3 Keys to Financial Independence
What Is Financial Independence?
In the simplest terms, Financial Independence is the concept that an individual or household can produce enough passive income to cover the basic living expenses such as food, shelter, and clothing. Passive income is income that is derived from sources other than physically working. Some types of passive income include dividends and capital gains from investments, book royalties, gas and mineral rights income, and rental income from real estate that is managed by someone other than the owner.
There are two basic ways to achieve Financial Independence. Financial Independence can be achieved through either increasing passive income or decreasing fixed expenses. For instance, an individual or household can invest a larger principal amount into an investment to produce more annual dividend income. On the other hand, one could pay off their home mortgage in order to reduce their living expenses and in turn require less passive income to cover these fixed expenses.
Why Does it Matter if I am Financially Independent?
Most people strive to become financially independent at some point in their lives because financial independence allows you full control over how you spend your time. There is a strong sense of freedom and fulfillment that comes with financial independence that people find highly important. Without further ado, let’s focus on the 3 keys aspects of achieving financial independence!
1. Reduce and Eliminate All Debts
Personally, I rank debt elimination as the key factor in achieving financial independence because of what debt represents. When we have debt, we have an obligation that must be paid before we are completely free. With debt, more annual income is required to make payments each year. Without debt, the level of passive income needed to cover expenses is significantly less. Let me illustrate with my own financials. I currently have no debt of any kind except my home mortgage payment which is $1,332 a month with a total principal balance of $159,000. My top priority is to pay off this principal balance to reduce the level of passive income needed to achieve financial independence by $1,332 per month. If I can eliminate this debt, my remaining fixed expenses relating to housing and food will be less than $800 a month. All in all, reducing debt is my top focus on the journey towards financial independence, but conducting an expense audit is a very close second.
2. Conduct a Household Expense Audit
You may have never heard the term “expense audit” before, but it is essentially a fancy way of saying to look at all of your expenses on a monthly basis and look for inefficiencies and methods to reduce those monthly expenses. To highlight, lets looks at one specific fixed expense that everyone has that can be significantly reduced. First, most people are paying hundreds more in auto insurance than they should be. To reduce your auto insurance quickly and immediately, simply purchase your insurance “direct” from insurers such as Progressive, Geico, or Mercury Auto. By purchasing direct, you get the absolute lowest price and cut out the middleman, which is the insurance agent. My 6-month premium for a 2002 and 2006 SUV, one with full coverage, is $235. I maintain liability coverage of $250k/$500k to fully protect myself in the event of lawsuit. Please do not hesitate to reach out to me in the comments for additional guidance on how to really cut costs on your auto insurance. In conclusion, this hub, How to Effectively Save Money I and this hub, How to Effectively Save Money II, go into much greater detail on creative ways to cut expenses on things we usually pay monthly without even questioning.
3. Increase Savings Rate Over Time
Finally, in order to truly achieve financial independence, it is important to strive to increase your savings rate to 50% of earned income over time. With a high savings rate, you can make your dollars work for you rather than the other way around. I suggest starting at a 15% savings rate and increasing that percentage rapidly without increasing your lifestyle. It is important to invest the majority of these savings into diversified index funds with low expense ratios. By doing this, a return of 8% annually can easily be expected over the course of a couple decades.
I have access to numerous calculators and projection tools to help in projecting when the point of financial independence can be reached based on expenses, income level, and savings rate. I also have numerous debt reduction strategies at my disposal. Please feel free to reach out to me through the comments or a private message, and I will gladly run a quick analysis on your financial situation to help you reach this admirable goal of financial independence in a shorter time than you thought was possible!
Have you ever consulted someone's help on the subject of reducing expenses or debt?
My Other Hubs on Anything Related to Money
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