I love talking about saving, spending, and investing. However, I know some people don't really like to talk about it or hear about it all that often. It could be because of the highly complicated nature of the subject, (even though it is pretty simple once you get passed all of the obstructive lingo) but I found that at the most fundamental level, it is really because of a lack of education. Everyone I ask says that they would love to have a financial management/basic investing class at school, but only a small percentage actually do. Even those that do regrettably admit that they didn't learn anything ACTIONABLE. Well, I hope to make this blog post the most actionable one yet. If YOU want to become financially independent one day, read on!
There are 3 basic things to understand about money before you can be financially free:
1) You NEED a positive cash flow (Income - Expenses)
2) You NEED to invest (Inflation will crush you if you don't)
3) You NEED to build a portfolio worth 30x your annual expenses (So you can live off of your investment income, forever)
Lets go through those three points in order, briefly brushing over the math but more importantly tackling the concepts at play.
If you have never used a spreadsheet or saved a receipt, boy do I have an app for you. Check out "Mint": the all-in-one money tracking app that tells you how much you have make, spend, and where you stand with your net worth. You can add credit cards, bank accounts, and investment accounts to keep track of everything all at once. I recommend using a software like mint to keep track of where your money is coming from and going to at any time.
DISCLAIMER, mint will not solve all of your money problems. It WILL give you access to the data you need to make better money decisions, which is like having all the power in the world. By understanding where you are in the "Cash Flow" process, you can decide if you should really charge that grande-soy-mocha-frappucino-with-whipped-cream on your card. (Probably not)
Once you have a consistently positive cash flow and an emergency fund with 6-12 months of expenses, move to number 2.
If you have never bought or sold any financial securities before, this section is for you. If you HAVE, this section is probably still for you.
By investing your money, you are literally putting it to work. Your money will be like employees that bring in more money, this new money goes out and makes you even more, and it becomes an incredible self-reinforcing cycle. The only problem is that you need to start the cycle NOW so that your employees can clock in and get to work. How do you get started? Good Question:
First things first, invest in your employer sponsored retirement plan, like a 401k or 403b. Very often your employer will match a portion of your contribution, this is free money and it would be incredibly stupid not to contribute up to the match %. I recommend slotting 10% of your income into this type of account and setting it on autopilot, investing in low cost stock/bond mutual funds.
Next, open a Roth IRA with Vanguard and contribute the Maximum every year. This is usually $5,500/Year, unless you make an astronomical amount of money. Money goes INTO a Roth IRA after tax, but it is tax-free when you pull it out after you hit 59.5 years of age. USE AND ABUSE THIS TYPE OF ACCOUNT IF YOU CAN. YOU WILL BE RECEIVING EXPONENTIAL GROWTH ON YOUR MONEY WITHOUT ANY TAX LIABILITY WHATSOEVER. If that doesn't get you pumped up, its ok. Im weird. But trust me on this one and do it. Open the account and buy another low cost stock/bond mutual fund or exchange traded fund.
After having a 401K and Roth IRA, open a "Taxable" brokerage account with Robinhood (my favorite because it is free) or other low cost online broker. You can use Vanguard for this as well, but I like Robinhood's user interface and free service so I use that. Contribute all remaining cash flow after your emergency fund or other saving goals to this, buying similar low cost exchange traded funds. The money you make from selling these investments will be taxed regularly, although you should be buying stocks with the long-term in mind. If you MUST sell an investment, do not worry too much about calculating the taxable gain out by hand. All brokerage firms will send you a Form-1099 to provide the IRS with your tax liability or credit.
By contributing to these investment vehicles regularly, you will be putting money to work. The more money you put to work, the more money it creates, and like I mentioned earlier, it just needs a bit of a push from you to get going. Check out this cool compound interest calculator. Plug some numbers in there (how much would you have by investing $500/mo at 7% interest for 40 years?: About $1.2 Million) and play with the outcomes. How much do YOU need to contribute and earn in returns to be a millionaire by 40? How about 30? I like to use conservative numbers as often as possible to keep from getting overzealous in my forecasts.
Just because I talk about investing in financial securities (stocks/bonds) does not mean that you can skip out on other investments. Real estate can be a great investment (if you do it right!)
The third and final step in the financial independence process is to have an investment portfolio worth 30x your annual expenses. Why? Lets break it down with an example.
Marco Moneybags calculated that he spends $40k-50k/Year on average and has been saving/investing since he was 21 Years old. Now, at 35, Marco has $1.3 Million in investments. According to historical data going back hundreds of years, the stock market has returned 7%/Year on average. That is a FACT. Were there years of negative performance? Absolutely. Were there MANY more years of positive performance? You betcha. There is NO REASON to think that this trend will end now and that the investing world will come crashing down.
Based on the third step to financial freedom, Marco is right smack in the middle of his target "freedom number". At his max spending with maximum retirement safety, he would need $1.5M (50k x 30). At his minimum 40k spending level, he is perfectly safe to retire now and he will have enough money to sustain his lifestyle literally forever. All you have to do is withdraw 3-4% of your total assets in the first year, and then add the amount of inflation per year (Measured by the CPI or "Consumer Price Index"). So if Marco Moneybags retired today, he could withdraw 4% of his total assets or $52,000 ($1.3M x .04). Next year, he would see how much the CPI went up or down and adjust his withdrawals according to that. By figuring out the math now, he will be able to use his pool of assets as a source of income without having to work another day in his life. To be more conservative, he could only withdraw 3% of his pool of assets and lower his annual spending.
In addition, it is very rare for someone to make $0 after they retire. There is always some way to make money doing something you enjoy. So once you hit your freedom number, you can dedicate every second of every day to the things that you love. You may even make a few bucks while you're at it!
When you think about personal finance, think about it like this:
The Golden Key to success with money is being able to forego the ordinary things in life now, so that you can experience the extraordinary later.
So when you skip that latte, you are investing in your ability to buy your time in the future. And what is more valuable than being able to do whatever you want with your own time?
If you thought this was helpful, terrible, or somewhere in the middle, please leave me feedback in the form of a Direct Message on instagram @nico_pasq, or feel free to send me an e-mail/text to the information on my Home Page. I truly appreciate constructive criticism and opposing views, so bring em on!
P.S. New blog posts coming your way every Monday!
I love books, so it is probably a natural progression that I have come to LOVE AUDIOBOOKS! Here is a link to a 30-day free trial to Audible, along with TWO free audiobooks of your choice. Don't like the service? No problem, they will let you cancel and you'll even get to keep the books you chose to try. Enjoy!