If your goal is to reach early financial independence, you will need a lot of firepower to do so. Your time horizon is short, so you must use this exceptionally short time window wisely. The only way to realistically get to early FI is to acquire as many assets as possible. To maximize your progress, you will need the following:
- Earn a high income.
- Save as much of your earned income as possible.
- Earn additional income through side hustle ventures.
- Start generating passive income as soon as possible.
- Re-invest all excess funds into acquiring more income producing assets.
Of course, the above is easier said than done. After all, you have no control over how the markets will react during your working years. If you start near a market bottom, you’ll have a reasonable chance of capitalizing on substantial appreciation gains. However, if the bulk of your investments are made near a market top, you’ll be in for a rude awakening if a collapse occurs just as you are ready to exit stage left.
Cash Flow Rules
In any event, your primary focus MUST always be on increasing your cash flow. If you buy the right type of assets, the cash flow will hold steady even as the underlying principal oscillates off the screen in times of uncertainty.
Further, an added wrinkle that gets introduced is the concept of leverage. Some investors love it and swear by it since it allows them to rapidly accumulate valuable assets in a timely manner. On the other hand, there are investors who are more reluctant to take on the added risk. If the thought of using leverage keeps you up at night, it’s probably not the best strategy for you.
You must assess your own situation, and ultimately find the right balance that works for you.
Focus on the Income
I’m a firm believer that the quickest path to early financial independence is through earnings, not savings. In other words, focus on your offensive gameplan, and not so much on pinching pennies or cutting coupons.
Granted, you need to save a large portion of your income, but you don’t need to overdo it. For instance, if I have a craving for a pumpkin spice latte at lunchtime, I’ll go buy one. It’s all about finding the right balance between enjoying today and saving for tomorrow. Extreme frugality, as a strategy, should only be utilized if you know for certain it will not break your spirit. If your morale dies, so will your progress!
These days, I don’t keep tabs on a budget, and spend as I see fit. Quite frankly, my time would be better utilized trying to find the next killer investment as opposed to trying to save 50 cents off a box of cereal. In other words, if I’m trying to invest $100,000 into buying more assets, I need to focus on ways of increasing my net returns from 10% to 15%. That’s the difference between earning $833.33/month and $1250/month in cash flow. If you’re successful in finding ways to generate that extra $400/month, you can buy as much cereal as you’d like afterwards.
Compounding is absolutely at its most powerful when it’s snowballing an object of massive proportions!
The easiest way to introduce offense is to get a job. Ideally, a high-paying one. A JOB will of course require your time, since it’s earned income. However, for most of us, this is unavoidable and simply the price of admission we all have to pay to help us reach the end game of financial freedom. So, suck it up and get to work! If you’re lucky, you’ll land a job that also regularly pays out: bonuses, stock options, RSU’s, ESPP, etc. Take everything they will give you. For the first few years, at least, your JOB will be your primary source of income and your most important horseman.
Full disclosure: In my own situation, I’m an engineer working in high-tech. I earn a fixed salary of over $100,000 that is evenly distributed throughout the 52 weeks of the year. My bi-weekly paychecks are always the same, regardless of how many hours I put in. My biggest pet peeve is the fact that I actually have to be in the office (physically) for 40 hours each week (minimum). However, my job does offer some pretty good benefits such as: bonuses, stock options, RSU’s, and ESPP. I am fortunate in this regard. These rewards are extra, and provide a boost to the base salary.
At this stage of the game, this horseman is still absolutely needed. My plans would fall apart without the earned income.
The second horseman is side hustle income, which is still considered earned income. It may be something you do in the comfort of your own home, without any real commitment (or consequences), but it still requires you put in hours to earn a paycheck. There’s nothing wrong with that, and a side hustle gig is a great way to add extra income into the mix. Some popular ideas are blogging and freelance writing. These are relatively easy to do (doesn’t require training or special equipment), and the barrier to entry is low.
Full disclosure: I write on a blog (obviously), and this is something I do in my spare time. I don’t yet earn much from it (maybe enough to buy a steak dinner every month?), but it is my goal to try and build up this “business”. I would love to see the day when this site is earning $1000/month (just being honest), but that by no means is the main objective of this blog. Freelance writing may be a better option to earn side hustle income at this time.
At this stage of the game, this horseman is weak and not contributing much to the offense. It’s still a baby colt! My plan is to focus on more side hustle ventures in 2014. This includes blogging, and freelance writing. Freelance writing seems like the most logical starting point to actually start earning some side income, though.
The third horseman is easily my favorite, the early FI income stream! The first two horsemen will help you get to financial independence, but this stream is the one that will allow you to enjoy it! The early FI income stream will consist of any cash flow that is generated through passive, or semi-passive investments. For most people, this will mean owning assets in: stocks, bonds, mutual funds, real estate (single family homes, multi-family apartments, commercial space, public storage, etc.). Remember, assets are your ticket to freedom, so work on acquiring as many as possible.
Full disclosure: Before I set sail off into the sunset, I would like to build a substantial investment portfolio made up of mostly real estate (single family homes, multi-unit residential properties). The current goal is to reach 10 properties by the end of 2015. Today, the rental income is right around $1300/month.
In addition, I would like to rebuild a dividend portfolio so that I have funds that are readily available and easy to liquidate. The dividend portfolio will serve dual purposes: 1) Cash flow reserves. 2) Additional passive income yielding around 3% to 4% annually.
At this stage of the game, this horseman is still young, but growing up fast! We ended 2012 with a passive income stream generating $777/month (including retirement accounts). By the end of 2013, the passive income stream will be at $1300/month (excluding retirement accounts). It sure would be amazing progress if I’m able to double the cash flow each year until I retire!
The fourth horseman is my least favorite, and the one I’m starting to neglect. This is also the one your employer encourages you to invest most of your spare capital into as well, because it’s one that will force you to stick around. You might have guessed it, we’re talking about traditional retirement plans!
Traditional retirement plans are set up to promote employee retention since you can’t easily access the funds until age 59 1/2, which defeats the whole point of early retirement. Your employer lures you into investing by often times providing company matching (free money). Free money is never a bad thing, but if your goal is to reach early financial independence, you probably shouldn’t invest more than up to the free match. You’ll need the extra capital to help build up your early FI income stream, instead.
Full disclosure: When I was a young buck, I threw all my spare capital into the 401k and Roth IRA retirement accounts because I didn’t know any better. Early retirement never even crossed my mind…
In hindsight, it wasn’t a mistake because I’m now sitting on $150,000 in retirement funds. These days, I just believe I know how to better invest that capital. My rationale is, “why invest in a 401k and Roth IRA that will only feed me later in life, when I can invest in rental properties that will feed me both today and tomorrow?”
This year, I firmed up my gameplan and realized that I wanted to now retire at age 30. In order to make this possible, I decided to stop all 401k deductions in June. The retirement plans aren’t all bad though. They do give me a backup plan in case my early FI plan fails, and I have to keep working until traditional retirement age. Further, the 401k and Roth IRA count towards capital reserves, so are extremely useful when you’re trying to get loans for rental properties.
At this stage of the game, this horseman is sufficiently grown (fed)… and can probably stand to shed a few pounds. I don’t have any future plans to invest again into a 401k or Roth IRA.
To reach early financial independence, you’ll need assets that produce cash flow. In order to get to the end game quickly, you’ll need to buy up as many assets as possible.
Focus on the four horsemen! More specifically, utilize horsemen 1-3 to help build up as much income as humanely possible. Re-invest the excess into buying even more assets. Lather, rinse, repeat. Over and over again. Soon enough, you’ll have the cash flow needed to allow you to retire early.
In regards to horseman #4, if your plan is similar to mine (you want to use leverage to acquire properties), it may be worth building up this colt, to some degree. From my own experience, I stopped funding traditional retirement accounts when their total value reached $150,000.
The great thing about the 401k is that all contributions are made with pre-tax dollars. If you get a company match, even better. This makes the task of building up this portfolio even easier… and when you get to underwriting, the pre-tax dollars will count ~70% towards capital reserves! The 401k is a great tool to use to get through closing.
Here’s my own visual aid to help summarize:
For fun, here’s a far-reaching goal for me to aspire to (not my actual numbers):
About $198,000 in yearly income. One can dream, right?