So you want to make your escape from the corporate rat race? You want to gain back the freedom to live your own life? Reaching the goal of Financial Independence is a fantastic achievement. It definitely can be done, I’m living proof of that!
Be warned though: The Road to FI isn’t always easy…
The Road to Financial Independence is a long, empty, and lonely road. Other than your passengers, there are no other cars in sight. Other than people on the internet, I’ve never actually seen anyone else on The Road.
Going it alone can be tough. Uncertainty about your direction and the process of achieving FI are real concerns. So when readers ask me questions, I really try to answer them…
Today’s reader question: “I’m saving about 25% of my income, but it’s taking a long time to get anywhere. How do I reach financial independence faster? Should I focus on saving more? Or, is it more important to learn better investing?”
Mr. Tako’s answer: It depends! It depends upon where you are on The Road to FI. Without a doubt, saving is most of the work (maybe 75% of your effort). The other 25% of the effort is about investing (and learning investing). Where and when you apply that effort is actually pretty important…
How The Road Changes
Imagine The Road as a highway leading up into the mountains off in the distance. The peak of the largest mountain is your goal. From the starting line ($0 net worth), it looks easy. Everything looks easy when you’re young!
There’s a long, straight paved road at the start. It looks straight, and flat. Intuitively we know it isn’t going to always be this easy. We don’t realize how hard it’s going to be. We know the terrain is going to get steep. We’re going to need four-wheel-drive, and climbing gear at some point….we just don’t know when.
Early Days On The Road To FI: $0 to $200k
The beginning of The Road is flat and easy. These are the Early Days, and you’re going to be young and full of energy. At this point in your life, your financial responsibilities are probably minimal. The Early Days should be all about maximizing savings and working hard to get that promotion at work. Saving is most important when you have this few assets. Save as much as you can – 50% is a good starting place!
Initially, your earnings from investments are going to be tiny. Say for example you save $100k in your first few years after college. With a “normal” stock market return of 7% you’re going to be looking at returns of only $7,000/year. That’s nothing to sneeze at, but it certainly isn’t anywhere close to $26,250 (50% savings from a 70k job after taxes) Your savings for the year are going to far exceed your investment returns.
My advice for people in the Early Days: Skip the social life. Keep your foot on the “savings” pedal. Focus on saving as much money as you can, and working hard. Save 50% or more. Live with roommates to keep costs low. With luck, you’ll get a promotion at work, and break free of the “Early Days” that much quicker. Don’t worry about trying to make great investments at this point. Your investment returns will be insignificant next to what you can save. Just dump it into a index fund and keep saving. Make good use of work 401k plans and matching programs. Start reading some good investing books.
Middle Of The Road To FI: $200k to $600k
So you’ve been able to save at least $200k. You are at what I call the “Middle of The Road”. Your annual return from investments is probably going to be at least $14,000 (at 7%). Meanwhile you’ve kept expenses under control and are still saving at least 50% of your salary…which has probably grown due to hard work.
Saving is still going to be the most important thing you can do! Saving 50% should now be like a bad habit…impossible to stop!
By now, you’ll probably have extra money for some fun! A social life and limited travel probably wouldn’t hurt….but don’t get tricked into buying luxury possessions, those things are detours that can seriously derail your Financial Independence. Your peers may be buying these things, but don’t stray from the path. Resist the social pressure!
My advice for people in the Middle: The “Middle of The Road” is a good time to learn about other investments. Start learning about different funds, REITs (or Physical Real Estate), Preferred Shares, small businesses, and Stocks. Educate yourself and begin diversifying your investments.
You’ll also want to start building up a taxable account, while still contributing the maximum to tax-exempt retirement accounts. As you build up the taxable account, it will begin spitting off dividends. For now, just keep reinvesting the dividends. Don’t spend them!
All the tools and knowledge you build now are going to help you later on…when things get tricky; when you own houses, rental properties, and have real responsibilities like kids and a spouse.
“Later Days” On The Road To FI: $600k to $1.2m
At this point, your income from investments is going to be pretty significant. Your portfolio will produce returns nearly as large as you can save per year. Somewhere between $42,000 to $84,000 using our hypothetical 7% return. Financial independence actually looks possible! But this is also where navigating the road has the most pitfalls and distractions. The Road is toughest here. It’s filled with life’s endless financial pitfalls…like a broken furnace, or braces for your kids.
Saving 50% or more should still be on auto-pilot!
My advice for those in the “Later Days” on The Road to FI: Financial independence is coming soon. Now is the time when those investments skills are needed. Prepare yourself to live without a job! Diversify your income streams! Start building up side-gigs or micro-businesses to bring in income from outside of work. Funnel more cash into the taxable account and build a dividend growth portfolio that spits off significant cash flows.
Finally FI: $1.2m and beyond
So, you’ve finally reached Financial Independence. Congratulations! A portfolio of $1.2 million (or more) can produce $36k/year at 3% and $48k/year at 4%, depending upon which rule you like to use. That’s enough to live-off in most of the United States!
Because your spending hasn’t grown much over the years, investment income should now exceed your expenses! Your lifestyle shouldn’t need any significant changes!
Well done! A job is now optional. It’s time to execute your escape plan!
Job income will now become less important than investment income and alternative income sources; these should now be your main focus.
Investing “skills” are paramount at this stage, because they will sustain your Financial Independence. I hope you’ve been learning and practicing!
The frugality skills you built-up (to save 50%) should still be in place, but now they can be used for having frugal fun!
Now, take a moment to breath deep and reflect. You’ve worked hard. You’ve busted ass to get here. It’s time to really live and enjoy life. No more Monday morning staff meetings. No more jerk bosses. You are free!
I reached my own Financial Independence at the age 38. My road was filled with potholes and detours. It was a terrible mess.
I made every mistake in the book. I didn’t even start at $0. I started at -$50,000. I wasted tons of money on stupid stuff, like cars! There was a couple recessions along the way! But eventually, I did arrive. No speed records were broken, that’s for sure!
In your case, you might reach FI sooner than I did. Or, you might reach it a little later…but you CAN reach it.
Remember, it’s not a race. The important part is just staying on the path. Remain true to the principles that got you here…there is a reason you made it this far.