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Reaching for FI

Unless you got some lucky windfall to jump to financial independence (FI) you were working hard through stages and thus acquiring not only the resources of which to live off but also the discipline and habits that will make and keep you financially independent.

You made some serious and good decisions about your goals and lifestyle you want.

And even if you’ve got here getting some inheritance or winning the lottery to keep your financial independence secure you depend on the regular income which must meet your spending.

This income is supposed to be of passive nature, meaning you don’t need actively to work for it. Examples of passive income are:

  • Profits from business you don’t materially participate
  • Dividends or interest income
  • Rental income
  • Royalties paid for intellectual property such as music, books, manuscripts, computer software, or a patent

Of course there are many people working long hours and hard in this areas to earn money. But the key phrase here is »you don’t materially participate« as this is supposed to be low risk and passive income, remember! If you need to control and shuffle your portfolio on monthly basis that can’t be considered passive income. It can be a hobby, but you sure ain’t passive about it 🙂

It is also wise to diversify passive income between stated categories and thus lower risk of running into trouble.

Life beyond pay checks

There are definitely more ways to achieve financial independence and freedom, but some are just way too unreliable to be recommended. I don’t believe a lottery ticket can be called a good (retirement) plan and neither do I believe in random good-willing email propositions offering us provisions on gold or money transfers from Nigeria that would make us instantly rich as James Veitch beautifully presented.

We already discussed how it’s like being on the side that is paying for the money lent and issues with that. Now we are talking about the opposite side – being payed to lend money or assets and using that income to support our needs.

This income is usually called passive income in reference to requiring minimal to no work to maintain it. Examples of such income are property rentals, interest income, royalties for intelectual property or patents, dividends etc. Obviously all of this can require huge involvement, time and effort, however following certain strategies they can result in minimum involvement with satisfactory result (using a rental management service to manage rentals, using a »Lazy portfolio« strategy for portfolio investments, etc).

The purpose of passive income is to provide us with income needed while pursuing interests that may not produce (sufficient) income. Not all musicians can live of making music no matter how much they love it. With financial independence it can suffice for the musician to simply enjoy composing, producing, playing or listening to it.

When such passive income is at the level to cover our basic needs like calories&shelter we have reached financial security – you have saved and invested in a way to provide you sufficiently for the bare existence without the need to work for another day in your life. The fresh air you’re breathing? It’s the scent of freedom from now on!

Freed from living off pay checks this releases most of our time (40 hours per week and more) for such interests if you wanted to do it over anything.

The breaking point

When working toward financial freedom an important milestone is the achievement of »the breaking point«. This is the time when you’ve moved to  having positive net-worth.

Net-worth is simply calculated when you sum up all value of assets (money, housing, equities, etc) and then substract debt from that. The breaking point is at 0, when value of assets is the same as all existing liabilities.

You might want to calculate your net worth at the moment, to see where you stand and compare it with others on a global level at the Global Rich List. Do it, you could be surprised..

Turning over to positive net worth free agency is achieved, enabling ability to do what you want. You can quit job and take time to pursue opportunities without liabilities hanging over your head. You have eliminated all debt and saved some money to live off of it for a while.

Having said that, some debt can be good to be had (especially with interest rates in some parts of the world being below zero in 2017). An example would be having it invested in business or assets generating earnings higher then the debt interests. But achieving this stage means money saved is sufficient to repay liabilities instantly when circumstances change.

With this you move beyond mere survival of all the expenses hitting you and paying a mark up in the shape of interests on debt. The money available is spent efficiently. What’s more money is accumulated beyond being a mere safety net towards starting to work for us.

Are you paying.. or receiving?

 

There are two kinds of people in this world – those who pay interests and those who receive them (Hat tip to Clint Eastwood). Buying things on credit means you are paying the price on the tag and then some. The latter part being interests going to those that had lent you the lacking money for the while until being repayed.

You are paying for the money. While a few percent mark up may not seem much it adds up pretty quickly. It’s a very successful business model for many organisations and people who live off of this.

For example lets take a look at the price of a leased car (leasing being is at all times high currently).  If a car carries a price tag at 30.000$, paying in cash up front that is also the money you spend on for buying the car. If you are paying off the lease at 5% rate for 1 year, money spent would be nearing 31.000$, but having a lease for the currently average 72 months expense is getting to about 35.000$. That is 5 thousands that could be saved or available for additional things to enjoy. That is almost 20% more than the intial price tag said. Imagine anyone convincing you what a good buy it is to buy something  priced at 30k with 35k of money? Except the creditors of course, just not with those words..

Reaching the stage of financial stability is to eliminate bad debt and to accumulate a buffer of savings. Debt can be good under certain conditons, like if it’s an investment for the future like education or businesss growth. Also when debt is aquired to limit bigger damage like using it for immediate health reasons.

Bad debt however is when debt is aquired to finance consumption and this should be eliminated, which leads out of dependence on debitors and leads to immediate savings due to not paying the interests.

If owing on more then one account, different methods can be used to prioritise which debt to eliminate first. On one hand repaying debt with highest interests and latter others (debt avalanche method) would have biggest effect, however sometimes going by increasing steps is more achievable (debt snowball method).

Other part of reaching for stability with finances is to accumulate a buffer of savings for for unexpected events and expense, like losing a job, car breakdown repair, etc. Such costs can be high relative to our income. Suggested amount of money to be saved for this purpose is between 3 to 6 months of expenses. This amount should be made easily available like in a bank account, not invested in equities which value can fluctuate significantly nor term deposited due to not being available immediately.

When we have cleared bad debt and accumulated the buffer our finance become stable. No longer unefficiently »leaking« money away and less prone to becoming indebted to some urgent unplanned expense.