“Real wealth is not about money.
Real wealth is: not having to go to meetings, not having to spend time with jerks, not being locked into status games, not feeling like you have to say ‘yes,’ not worrying about others claiming your time and energy.
Real wealth is about freedom.”
Tweet from James Clear
Author of Atomic Habits
The term “financial independence” always felt like something rich people did.
Something you’d hear from a bratty, aristocratic, sixth generation multi-millionaire twenty-something fresh out of college. “No daddy, I don’t want to be Vice President at your huge company after I graduate. I want to take a year to travel Europe. Maybe go to art school in France. Be financially independent.”
Financial Independence was for “the others”. For the elite. Not for me.
It took getting broke living a consumer-driven lifestyle on a huge salary to reset my relationship with money. And with my journey toward financial independence.
As a young adult, I saw money as the solution to all of life’s problems. And, therefore, an abundance of money could solve all of life’s problems. So much of my time and energy was focused on climbing up a corporate ladder in pursuit of more income, I forgot about two very important things: my expenses, and my time.
The goal of financial independence is simple: have enough passive income to cover your living expenses. Once you no longer rely on a job for money, you have the freedom to do what you want with your time.
Financial freedom does not necessarily mean leaving your job. Many financially independent people continue working in fields they love. Some start their own businesses. Pursue the arts, or philanthropy.
Financial independence does give you the most valuable, non-renewable resource in the world: time. You can always make more money. You can not make more time. This precious resource of time will be invaluable in your journey to becoming just one percent better.
The pursuit of financial independence on your journey to a life that’s just one percent better everyday can be a difficult one. Like most things, your attitude is critical, and will make or break your experience.
And while the idea of exposing your finances might be stressful, even emotional, it is bound to provide vast relief once you rip off that initial Band-Aid. How you make your finances work for you, and work toward your future, depends on where you are now. But there are some common guidelines.
Get Honest About Where Your Finances Are
For the uninitiated, the first step is the most painful. You have to understand where you are financially. For the past twelve months (yes, all twelve months), you need to know every transaction on all of your accounts. Every paycheck. Each ATM withdrawal. All of your recurring ACH withdrawals. And don’t forget about all of those debit and credit cards.
If you have a computer, and an internet connection, and a spreadsheet software, like Excel, you can do this.
You won’t like it, but you can do it.
You will go to all of your accounts and export all of your transactions with all details, like date, amount, payer/payee, etc. Every bank account and credit card. You will combine all of these transactions into one sheet. To do this, you’ll choose a small number of “columns” that all of these transactions have (date, amount, payer/payee).
You’ll want these columns all in the same order – so if you download your bank statement data and you have: Date, Payee, Amount… your credit card data will also need to have only the three columns: Date, Payee, Amount. Then take each of these trimmed down data sets and copy/paste them in a new sheet. Paste all of your bank transactions on your new sheet. If the transactions stop at row 350, start pasting your credit card transactions on row 351. Continue until you’ve put all transactions from every account into this “master sheet.”
Once you’ve gone into each and every account, downloaded all of your transactions on several independent spreadsheets, deleted columns you don’t need in each, then copied and pasted the data left from each into one master sheet, you can begin working. 😉
Now you’ll need a couple of extra columns: Credit/Debit, and Category. Credit/Debit will determine the type of transaction: credit if money is going into your account (paycheck), and debit if money is going out of your account (ACH debit, credit card purchase). Category will tag each transaction as a certain type of income or expense. Then, you’ll go through each transaction and tag each as a credit or debit and add category.
This will be tedious. But you will get invaluable information from it.
Before you begin tagging, go ahead and write out a high level list of categories. I prefer a small list. Overcategorization is not worth it, especially in the beginning. You can choose categories like these:
- Auto & Transport
- Bills & Utilities
- Business Services
- Education
- Groceries
- Restaurants
- Health and Fitness
- Home
- Shopping
- Travel
Adjust categories as needed to fit your life. But don’t overcomplicate this. Now, get your beverage of choice, and depending on how many transactions you’ve racked up over the past year, plan a few hours of quiet time and get to tagging.
Sucks, doesn’t it? Must be a better way?
There is. Do this anyway. Physically going through each expense you’ve made over a year is both grueling and eye opening. What’s even better? Once you’re done, you’re going to make a pretty table.
Most spreadsheet programs have the option to make a pivot table – which is an aggregate table. Take all of those categorized transactions and make one. Drag your category column into the “Rows” section, then your amount column into the “Values” section.
Boom. That’s how much you spent or earned in each category over the year. With some more spreadsheet-foo, you can modify further. And I encourage you to do that – slice by credit and debit, further slice by month. But for now, let’s just look high level. Are you spending more than you make? Are the top spending categories a surprise?
Save this file and take a break.
The Almighty Budget: Path Toward Financial Independence
A budget is simply a target for your expenses. All of those expense categories you created and now have annual expenses for will benefit from a target. With a budget, you can target a monthly, quarterly, or annual amount you want to spend in each category. Write that down and hold yourself to it.
If this is new to you, make monthly budgets. This will develop the ‘conscious spending’ muscle. And like all muscles, it will get stronger over time.
Before you get into each category, you need to assess where you are from a credits and debits perspective.
Did you spend more in the past twelve months than you made?
If so, your budget goal for the next three months is simple – divide your annual income by twelve, and that’s all you’re allowed to spend each month for the next three months. Now take that total monthly budget and divide into categories as needed.
Here is where you need to be honest about your expenses. This can be an emotional part for some. Because, honestly, you probably don’t need all that crap you’re buying.
That money will be better put into investments that will make you money. Investments will turn into passive income. And passive income will turn into financial freedom.
But you can’t do that if you keep spending all of your money.
Sure, you may be able to negotiate a pay raise (and you probably should), but what you have absolute, 100% control over is what you spend your money on. Take charge of that. Get used to changing your habits to improve your future. This is another muscle that will get stronger over time. And will serve you well as you build a life that’s just one percent better.
Once you’ve grown accustomed to spending only what you make, target a savings rate. Can you save 10% of your income every month? Maybe 25%? The higher this number is, the easier financial independence will be for you. You’ll be happier with less, and you’ll need less passive income to become financially independent.
I recommend challenging the things you think you need. Again, everyone comes from a different place. Perhaps you’re a high-paid, single doctor with a four bedroom house, a swimming pool, two cars, and a boat… and a six figure student loan debt. Or, maybe you’re a single parent and school teacher with two kids living in a two bedroom apartment with no debt, but living paycheck to paycheck.
Specific financial advice for each will be very different, but with the same goals. Understand what you’ve been spending your money on. Then start being intentional about where that money goes every month from here on out. And try to spend less than you make every month.
Oh… and congratulations. Now that you’ve been through “Excel Hell” to get a grasp of your financial situation, you’ve overcome a huge initiation in the financial independence quest.
Now, go find an application called Mint (it’s free). Download it, link all of your financial accounts to that app. Update Mint’s default categories to what you came up with earlier. Categorize your transactions. And set up your budgets. Visit this app regularly to categorize your transactions and keep an eye on your budget. If you ever do want to get your spreadsheet-foo on, downloading transactions from Mint will be much easier. It’s already aggregated all of your accounts and categorized your transactions. You’re welcome.
Debt Payoff: Remove Roadblocks Toward Financial Independence
Debt is the worst. And so many use it with the nonchalance of deciding what show to watch on Netflix. So many kids start their careers in debt because they took out student loans in university. As soon as you get a job… hell, an address of your own, the credit card offers will roll in. And used correctly, credit can be a great tool. But like many great tools, if not used correctly and maintained, it can end up doing more harm than good.
Debt costs more than you think. When I bought my first house, I looked at the amortization schedule for a 15-year and 30-year mortgage. The 30-year mortgage had me spending more than twice the purchase price of my house over the life of the loan. OVER TWICE THE PURCHASE PRICE! Sure, the monthly payment was a couple of hundred less than the 15-year loan. But over the long term I’d lose way more money taking longer to pay off the debt.
And that’s how I want you to look at all loans. Credit cards, car payments, student loan, personal loans, home mortgages. Monthly, these may seem reasonable. But banks make money on the interest you pay, and over time, that adds up. That money could be going toward one of your investments. Making you passive income.
So take stock of all of your loans and lines of credit. Unless you are paying it off completely every month (the way you should typically use a credit card), write it down. Write down how much the monthly payment is, what the interest rate is on that loan, and what the remaining balance is. This may take some time and homework. That’s okay.
Because now you know what you should pay off.
If you have high interest loans with small remaining balances, target those first. If you have many loans, it may be worth a visit to your bank to discuss rolling all debt into one, lower interest loan for quicker paydown. Understand how much monthly income you gain by not paying these loans – that will be your reward.
This is another difficult step. Depending on your situation, it can take many years to pay off debt. And that’s okay. Because this is the path to building a life that’s just one percent better than the day before. Every dollar you squeeze from your budget and apply toward your debt is one step closer to financial independence.
Because once those dollars pay off your debt, you’ll have some cash to play around with.
Emergency Fund and Investments: Protect Your Financial Independence
Oh, the good old emergency fund. Cash on hand for a rainy day.
A really rainy day.
Not when you want a vacation. Or a new outfit. This is when you total your car. Lose your job. Family has unexpected medical bills. The serious stuff.
How much you save for an emergency fund is up to you. I recommend saving at least six months of your current income. Some say three months, others as much as twelve to twenty-four. Pick something that feels right to you. And either while you’re paying off your debt, or right afterwards, go ahead and start stashing that away. And forget about it. I hope you’ll never need it. But if you do, it will be there.
Pretty easy…
Now for the more difficult, but more exciting part. How will you invest your money!?!
There are many, many options. For passive income, you have two high-level categories: stock market and real estate.
You can invest in other things, like building a business, but passive income is considered income coming from an asset that you’re not actively involved in. The IRS even recognizes and taxes this income differently.
I invest in real estate. Actually, I stumbled into it because I didn’t want to pay rent, and feel comfortable with this asset. I understand the type of real estate I invest in very well. As of this writing, I personally self manage my real estate assets so I have a slightly more active role. Compared to being a corporate leader (and after a proper education), this is a cake-walk for me. But some have described managing rental properties as a personal hell.
Many love the stock market. Set it and forget it. Index funds are particularly popular in the “financial-independence/retire-early movement”. Some enjoy handpicking stocks from businesses they’ve researched and believe in. If I were to invest in stocks, I would go with index funds. If you have a financial and business background, perhaps handpicking stocks is the best option for you.
In the end, take the time to research your options and choose an investment that feels right for you.
You should understand what you’re investing in. Understand the level of risk, the return on investment. More importantly, you should understand your target earnings. For stocks, it’s typically your dividend. Real estate, it’s your cash flow. Either way, know how much money should these assets need to make annually to cover all of your expenses. And how much you need to invest to get that annual passive income.
Because that, my friend, is that magic number toward financial independence. When your investment assets make as much or more than what you spend to live every year.
And while this magic number is the goal, this is a fun journey. As you start increasing cash flow, you may decide to take a less stressful job. Sure, this my slow your progress toward financial independence. But getting to that ultimate number is not necessarily the point.
The point is building a life that is just one percent better than it was the day before. Having options is one of the best ways to increase happiness. No one wants to feel stuck. Gaining control of your finances is one of the best ways to get unstuck from happiness-killing habits.
Once you are in control of your finances, you’ll start breaking free of other happiness-killing tendencies. And you’ll realize how little influence money has on your happiness, anyway.