Are you ready to retire?
Yesterday I almost took the best photograph in my life.
I was finishing my run on the beach when I saw a bride and groom literally walking hand in hand into the sunset. If you were very ungenerous, you’d have thought of the bride as rather overweight; I saw her as ripe with new life. Their backs were towards me but I could feel the promise of happiness in their bodies.
Their official photograph was covered in the sand doing his thing.
I almost pressed the camera button; I didn’t.
Do you know why?
Because, in a flash I realised that I’d rather keep the feeling of the memory (yep, the Greeks have a word for this and I know it) than commit it to the screen.
I tried to hold to the perfect moment when the Universe is in complete harmony and you experience profound sense of calm and wellbeing.
It lasted couple of minutes.
Still, my experience last night made me think.
Think about all holidays that I didn’t allow myself to enjoy.
Remember all breaks when I ended up more stressed than I started.
Reminisce about all the beautiful moments that I’ve spoiled.
I also reflected on happy and restful we’ve been this holiday. I thought that this is the one holiday we love unconditionally.
Do you know what is the secret to love your holiday unconditionally?
I reckon these seven tips will help you make memories, love your holiday and get back to your everyday life rested and contented.
#1. Don’t worry about spending money
This one is very hard for me. What I realised is that I failed to enjoy previous holidays because I was too preoccupied worrying about money and trying not to spend it.
So, I always ended up away, not spending much on fun and living basic life in difficult conditions (yes, have you tried to prepare a meal in a self catering apartment on a Greek island?).
This time, we are spending on fun and I am not feeling guilty about it.
This doesn’t mean that you should live completely without regard for money. You can change the worry for planning though.
#2. Don’t get in debt
I remember many holidays when all spend went on credit cards. No wonder, I was so worried all the time that there was no space for joy and play.
This time, the use of credit cards is a matter of banking connections rather than cash flow issues (for some reason, Greek ATMs don’t connect to our current account well).
This is why I managed to take a ‘chill pill’ (this is what my son calls it).
If you want to love your holiday unconditionally, make sure you are not building debt.
#3. Make memories
I’m a big believer in making memories because memories are what connects you to the people in your life and keeps you warm and smiling on a dark, rainy day.
Some experiences that build memories will cost you. For example, this year our son took to water skiing – it costs a bit but the smile on his face I’ll remember forever.
Most experiences are priceless but not costly.
Do you think I’ll easily forget running on the beach and crashing a wedding in my dishevelled state?
#4. Don’t accumulate things
Minimalist I probably would never be. I’m leaning towards ‘essentialism’ though.
This means that I have limited buying ‘things’ to the absolutely essential and this can be one of two things – either ‘absolutely necessary’ or irresistibly beautiful.
I can safely say that this year we’ve bought very few essential items.
#5. Live for the moment
I usually have a great problem leaving my problems – or even simply preoccupations – behind.
Even on this holiday I spent couple of days get it wound up about selling the apartment in Sofia (yes, this is still going on).
Generally, one of the reasons that I love this holiday unconditionally is that I’ve managed to stay away from work and worry.
I’ve tried to learn to live for the moment.
There is a lot of joy to be had from playing a beach game with my son (even if I suck at it); or playing cards (even when losing).
#6. Let go and listen to your body
Do you live according to a strict schedule?
I usually do. I get up at 6.06 am; read, write, work…
I have breakfast, lunch and dinner and hardly ever drink.
When you are on holiday you can let go a bit. I’ve done.
I wake up when I wake up; no alarms. I sunbathe, swim, train and run. I written a, bit but my writing schedule has been all over the place.
And you know what?
If I fancy a beer in the morning, I have one (okay, the earliest for me has been lunch time but this is decadent for me).
#7. Challenge your comfort zone
Challenging your comfort zone is good for you in many ways. And makes for a very enjoyable and refreshing holiday.
You don’t even have to go big on this one. I, for instance, have been checking how many items of clothing I really need on holiday. During this break, I’ve been washing the items I wear every evening and…
…it looks like that next year I’ll be coming here carrying only a small backpack.
(John, doesn’t know yet and he’ll be rather upset. He has brought something like 10 t-shirts and five shirts – didn’t wear most of them but then he was not up for challenging his comfort zone so he is not learning.)
Going on holiday is not always – and doesn’t have to be – cheap. What is important is whether it is ‘good value for money’.
Now that I mentioned ‘value for money’ you are thinking about the things you get for your money, right?
What I mean is probably different from what you are thinking about.
Because for me, the value of a holiday is measured by how rested and relaxed you end up; value is measured by the experiences you collect and the memories you create.
It is about whether you love your holiday unconditionally.
How many breaks have you had in the last twelve months?
Just asking because today I realised that I no longer feel guilty spending on experiences. And for me the main experience is travel; getting out of my comfort zone and learning about new places, customs and cultures.
You know, over the last twelve months I’ve been to South Korea for a Soo Bahk Do (Korean karate for the non-initiated) retreat, to Florence for a long weekend and to Switzerland for a week of Soo Bahk Do camp. On Friday we are off to the lovely Greek island of Skiathos again.
This is a lot of travel for pleasure; and none of it comes cheap despite me doing my best to be a frugal artist.
Why, then, I feel no guilt spending on these trips? Won’t it be better to renovate the kitchen? Change the carpet in the hall and landing? Have the house decorated? Or even getting some new clothes?
The simple answer is that I no longer feel guilty spending on experiences for the following three reasons.
#1. Spending on experiences is top value for money
Spending on experiences lasts forever.
Yep. I know exactly how this one sounds: it sounds like the most annoying cliché ever.
Still, it isn’t. Experiences really last forever and give us pleasure repeatedly throughout our lives.
I won’t be surprised at all if one day, and I hope this day is far away, on my death bed I remember wondering through the Uffizi gallery in Florence with John. I would probably treasure forever the memory of practicing karate with my son; or eating kimchi and dreaming of chocolate.
Do you know the best part?
Spending on experiences is an incredible value for money because they stay as memories that give us pleasure forever. We can tweak memories so we never adapt to them; we never tire of them.
#2. Spending on experiences is a top investment
You can see this as an excuse to have some ‘instant gratification’. Or you can trust me when I tell you that today it is absolutely vital to be a maverick if you are to get anywhere in life; including, if you are to enjoy life.
For myself, I know that spending is always transforming and in a good way.
In South Korea, for instance, I learned Soo Bahk Do. But this was not even one of the important things that I learned.
Do you want to know the three life transforming things that I learned? I learned that:
- I need very little to live on and I’m very adaptable.
- What achieves mastery is honesty: when not sure about technique don’t bodge it, slow down and work on the detail.
- Small kindness goes a very long way and makes large difference.
I think spending on experience in this case was very much worth it and was one of the best investments in myself.
To make sure that spending on experience is a top investment you’d need to keep an open mind, reflect and act.
#3. Spending on experiences means cool pictures
Okay. This has to be seen as what it is: a bit of a joke. Still, I took some really cool pictures in Switzerland that I’d like to share.
(When I sent one of them to John, his reply was ‘WTF’; and my very articulate husband is rarely that speechless. See why for yourselves.)
The clouds are rising, Jon Snow!
This is all for today from me.
Do you spend on experiences or on things?
Gosh it is hot!
I’m sitting here, nursing a frappe (which incidentally I love) and looking at my son and husband playing in the pool.
Around me, relaxed, smiling people are having beer, chatting and making new friends.
You see, we could have decided to save ourselves the money we’ll spend on this holiday. If we did that, we’ll be at home, keeping busy and stuck to our computers.
As it is, we are in for a great holiday of sun, sand and smiles.
This made me think again about the thin lines between saving and lost opportunities, between spending and being opulently wasteful.
Sometimes you just have to spend! As I’ve said before, spending on having fun (and budgeting for it) is the Cinderella rule of personal finance.
How much you spend, do you have the money to spend and what you spend it on are the questions we should ask.
To answer these questions first:
- This holiday will cost us approximately £2,700 (three people for two weeks);
- Yes, we have the money. This is very slightly more that one month’s positive cash flow at the moment; and
- This time I’m absolutely determined to buy experiences.
I love Greece; always have done.
Greece is almost the opposite of the UK and very close in temperament to my native Bulgaria. It is sunny, hot, relaxed and friendly. People really know how to have fun and enjoy life even when life is not as easy as it could be, or as it has been.
The food is great and people here don’t need one of the ‘slow’ watches advertised so much: time is still measured in cigarettes (even by people who don’t smoke). For example the nearest beach is ‘two cigarettes away’.
I also tend to worry about money. This was justified before 2013 when we paid off our big debt. Now I have no reason to worry: we’ve been saving and investing aggressively; we’ve increased our income considerably and have a positive cash flow that would have made my breath hitch two years ago.
I still worry. The woman who would rather miss out on life experiences than spend a bit of money is still inside me and come out to play often.
Because of this woman many of our holidays were missed opportunities. Looking back, we’ve been to some awesome places just to settle into a routine of swimming, beach, ice cream and the occasional dinner out.
Relaxing no doubt; but in a way where memorable experiences are sadly off the books. This is how the Bulgarian Black Sea, the Algarve in Portugal and the Greek islands all blend into one.
Reaching back to our holidays over the last five years, I can’t recall a single memorable experience. (It turns out that it is different for John. He remembers doing things probably because they were the kind of activities I don’t enjoy and had given a miss. Last year, for instance, John and our son went shark fishing in the Atlantic. I didn’t go: who want a woman being sick all the time on the boat anyway?)
This time, I’d like to break away and collect experiences. After all, experiences enrich your life and make you happier.
Each of us wants different kind of experiences. Our son wants to go water skiing, paragliding and jet skiing. John would love to spend his time on a boat.
Me? I’d love to do the following:
Explore at least eight beaches
Skiathos is a small island but it still has sixty-eight beaches. Normally, we’d settle into going to the nearest one to out hotel.
Not this time. We’ve decided to explore as many of the beaches as we could during the 12 days we are here (and no fewer than eight).
We will give the Small Banana beach a miss though. (This is the nudist beach here and visiting it may be a bit weird with my son.)
(Note: Today is wasted as a beach-exploring day – it rained heavily this morning and the weather is the best at the moment either. Still, there will be enough time.)
Go on jet skis
I’ve never done this so it may be time to have a try. Looks fun and if I chicken out of driving one of these myself, I could always go behind John. (John’s reaction: ‘And then we’ll both fall off!’)
Do some Greek dancing
This one will be really interesting given my opinion of Greek music. Still, I quite like dancing. Why not!
(Note: This has already been done. Last night there was a party here and we drank a bit and danced a lot. Simple Greek dances but still…)
Visit the local dog shelter
There is a famous dog shelter on Skiathos where people can go and walk the dogs. Have a look at their Facebook page. (I’m already in love with a pup called Sushi. She’s so sweet but John won’t let me take her home.) Anyway, walking dogs will be good for us because we are pining after Suzi the Dog. And it is something different to do.
Fun with family
Our busy lives mean that we have little time for simply spending time with each other when in Manchester.
Here is an opportunity to remedy that. Last night the three of us played a card game and it was fun; even though I lost to our son four times.
Our son has also started to include me in his fitness training. Yesterday we did upper body. It is madness: I did only three sets and fewer repetitions and today every single muscle on my shoulders and chest hurts. Today, we’ll be doing abs (and I’m already dreading it but I won’t give up).
We already have a hired car to be able to explore the beaches.
We are still to find a beach where there are jet-skis but I believe we will.
Let the fun continue!
Are you tempted to save on holiday? What are the things you are most likely to spend money on?
While suffering with a stinking cold, I decided to read a book.
I’ve had this book on my Kindle for couple of months now. Between the daily hassle of working and the nightly hustle of blogging there wasn’t any time to read it.
What is the book, you wonder?
I’ve been reading ‘Money Master the Game: 7 simple steps to financial freedom’ by Tony Robbins.
Tonight, I’m not going to review the book though I may do it at some point. It is well worth reading despite the many pages of padding that I had to skip. (What I consider padding may be very useful to someone who has never read anything about personal finance before.)
What I’d like to share is an idea I do find very useful.
You know how there is a lot of talk around about financial independence?
There are also debates about what is it, when you’ve got there and whether someone is ‘retired’ (I suspect that I’ll never understand some young people’s obsession with early retirement; or any retirement for that matter, but each to their own.)
I may have a problem with ‘retirement’ but John and I have achieved financial health and are working towards financial independence; which in my book means that by October 2018 we’d like to be in a financial position where I don’t have to be employed if I don’t want to be.
To achieve this, we used TMP retirement calculator and worked out that to be able to do what we wish to do we need the staggering amount of £2.5 million (or the equivalent which is £10,000 passive income per month).
I am a very brave person (some may say that I’m slightly foolish when it comes to courage). Even I find this number daunting.
We have slightly less than four years left and slightly under £100,000 saved and/or invested. (John claims that we are still on track but we have to find some really hot investments. Astonishingly, in 2014 we had £10,444 passive income about which I’ll tell you some other time.)
Reading Tony Robbins’ book has given me the will to continue.
Tony gives a lot of very useful messages in his book.
One of these is:
‘If you want your life to be better, you have to become better.’
Another one is that there are different degrees of financial independence.
#1. Financial security. This is achieved when you have sufficient passive income to cover the very basics in your life like the rent (mortgage), bills and basic food.
#2. Financial vitality. At this level of financial independence, your passive income can allow for more things like clothes, going out and having fun, and basic holidays.
#3. Financial independence. This is the level where your passive income is sufficient to allow you to have your current quality of life.
#4. Financial freedom. At this level of financial independence you can up-step your lifestyle to the one you desire.
#5. Absolute financial freedom. This is the level where money stops being an issue and you can do anything you want.
You see, very few people will get to the 5th level; this of absolute financial freedom.
Some will get to the 4th level.
Everyone can get to the 3rd level of financial independence.
Do you know why reading about these levels of financial independence gave me the will to go on?
Because I did put numbers to the different levels. (It is a very good exercise and very useful to keep you on track; so get a pen and start working out your numbers.)
Here is what I figured out (all numbers are of income after tax).
#1. Financial security. For financial security we need passive income of £24,360 per year. We are above that today.
#2. Financial vitality. For this level of financial independence we need £38,400. At the moment, we are over-shooting this one if I include our advertising income (which is not entirely passive).
#3. Financial independence. For financial independence we need annual income of £48,000. At this moment, we fall short of that by approximately £4,000.
#4. Financial freedom. This is our programme maximum and you know we are rather short here.
#5. Absolute financial freedom. We have not even allowed ourselves to dream about this one!
Now you see why I’m encouraged. We are very close to financial independence today. The way we are going we’ll certainly be there in four years’ time.
This means that even if we don’t get to financial freedom (our £2.5 million plan) I’ll have a choice!
Where are you on the way to financial independence?