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Income from passive sources is greater than expenditure equals financial independence. Sounds simple? There are some nuances!
Time and money
Most people work for a living. They get up at 7am on a Monday morning and get ready for work. They go into the office or work online from home and trade hours of their life for money. At the end of each month they get a paycheque that compensates them for their work/time. This is how the world is set up and most people have accepted that they are going to get a job after they have left education and work until they retire (which is 65 and rising in the UK) when they will get their time back to do what they want to do.
This is the standard plan, and most people have accepted it and will never challenge it. They don't think about doing things differently to get different results. They sit in jobs they don't like waiting for a retirement where they can actually do what they want when they are free.
In a job you trade your time for money and if you stop giving time then you stop getting a pay cheque. It's that simple.
The question for most people is whether the money will last until the end of the month when they get their next paycheque. In a recent report*, fewer than half the UK's households on a low to middle income have any money left at the end of the month! Fewer than HALF!!
At the root of the concept of financial independence is decoupling time and money so that even if you don't work you have enough to live each month. If you take some of your monthly income and invest it each month so that it compounds over time you will build passive income. At a certain point the size of this pot produces more money than you need to live on and you are free to do whatever you want with your time!
It is about investing in assets that generate a return whether you work or not.
Never have to work again?
Investments and buying assets
I remember turning to Katie and saying, "You know we don't have to go back to work if we don't want to?"
I was 40 at the time and Katie was 35, and we had hit financial independence. This meant we never had to work again if we didn't want to. It was a strange situation to be in and not a normal thought.
My conclusion was that I had bought back 25 years of my life compared to the average retirement age. 25 years.
The question then became what do I want to do with that time? Financial independence buys back your time so you can spend it how you want to spend it!
Use your money to buy assets not liabilities. Most people have no idea where their money even goes let alone investing it wisely! Do you know where your money goes?
There are so many different ways you can invest your money. I wrote a guide to investing that will help you get going.
The financial independence community, as a whole, broadly recommends investing in Vanguard index funds over the long term. I am going to write an article soon which shows you tactically how to do that and how to get started but that one is coming soon. Update: we created a YouTube video to help you get started.
The key to this whole thing is to buy investments that compound over time to leave you financially independent where you don't have to keep putting in time to get a return.
Invest your time to earn money. Invest your money in assets that produce you an income and give you back time.
The problem that occurs normally at this stage of the conversation is that assets and stocks and shares are confusing and there is so much to learn. After I lost 90% of my life savings (it was only £6k at that time) in the dotcom bubble crash I was scared of investing, and it took me a long time to build up confidence to have another go!
The best way to proceed is to learn about investments and understand the different tools available to you!
Once you have an understanding, you can then pick an investment and start to buy assets. This is the first step to FI.
So this all sounds good, but what next...………..
The 4% rule and property
The maths of early retirement is actually quite easy. The concept comes from a report written on long term returns from the stock market called the Trinity Study, which examined how long you could survive on your investments in different scenarios.
Here is how it works. You can live on 4% of your investments (if invested in low-cost index funds such as Vanguard) without having to worry (too much) about ever running out of money. So take the lump sum you have invested currently and times it by 4% and that is what you can live on each year.
If you had £500,000 saved and invested, you could live on £20,000 a year forever without having to work again.
If you had £1,000,000 saved and invested, you can live on £40,000 for the rest of your life without having to work again.
The maths is very simple but the act of getting this sum saved and invested over time is the real challenge and one that most people will never achieve. But you are smarter than most people (you must be as you read my blog!) and we can work out how to do this together.
I have run a few workshops on the 4% rule and FI and there is quite often the reaction of, "That sounds great, Alan, but I could never get that much saved and invested!" "That's impossible!" If you think it is impossible, read this article: "The Insurmountable Mountain"
Getting started is actually quite easy. You need to work on increasing your income, reducing your spending and then using the magic power of compounding over time to be able to reach your target.
Katie and I have 2 small investment studios that we rent out. The return on these two properties is between 8-9% at the moment and this comes in the form of rent paid to us each month.
Property gives us a slightly higher rate of return but it is less passive. I get calls to repair the tap and the toilet, and I have to work for my money.
You can achieve better returns than 4% by investing your time again but then you are back to coupling your time to your income, and the purpose is to de-couple the two so you are free to do whatever you want!
We are working to sell off our properties and put the money into the stock market at the moment. We want to move to more passive investing.
The whole purpose is to invest your time and energy into making money that will buy you assets and free you from having to work. Freedom is the aim. Free to do whatever you want with your time.
There is a shortcut. Don't spend anything at all and then you are financially free right now because you don't need any money to live off.
Most of us want a base level of stuff, house, food, a nice coffee every now and again, and these take financial resourses to get. Financial independence gives you these financial resources without having to work again.
One of the challenges that always comes is, "Yeah but I love my job so why do I need freedom?"
If you are in that position then that is awesome! Congratulations. I love working at Rebel Business School and don't want to stop, but I do want to take a break every now and again and go and do something else. Financial independence gives me the power to step off the conveyor belt of income needed and go and try other projects. In March 2019, I took off 2 months and travelled to Hollywood to write a movie.
If I had needed the income every month, could I have taken 2 months off to follow my dreams? FI gives me the option to be able to unhook from the wages drip feed and go and do other projects without worrying about money at the end!
Even if you love your job now, things change, situations arise, and I would rather be financially prepared for it than in a mess.
I think financial independence is a worthy goal for everyone to work towards to a certain extent even if you don't make it all the way. Even if you only saved and invested a small sum each month, the feeling of having money compounding in the background gives you an incredible sense of freedom.
Even if you think that you will never get to financial independence, should you give up working to be good with your money?
Before you get into investing I would HIGHLY recommend working on your relationship with money. If you don't sort that out first then you are going to struggle to follow the path to FI.
If this stuff sounds remotely interesting then the first step is learning more. What's the downside to a little more knowledge and a few more options in life?
You have some resources here on my blog:
A great place to start learning about how to invest is the book The Simple Path to Wealth by JL Collins. There are a couple of American-focused chapters that you can skip over if you're not in the US but the general principles in this book are so useful to get you on the journey to FI.
Why am I writing this stuff? There are 3 main reasons:
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