Achieving financial independence seems an impossible task if you've got a mountain of debt and an average income. However, the truth lies in the formula, and there are many who have done it. The good news, is regardless of your financial situation, early financial freedom is achievable. It all starts with a plan and a proven process.
There is no way to achieve financial independence by cutting corners. There aren't any secret actions to take that only the financially free know about and are keeping it secret from the rest of the world. There is a proven process that is guaranteed to work, if you follow it. Here's the logical approach on how to achieve early financial freedom.
What Is Early Financial Freedom?
In short, early financial freedom is when one accumulates enough money to support their desired lifestyle without ever running out of wealth. In other words, its another term for early retirement. How is one to ever attain enough money and never run out of it?
If one is able to accumulate $1,000,000 in wealth (for example), and that wealth is invested into a diversified investment portfolio that generates a 6% rate of return each year, and that same individual withdraws only 4% of their wealth each year to live on ($40,000 per year), your net result would still be an increase of 2% growth (Investment return of 6% – withdraw of 4% = 2% net return). In other words, you will never run out of money!
The Formula To Achieve Early Financial Freedom
Early financial freedom is really just a simple math equation. All one needs to do is determine how much money they are comfortable living on each year, then calculate how much you need to save and invest to maintain that income! Here's how it works:
- Determine how much per year you are comfortable living on
- Use the 4% withdraw rule to determine how much you need to accumulate total
- Determine how you're going to get there!
It's obviously a lot easier said than done, but when laid out in a simple formula it makes it look less intimidating. The hardest part is step 3, which we will also discuss in detail to help accelerate the process.
Determine how much annual income you are comfortable living on
Of course we all would love to live on a million dollar per year lifestyle, but be realistic here. If your average living expenses per year are $40,000 per year, and you expect your income to increase over the years, you might be comfortable saying you would feel comfortable living on $60,000 per year. You be the judge, but keep it realistic.
How to apply the 4% withdrawal rule
The 4% withdrawal rule is the average amount financial advisers usually recommend someone entering retirement withdraw each year in retirement. Why 4%? Generally speaking, its not uncommon to have a diversified investment portfolio that generates a 5% – 6% return each year. Thus if you withdraw only 4% each year, you will never run out of money.
Should you want to be a bit more conservative, you might use 3%. Should you believe you can achieve a better annual return in retirement, you might use 5%. Either way, 4% is the general rule of thumb.
Lets say your living expenses you are comfortable living on is $80,000 per year, and you plan to withdraw only 4% of your total balance each year when you achieve early financial freedom, you can calculate how much money you need to accumulate.
- $80,000 ÷ 4% = $2,000,000
In order to live on $80,000 per year, you will need to accumulate a total of $2,000,000 total to ensure you never run out of money in retirement.
The hard part – determine how to get there
The formula is an easy one, but actually accumulating the amount of money needed to achieve early financial freedom is no easy task. However, many entrepreneurs have shown us how to accelerate the process to achieving early financial freedom.
They all have one thing in common, and that is they created multiple streams of income throughout their lives. The more streams of income you have the quicker you will get there. Here are some revealed income streams with great rates of return.
Get rid of your bad debt
First and foremost, bad debt is only slowing down your progress towards early financial freedom. What is bad debt? We define bad debt as debt that has high interest rates and most often is non secured. Examples of bad debt may be:
- Credit cards
- Unsecured personal loans and lines of credit
- Car loans
Each of the above types of debts either have a high interest rate nature (credit cards, personal loans and lines of credit), or are used to purchase a depreciating asset (car loans, boat loans, etc.).
By paying off your 25% interest rate credit cards, you are in essence, making a 25% return in the form of interest that you “otherwise would have paid” to the credit card company. You are saving yourself from paying the cost of high interest bearing debt, by paying that debt off as quick as possible.
In many cases, using a debt consolidation loan may save you money on your high interest bearing debt by combining all your high interest credit cards into one lower interest loan with one payment.
House hacking for passive income
This process is taught in greater detail by the real estate investing community BiggerPockets. I first learned how house hacking works from reading “Set For Life” by Scott Trench, the Vice President of BiggerPockets.
By purchasing a multi unit home such as a duplex or triplex, you can easily live in one unit while renting out the other, generating much higher than average return on investment. That along with your regular income from your full time job will accelerate your progress to achieving early financial freedom by tens of years!
Early financial freedom requires regular investing
Regardless of how much extra money you have available to invest, the important thing is to begin investing what you can today. Whether you are working towards early financial freedom or simply being able to retire by age 65, you will not get there without investing regularly.
Recommended Reading: How To Invest In The Stock Market For Beginners
If you're new to investing or have less than $25,000 of investable assets, your choice of investment vehicles in the stock market are not as important since the difference in rates of returns on a relatively small balance will not change your progress by anything worth noting.
If this is you, your best option is to begin investing with a trusted robo advisor. Robo advisors allow you to invest in a professionally diversified portfolio with as little as $5, and even have access to professional help. The portfolios are put together for you by a professional financial expert, and are customized to you based on your investment goals.
Once you've attained larger amounts of investable assets (above $25,000, or even $100,000 and above), what you invest in becomes more relevant. As you attain larger amounts of investments, be sure to seek the advice of trusted financial experts.
Personal Capital, an automatic budgeting software, allows anyone to use free financial tools to track their financial progress. They give you access to expert financial professionals who help you choose and plan for your investments, allowing you to ensure your path to early financial freedom is well planned.
Be an ambitious entrepreneur
Being an entrepreneur doesn't require that you quit your day job and pursue your new invention idea full time. Rather, you can keep your salaried job to help you apply the above listed steps, while dedicating just an hour or two each day to creating multiple streams of income.
These come in the form of building an online business, doing freelance work, working on your next big idea/invention, and continually educating yourself to expand your entrepreneurial mind.
Some examples of easy to start entrepreneur businesses are:
- Build an ecommerce store
- Create an affiliate marketing website
- Make money email marketing
- Start a blog
- Build a freelance business
The options are many, and your potential is nearly unlimited.
The Secret To Achieving Early Financial Freedom
The truth is, there is no secret to early financial freedom, that is in the sense of a magic formula or trick that will make you rich overnight. There is, however, a guaranteed result of consistent effort in applying the above formula. That result is called “compound interest”.
Progress may seem slow in the beginning, but as you grow your overall net worth, pay off more debt, and start making more money, numbers begin to work in your favor very very quickly. Allow me to illustrate in the following example:
If you were given one cent ($0.01) and it doubled in value every day for 31 days, how much money would you have after 30 days?
The answer: $10,737,418.20
Would you have believed me if I told you that before you knew the answer? The point is, doubling your money when you have $0.01 vs. doubling your money when you have $5 million dollars is drastically different.
The more money you accumulate, the bigger and faster your progress will become towards early financial freedom. The more streams of income you create, the quicker your progress will be as well. Notice that the biggest changes didn't happen until the last couple days of the month!
Many entrepreneurs have proven that it doesn't take an entire 40 year career to retire, but rather when you use math to your advantage and work hard, you can easily achieve financial freedom at a much earlier age.
What is your biggest obstacle in achieving early financial freedom and why? Post your answers, questions and comments below and i'll personally respond asap!
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Interesting article – thanks for posting.
I think financial freedom means different things to different people but in all cases I do agree that it means having money left over after all expenses paid – those expenses include the little (or big) luxuries we deserve in life.
I was a financial adviser for 30 odd years and found a couple of things that were common to those who appeared to have financial freedom.
1. They started off with a written goal and a detailed plan to get there.2. They were disciplined and stuck to their plan. Plans were fluid enough to make adjustments for unforeseen occurrences.3. They loved what they did.4. They did not go out and buy the newest and best until they reached their goals and even then the habit of saving was so ingrained that the “best” was often not worth it.5. Property and shares (capital growth items) were the cornerstone of their portfolios.6. Most of them believed in life assurance to take care of their family or themselves in the event of disabilty if they were derailed.
For those who never got wealthy there were common traits too.
1. They would start saving “tomorrow” – as soon as the current debt had been paid off.2. They believed there was “plenty of time” to start saving, later!3. They hated what they do.4. They had the best toys – always on credit.5. They lived for the moment and had no plan or concrete goals.6. They always blamed “life” for their predicament.
I sincerely hope that people take up on your article and read the books you recommend and then act on that information.
BTW have you ever read “The Millionaire Next Door”? Its a fascinating book and one I highly recommend.
Great points, Lawrence. Yes I have read The Millionaire Next Door, one of my favorites! Definitely a good read to learn about the habits of today’s millionaires.
Everyone wants early financial freedom, but it’s not as easy to be achieved. I’m thirty six, have two kids and a lot of bills to pay. It’s almost impossible to save money at the end of the month. I have noticed that if my incomes increase, in parallel in real life even the expenses increase. Please can you suggest any method how to save money and help me solve this dilemma?
Yes, financial freedom can be a difficult process and requires patience. However, I very much (and respectively) disagree with with the second half of your comment. Here’s why, along with my suggestions.
Yes, it is difficult when you have bills to pay and a family to support, I can attest from firsthand experience. I would approach saving money by first evaluating your budget and determine where your expenses fall between wants and needs.
In most cases, you will find it easy to find an extra few bucks here and there that add up and can serve as your starting point of saving money each month.
If, after evaluating your budget, you still don’t have any wiggle room to save money after living expenses, then your focus should be on increasing your income. This begins with getting a part time job, asking for a raise from your current employer, doing freelance work for extra money, or delivering pizzas on the weekend (for example).
The idea is to get started saving YESTERDAY by any means possible. As you seek for ways to save on expenses or seek to increase your income, then your ability to pay down debt and to save will become increasingly easier.
Which takes me to my response to your second half of your comment. Why do your expenses have to increase when your income increases? This should not be your reality, and is not “real life”, but rather a lack of financial priorities and/or budgeting properly. Your income increasing DOES NOT have any impact on your expenses by any means.
Your mindset when you get a raise in income, should not be “Now I can afford that new car”, but rather it should be an excitement that you now have the ability to pay off more debt, save more and create a healthier financial outlook.
The idea is to live on less money than you make, and, to your best ability, create a financial scenario where you are able to be more selective in what and when you are able to pursue higher paying careers and opportunities.
Worst case scenario by following this process, is that you work a full 40 year career and have a retirement nest egg saved up come retirement.
Best case scenario, is that your healthy financial habits allow you to quit your salaried job in the near future, and allow you to build a very successful small business, or seek entrepreneurial ventures that accelerate your savings to early financial freedom.
I am in my early fifties, have a pension plan with my employer which should provide about half of my actual salary when I retire in 7 or 8 years, a 12 unit apartment building (which is not paid off, but pays for itself) and some mutual funds investments. My question for you is this: when I purchased the apartment building about 5 years ago, I put in all of my Retirements savings in it and used some lines of credits to get to the 25% equity needed to borrow from the bank.
I originally thought that the building would be able to make enough profit to pay off the lines of credits I borrowed, but it’s not the case. Now 5 years later, I still have a lot of those “bad debts” but I managed to get incredibly low interest rates from the bank.
Should I go on until I retire and then sell the building and cash in the equity I have gained up until then or should I sell it now and end up with 5 years of work with nothing to show for…but with no more debts…
I found myself in the exact same scenario as you in terms of purchasing an investment property and using a line of credit to help with the down payment, so I can relate firsthand.
In my mind, a bad debt is one that is taking you backwards and not forwards. In most cases, bad debts are debts that have no collateral such as a credit card, or a depreciating asset such as a car loan.
In your scenario, If it were me I would look at it entirely from a logical standpoint. If your investment properties bring in enough to pay for the mortgage AND the lines of credit, as well as bring in a little left over to set aside for maintenance, then it is essentially paying for itself. The risk you take is not having any tenants and the income dropping, but hopefully your savings for maintenance and months with fewer tenants can cover that.
If it is able to run itself without affecting your personal finances negatively, I would keep it if it were me. Because, technically your tenants are paying down your equity for you, not affecting your income outside of this real estate.
If, on the other hand, you find yourself having to dip into your money outside of the real estate investments to keep things up and running and making payments on time, then I would look at selling and restructuring it so that the real estate is able to pay for itself and then some, which will benefit you in the long run.
A book you might enjoy about this topic by the VP of BiggerPockets called “Set For Life” sounds like it may fit you perfectly and help answer your question with even more detail.
Follow the link above to see it on Amazon, or you can read my book review of “Set For Life” by Scott Trench here.
I hope that helps, and best of luck! Sounds like you’ve got your hands in a few different areas of investments and entrepreneurship, which I am always a HUGE advocate for and believer of. Keep in touch!