The Formula for Financial Freedom


The Formula for Financial Freedom
April 23, 2018

Hi there :) Welcome back!

On this edition, we are going to look into what I call the “Formula for FI” or financial independence. I call it the formula because it really is as easy as “plug and chug” like my math teachers used to call simple equations where all of the variables are already given to you. Here it is:

(Income - Expenses) > 0

I bet you were expecting some crazy mathematical equation but sound money management is NOT rocket science. This equation is so simple anyone can use it, just sit down at the kitchen table and really analyze your spending over the past six months. In any given month has your “cash flow” (income - expenses) been negative? If so, you need to look long and hard at why that is.

I am going to give Mr. Kiyosaki the book of the week on this post because in Rich Dad Poor Dad he focuses A LOT on cash flow and why it is the most important thing when it comes to your finances. He even has a board game called CASHFLOW that is designed around making decisions that will increase your cash flow and net worth over time.

I think cash flow is so important because only when you analyze your income generation and spending habits closely can you really dive into the concept of becoming financially stable/independent. Without that analysis it’s like trying to play a game of chess when you have no idea what the pieces do. Every dollar you make (but more importantly every dollar you spend!) should be built into a tactical plan. You need to tell your money where to go! If you don’t, it will leave you.

At the end of the day, you want to have a significantly positive “cash flow” every month. All income - all expenses = cash flow. It has to be positive, and it has to be significant. Significant means 30% of your take home income for that month. So if your money left over after spending is less than 30% of your monthly income, we have some exciting money making to do! CUT THE CORD, STOP PAYING VERIZON $300/mo, DOWNSIZE YOUR HOUSE , GET A CHEAPER CAR (because yours is costing you millions) , do whatever you have to do to get that savings rate UP!

After you do those things, the real magic happens. You will feel like you got a raise when really all you did was trim the FLUBBY FAT out of your financial life. I’m not saying starve yourself, but eating out 3x a week or more is significantly reducing your savings rate. So get down to business and use that magical formula to save MORE. When you have your significantly positive monthly cash flow, look to do these next steps:

First things first, do you have an emergency fund? Or what I like to call the inconvenience fund. I call it the inconvenience fund because it turns what used to be an emergency (car broke down, unforeseen medical or education expense, etc.) into just a monetary inconvenience and not a monetary emergency. If you had $0 saved for this type of event, I could see how that would be a real emergency! Sirens blaring and all.

I say shoot for 6-12 months of expenses in liquid cash because I am on the more conservative side, some people say 3-6 is perfectly fine. It all depends on your personal risk tolerance.

If you have ANY debt, you should keep a 1-2k cash balance at the bank for emergencies/inconveniences, and all other cash flow should be directed at paying off debt. Debt must go, once it is gone you will feel the weight of the shackles literally come off of your shoulders. Then save your inconvenience fund. Then you can build wealth because you are free and clear! So to recap:

1) Save 1-2k

2) Pay off Debt (if applicable, excluding mortgage***)

3) Save inconvenience fund (anywhere from 3-12 mo expenses depending on your preference)

4) Invest and Build Wealth

Number 4, which is the final step, is to start investing your cash flow. This one comes in many shapes and sizes. You can invest in so many different types of assets. If you have absolutely no experience investing, here is the simple rundown

Open a 401k and/or an IRA and invest in low cost stock index funds (Tickers VOO or VTI are sufficient) after maxing those out then open and fund a taxable brokerage account at Robinhood (my recommendation) or some other low cost broker and invest once again in stock index funds. Vanguard funds are the best and the cheapest, so just look for stock tickers VOO or VTI and you can’t go wrong. Their expense ratios are less than one tenth of one percent (.04% to be exact) per year and they track the stock market's performance just about perfectly in any given year.

Nervous about investing your hard earned money? Don’t be scared off by the doomsday soothsayers. Investing in financial markets is the most powerful wealth builder you and I can leverage. Take for example the average annual stock market performance of about 7% per yer and compound that with $500 invested every month from now until you retire (assuming you are 25 and you retire at 65) and you will come out with over $1.2 million. Pretty crazy numbers, and you can’t get those returns by keeping cash in your mattress.

Now, are there bad years in the stock market? Absolutely. Are there incredibly good years in the stock market? You bet! So that 7% return I am referencing is the AVERAGE over the past couple hundred years.

Without getting too much deeper into the math, if you are consistently investing $500/month, it is pretty obvious that you will buy MORE shares when the stock market is DOWN because the shares are CHEAPER to buy. This fancy strategy is called “dollar cost averaging”. You will naturally be buying more stock at the lowest prices, making you a professional investor just by being consistent and disciplined.

Follow these 4 steps and I can all but guarantee that you will be financially free:

1) Save 1-2k

2) Pay off Debt (excluding mortgage***)

3) Save inconvenience fund

4) Invest Your Cash Flow


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 @MakeDollarsAndSense, 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!

***If your mortgage rate is below 5%, (which is well below the average annual performance of the stock market over hundreds of years) it is more advantageous for you to invest that money than to pay down your mortgage because the return on investment is higher. However, some people are more conservative and would feel better with a paid off home and 0 debt, so if your only debt is your mortgage you can either pay that off or move to step 4.

Previous Article: The Slow Squeeze of Debt

Next Article: The Glacier Approach to Investing

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