I have a passion for investing. I then started wondering what financial independence was and how i could achieve it. While i have a low income compared to the living expenses in the country i live in, i have a goal of achieving financial independence, even on low income.
Financial independence is when a person has enough money generating assets (Cash-flows) which can cover all expenses. The cash-flows typically come from what is known as passive income.
Financial independence means that you have enough wealth to live without a job. Being financial independent do not mean you are rich. Heck, you can achieve financial independence even on a low income. Financial independence can be reached through multiple strategies. Examples of how financial independence can be reached:
- Save until you no longer has to work
- Invest difference between income and expenses
- Start a business (to sell for a huge profit, or to collect ownership salary)
No matter the strategy to reach financial independence, one thing is fore sure – Reduce expenses while accumulating cash-flowing assets.
Financial Independence and Passive Income
Financial independence is often associated with the retire early movement. However, the retire early movement is often described as not working at all when first retired. Whereas being financial independent will require small amounts of work. For example, if being financial independent through stocks paying dividend it is relevant to follow the market for company and industry changes. Furthermore, financial crises like the housing bobble can significantly influence your income if you are a real estate investor.
To become financial independent one should generate cash-flow for expenses. With the internet, passive income has never been more accessible.
Passive Income Ideas:
- Dividend from stocks, bonds and high yielding saving accounts
- Rental income (Could be anything from industrial buildings to residual complexes)
- Interest (such as P2P lending and crypto lending)
- Business ownership (A business you has to operate at minimum levels, e.g. being an business investor)
- Affiliate marketing (E.g. if you sign up and invest on Envestio, Mintos, FastInvest or decide to make a blog provided by the best website provider, i get a commission – Affiliate marketing)
- Royalty income (Books, EBooks, music or photographs)
The list is endless when it comes to passive income ideas. However, the most important when accumulating cash-flowing assets, is that the younger you are when beginning to invest, the more you can accumulate over time. This might sound logical, right? While it sounds logical, it has a bigger impact than one might think.
Start Now or Later?
|Age when starting||20||40|
|Money when starting||10.000||50.000|
Consider Jon and Bob. Jon is 20 years old when he started investing. He had 10.000 to invest. Bob, however, started when he was 40 years old. Yet, Bob had 50.000 to invest. Each year Jon contributes with 5000 extra to invest. Bob however, has 10.000 a year extra to invest. They both expect to retire when they are 65 from their investments. Look at the chart an tell me if you want to be Jon or Bob? The main difference here is that Bob started 20 years later. Even though Bob started with 40.000 more than Jon, Jon has 3.000.000 more than Bob when they both retire.
When you are in the lower income brackets you would typically be a Bob. That is understandable, but if you had to think about your long-term financial perspective, you need to do like Jon. This is also how people achieve financial independence, while being on a low income.
The example is without taxes, debts, and other liabilities.
The Mathematical Formula
There are multiple ways of calculating when and the time to gaining financial independence. However, the traditional formulas calculates when you reach financial independence, i prefer the calculation method of how long i am financial independent. This is due to the simple fact, that if i have a life expectancy of 90 years, i will have to be financial independent in 90 years minus the age i am today. This puts my focus on the right path. Whereas you might like the approach to when you can gain financial independence.
The formula for financial independence duration is rather simple.
This is where:
- A = liquid assets (stocks, cash, bonds, etc., things that can be converted to cash quickly).
- E = Monthly expenses
- PI = Monthly passive income, and semi-passive income.
To give a simple example: Lets say Jon, from the last example, had liquid assets of 20.000 and expenses for 3500 a month with a passive income of 1000.
A/(E-PI) = 20.000/(3.500-1.000) = 8 (Months)
As seen in the calculation above, Jon would be financial free for 8 months. Jon can chose to either reduce expenses or increase assets and passive income.
The pitfall of this model is the fact that it considers assets as a term of payment. Therefore, if your passive income is from dividends and your assets is stocks. You would have a decreasing passive income, when selling stocks to pay expenses.
However, the focus is to gain passive income. If the passive income exceeds the expenses, you are financially free.
How to Achieve Financial Independence
Starting the post i suggested different ways of achieving financially freedom through passive income. However, whenever you have more money, you spender more money. Hence, you lifestyle follows your wealth. Unless you are smart about it.
Graham Stephan is a well-known real estate investor who practice the frugal lifestyle. Graham has shown how you can get a Tesla model 3 for only 78 dollars per month. Furthermore, he is a true hustler when it comes to saving and investing.
Another big inspiration of mine is Jørgen Wolf at financiallyfree.eu. He has focused on p2p-lending and recently began to buy real estate. Another true hustler to get passive income for his financial independence.
Steps To Achieving Financial Freedom
Step 1: Track All Expenses
The first step to financial freedom is to track all of your expenses. This means ALL. Whether it may be energy drinks, Starbucks, Avocado toast etc. It is important that everything which costs you money is included in the part of your budget.
Read my guide on how to get started on tracking you expenses.
Step 2: Make a Budget
Now that you know all of your expenses you should make a budget. This budget is important, because if you use more money than you earn, you will never reach financial independence.
Read my guide on how to make a proper budget.
Step 3: Build an Emergency Fund
We have all tried that something unexceptionally breaking. The car, the laptop, the oven or maybe just a closet. However, it is important that you have the funds to repair/replace immediately, without taking any debt. The amount which you need to save is different from country to country. But i recommend that you save between 3-12 months worth of expenses.
Read my guide on building an emergency fund.
Step 4: Cut Expenses
Now the hard part begins. You will have to cut expenses which is not needed. Here you need to keep your logic in place. Do NOT terminate health insurance because you are healthy right now. However, you should look at your Netflix subscription and reconsider its worth. If you have the more expensive subscription, you should get the cheaper option. This also applies to music services like Spotify. Most of the music on the platform are on YouTube or SoundCloud anyway, and those services are free.
Furthermore, if you live in the city and has a manageable distance to work, you should consider selling the car, or just get an economic car. There is a huge difference on costs when comparing small cars like a Volkswagen Up to an middle class car like a Audi A4. Insurance, gas, in some countries taxes.
Read my guide on cutting your expenses.
Step 5: Remove Debt From Your Life
You should pay of any debt related to cars, houses, vacation or other liabilities which only makes you poorer. Removing debt can take a long time. Your focus should be removing the highest interest rate first. No matter if the debt is 50 or 1.000.000 the highest interest rate, is what will accumulate the highest costs (as a rule of thumb). There are many different methods of paying of debt, and taking the highest interest rate first, is just one of them.
Debt is an important factor based on two reasons. One, the interest rate on liabilities such as cars and personal residents are typically higher than you can achieve to earn in the stock market. For example, if you interest on the house is 7,5% and you generate 6% in dividend from the stock market. Paying of the debt on the house will yield 1,5% in relation to investing in the stock market.
Two, when you are free of debts, the money can go to income producing assets rather than liabilities.
Read my guide on how to get out of debt even on a low income.
Step 6: Earn More Money/Increase Your Income
This might shock some of you. “Work more? But i wanted to be financially free?” you say. Well my response is, the faster you get cash-flowing assets, the faster you can retire. Lets say you start a business today. The same business you will sell for 10.000.000 in 5 years. With an dividend strategy you could get around 5% dividends after tax. That would yield you 500.000 a year to live. This is an unlikely scenario for most, but the sky is the limit. Find a side hustle which you can be passionate about. You can even find a side hustle you hate, but makes good money. It does not matter when the end goal is to be financially free. However, it is just more fun to do something you like.
Step 7: Keep Grinding
Weird as it may seem, it comes with long work hours to be financially free. You still have to track all of you expenses, review if any expenses can be cut, finding new stocks/following the stock market, apply for loans to rental properties and so on. Being financially free comes with the commitment of work. Even people claiming they are financially free still do work. They have blogs, does YouTube, has multiple rental properties and so on. Such work types allows for passive income, but to keep the ball rolling you have to push it. In other words, you still have to work.
Step 8: Kick Back And Relax
Whenever you have reached the goal which can pay for expenses and other costs you might want, you can relax. Hire a property manager to manage the properties, financial adviser to keep track of stocks and dividend, virtual assistants to update blogs, etc.
The financial independence is in essence a difficult stage to reach. However, it can be obtained through discipline and hard work. The sooner you start cash-flow investing the sooner you can have financial independence.
Financial independence is attainable even on low income. With the calculation shown, you can find the appropriate amount of income you need to be financial free. This means, that you can adjust your expenses and be financially free even being in a low income bracket.