What is ‘financial independence’?
Financial independence is a term which is used subjectively. It could mean being able to move out of your parents house. It could mean paying your own way. For most (myself included), financial independence means owning assets generating more income than your expenses. If your expenses are $30,000/y , your assets need to make at least $30,000/y. This eliminates the need to work for your basic needs.
Why would I want to be financially independent?
The number one reason to strive for financial independence is freedom. If you didn’t need to worry about money, what would you do? Travel the world? Volunteer at your favourite charity? Spend more time with family? All of these things become possible through financial independence. If your living costs are covered without you lifting a finger, you can focus on what truly is important to you.
Money is only one of the reasons we go to work. You might enjoy chatting around the water cooler, or the satisfaction of nailing a big presentation. If you take joy in what you are doing then there is no reason to stop. Nothing says you have to give up your job just because you can afford to. Picture everything you love about your career, but without the stress that money brings into the equation. Considering that new role that looks interesting but would mean a pay cut? No worries – the income isn’t important if you are financially secure.
So how do I become financially independent?
The journey to financial independence involves two major stages.
Step 1: Reduce your expenses, increase your savings
Reducing your expenses has a significant impact on the amount of time and assets it takes to be financially independent. The effect of reducing expenses is two-fold, not only are fewer investments required to be sustainable, but also more funds are available to dedicate towards wealth creation. The below table outlines the effect of increasing your savings rate on the time it takes to become self sufficient:
Eliminating debt is a key component to reducing expenses. Every dollar of interest paid on debt is another dollar that needs to be earned. Repaying debt is a simple way to reduce your expenses without effecting your standard of living. This strategy is most suitable for high interest debt such as credit cards or personal loans. Some may choose to borrow tax-effective money in order to invest, this is a personal preference and depends on risk tolerance.
Step 2: Build your wealth
In order to generate the income required to cover the cost of living, building wealth through investment is required. As with all investment, it is important to consider risk and return. Low risk (defensive) investments such as cash and bank fixed deposits provide a stable income, however often the rate of return is quite low. Riskier (growth) investments such as shares to investment property provide a more attractive return at a higher risk. You should consider holding a combination of both defensive and growth assets in order to diversify your portfolio.
Income generated through royalties, patents or business distributions can also contribute towards generating the required income. Upon reaching financial independence, many choose to spend a portion of their time developing these sources of passive income through blogging, publishing or other creative works.
So how do I get started?
Financial independence doesn’t just happen overnight. As with any journey, the best way to reach your goal is to take it one step at a time. There are countless resources online to help you along the way. Set yourself a goal – it doesn’t need to be a deadline for reaching self sufficiency. Here are some ideas to get you started:
Becoming financially independent doesn’t take a genius – just patience and common sense. Good luck!