Financial independence is something that all of us want, but it can be elusive. For many of us, there’s always something that keeps us awake at night when it comes to our money.
I’ve been on my own journey towards financial independence for the last several years. It started when my wife and I graduated college with combined student debt of $124k. That was a lot of money to have hanging over our heads, so we put together a plan to pay it off over 5 years. We finished 4.5 years into the plan. When the loans were paid off, we had a chunk of extra money each month since we no longer had any debt payments. We could’ve used that money to buy a bigger house, or fancier cars, but instead decided that we were quite content with our lifestyle and didn’t need to spend the extra money.
But the question remained, what should we do with the extra cash that used to go to loan payments? I ran some numbers and realized that if we invested what we used to pay in student loan payments every month, we would have enough money to sustain our lifestyle without employment in about 10 years!
Being able to stop working earlier than the standard retirement age is an exciting idea. After all, we only live once. So, in this article I’ll address some common questions I get a lot around financial independence: what does it actually mean to be financially independent, and what can you do to achieve it at an early age?
What is Financial Independence?
There isn’t a dictionary definition of financial independence, but the term is generally understood to mean building sufficient wealth to no longer have to rely on income from a job to meet your living expenses. In other words, financial independence means that the wealth and assets you’ve accumulated can support your lifestyle indefinitely.
You might be thinking that, “This sounds an awful lot like retirement.” And yes, it does. In fact, a successful retirement is a great example of financial independence because once you’ve retired, you’re no longer dependent on regular income from an employer. And in retirement, you do rely mainly on income generated from your retirement portfolio and/or drawdown of assets in your portfolio to meet your everyday living expenses.
But a common distinction between traditional retirement and financial independence boils down to one big thing: timing. Social Security retirement benefits can start as early as age 62 or as late as age 70. Many Americans consider the standard retirement age to fall somewhere between these ages. However, many people whose goal is financial independence want to leave the workforce well before the age of 62. There’s actually a whole movement around people who want to retire ultra-early – it’s called FIRE (Financial Independence, Retire Early). Read more about FIRE here.
The long-term goal of financial independence is to save enough money so that you never have to work a full-time job again if you don’t want to, and more importantly, that your wealth is such that you aren’t staying up at night worrying about the mortgage payment or your children’s private school tuitions.
Making Financial Independence Happen
The idea of financial independence sounds great to many people. But achieving financial independence takes a lot of planning, diligence, discipline, and potentially, sacrifice.
Here are some guidelines to help you on the road to financial independence:
1. Set Financial Priorities.
Notice that I didn’t say set financial goals. Priorities and goals are two different things.
It’s fairly easy to set financial goals, and lots of people do so. For example, you might set a goal of accumulating $1 million in savings and assets by the time you turn 40 in order to become financially independent. But if you don’t make reaching this goal a priority in your life, there’s a good chance you won’t achieve it.
A big part of prioritizing your financial goals is creating a written plan for achieving them. This will give you something you can refer back to periodically to make sure you remain on track. You should review your financial plan every 12 to 18 months to monitor your progress and make adjustments as necessary.
2. Manage Your Cash Flow.
There’s an old saying that “it’s not how much money you make, but how much money you keep that matters.” There are lots of people who make a lot of money, but also spend a lot of money. These people will never really be able to achieve financial independence if they can’t get a handle on their spending.
Managing cash flow means spending less money than you make. This sounds simple, but it doesn’t come easy for many people. This is evidenced by the massive amount of credit card debt held by Americans, which currently tops $1 trillion, according to the Federal Reserve.
One of the best ways to manage cash flow is to create and follow a household budget. The term “budget” is anathema to many people, but good budgeting is the surest path to making sure that your expenses don’t exceed your income. Each household will have a different budget – for example, you may really value eating out and don’t see it as an area you want to cut back in. That’s fine, but you’ll need to make concessions elsewhere in your spending. The main idea is to be as efficient as possible with every dollar, and to understand the consequences of the budget you come up with. So, for example, if you don’t want to cut back on eating out, you’ll either need to be ok with pushing out your timeline for financial independence or reduce your spending in other areas.
The bottom line is that in order to achieve financial independence, you should spend considerably less than you make while saving and investing the difference for long-term growth.
3. Invest With Discipline.
Investing to achieve financial independence requires discipline and a long-term perspective. This can be difficult when you’re faced with immediate financial priorities and emergencies, such as major home or car repairs and unexpected medical expenses, or during times of market volatility.
Dollar-cost averaging is one strategy that can help develop investing discipline. This means that you will invest the same amount of money at regular intervals, such as each pay period, usually via an automatic investing plan. Doing this reduces the risk of buying securities at or near market peaks. Instead, your investments are spread out evenly over time, which could result in buying more shares at lower prices and fewer shares at higher prices. Also, we are creatures of habit, so something that is easy and automated will likely continue without contest, helping grow your balances.
4. Avoid Consumer Debt.
Racking up excessive consumer debt is one of the biggest obstacles to achieving financial independence. The problem for many people is that they have a hard time with delayed gratification. In other words, it can be difficult for people to wait until they’ve saved enough money to purchase items they want. Instead, they buy items on credit and eventually end up paying high interest charges on large revolving balances, essentially paying more for the item than the initial sale price!
Much of this stems from an effort to “keep up with the Joneses.” Achieving financial independence requires ignoring the Joneses and being content with what you already have and can realistically afford without assuming debt.
For example, could you be happy in a smaller, more modest and less expensive home in order to reduce your monthly mortgage? Or could you keep driving your high-mileage car for another few years by performing regular maintenance instead of buying a new car and taking on another monthly debt obligation?
Again, it comes down to understanding your priorities and the consequences of your purchases. If you need a bigger home or want to ditch the old car, that’s fine, but know what it means in the context of your larger financial independence goals.
5. Focus Most on Managing Big Expenses.
Saving 15% on a stick of deodorant or getting a couple of dollars off on your groceries is always good. There’s a saying that if you “mind the pennies, the dollars will follow.” And it’s true, but the biggest opportunities for saving and moving the needle towards your financial independence goal are your large, recurring expenses. This means housing, your car payment, insurance, and the like. Trying to find ways to appropriately manage and reduce those expenses will get you much closer to your financial independence goal than clipping a coupon for your morning cereal. It’s best to focus your energy on the biggest line items in your monthly budget – doing this will ultimately make the most difference when it comes to your timeline for achieving financial independence.
How We Can Help
Personal Capital offers a wide range of financial tools that can help you achieve financial independence. These include a dashboard that makes it easy for you to track and manage all aspects of your financial life; a retirement planner that helps you build, forecast and manage your retirement finances; and an investment checkup that lets you monitor the performance of your investments in real time.
In addition, our investment advisors can provide guided expertise to help you devise a plan that leads you to financial independence. This includes personalized portfolio management, full financial planning and fiduciary advice with transparency.