The Path to Financial Independence
The path to financial independence can be boiled down to a few steps.
- Increase your income
- Don’t spend the difference
- Save until you have enough funds to invest
- Invest for income
- Repeat until passive income is larger than active income
While the path consist of only five steps this does not mean that they are going to be easy.
Each step is full of potential obstacles that can derail and distract you from your goal of achieving financial independence.
Change Your Thinking
When you start to think about how you can increase your income you will start to change the way you view your finances.
I believe most people, myself included, were advised by their parents, friends, and family that saving is the way to achieve wealth.
While saving is of course of importance and is a critical part of the path to financial independence remember that it is not the first step.
You must first increase the amount of money you are earning. Nobody wants to admit that. Saving money is “easy” while increasing your income is considered “difficult.”
If you are focused more on saving than you are focused on increasing your income you might achieve results but there is only so much that you can cut back and save.
There is a very popular mustached blogger out there who advocates saving and cutting back on your expenses by reducing or completely eliminating your driving, riding your bike more, and cutting other cost from your life.
I think that all of these are great techniques to saving more money and agree that they would help accelerate your path to being independent only after you have increased your income as much as possible.
If you are earning only $25,000 a year and you cut and reduce expenses so that you can save and invest 50% or even more of that income you will still have an extremely hard time accumulating enough assets to generate significant passive income.
I believe that someone earning only $25,000 a year would have an extremely difficult time saving anywhere near 50% of their income.
I also believe that it would be close to impossible to maintain this savings rate year after year.
You are simply not making enough money for this to work in the real world.
Lets do the math
You make $25,000 a year from your entry level job.
I estimate about 20% comes off the top immediately to pay taxes.
This leaves you with $20,000 in take home pay to live, save and invest with.
This is $1,666 each month.
You manage to save half of this each month saving and investing a solid $833 each month which is $10,000 each year.
If you invest and are able to generate 10% annual income starting from zero it will take you 13 years to reach the point where your passive income exceeds your working income.
Only thirteen years?! This sounds great.
Until you realize how difficult if not impossible it would be to live off of $833 a month for 13 years straight diligently saving and investing half of your take home pay.
This does not take into consideration taxes on that passive income or unplanned expenses or the nearly unlimited other financial setbacks that will occur during those 13 years.
So lets do the math a different way.
You start out earning $25,000 a year from your entry level job and you instead spend the $20,000 that you would have saved the first two years to be able to afford some education to increase your earnings.
You decide to attend a tech school or complete more training that is focused on getting you ready to work as a specialist or a higher wage.
After you get out of school you spend the next 3 years working and improving your job skills. Now you are able to earn 2 or 3 times what you were earning before or maybe more.
This will depend on how good you have become at your new job. If you are only an average level employee at your job you will not be able to earn as much.
You need to be one of the best at your job. When you are not there you need to be missed. This is critical to increasing your income.
So you have spent 5 years focusing on improving yourself and increasing your income but now you have a lot more money to save and invest.
Lets do that same math again.
You now make $75,000 a year.
Now about 25% goes to taxes so you are left with $56,250 as your take home pay.
This is $4687 a month and you still manage to save and invest half which is $2343 a month.
I believe it would be a lot easier to live off of $2343 a month, compared to $833.
You would now be investing $28,116 each year instead of only $10,000. This would be impossible if you are only making $25,000 each year.
After 6 years of saving and investing you would already be generating over $25,000 a year in passive income.
The next year your passive income would cover your $28,000 expenses in full allowing you to invest or spend a larger percent of your active income. And it will only continue to get easier from there.
This is also assuming that you did not save and invest any of the money that you earned in the first 3 years after getting out of school. If you had the numbers would be even better.
This is just an example
Getting more education is obviously not the only way that you can increase your income, there are of course many other ways to increase your income.
The point I am trying to get across here is that if you increase your income before you start saving and investing it will be easier for you to save and invest a larger percent of your income.
In the above example it is obvious that it will be easier to maintain your target of saving half of your pay when you are earning 3 times as much.
Your ability to save invest more will only increase when your income increases first. There is only so much you can cut back and save if you are not earning enough money.
Your Thinking Needs to Change
This idea still applies if you are making more money than $25,000 a year. If you are struggling to save and invest money you need to earn more. There is simply no other way.
I have been earning between $60,000 and $80,000 for over three years and still have not been able to save anywhere near half of my take home pay.
I live in an expensive area of an expensive area because I want my family to be safe.
My wife took a few years off from working to stay home with our daughter.
We are currently in debt.
We have encountered unexpected health issues that resulted in enormous hospital bills even after the insurance companies paid their portion.
My income has gone up and down due to being paid on commission.
Life happens, things in the real world do not work as simple as the above examples.
We are fighting back though. We know we need to make more money and have been taking action to make it happen.
I believe that succeeding with money is my duty and obligation to my family. We live in a financially driven world and money has become a requirement to survive and prosper.
My goal is to create an indestructible income flow for my family.
I want to know that even if I die my family will get a fat check next month and forever.