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Financial Freedom in Five Years (and the Difference Between Rich and Wealthy)

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Below is a guest post from Early Retirement Extreme. As you might imagine from the title of his blog, he writes about extreme ways to retire early. This article serves as a good introduction to that philosophy. I encourage you to sign up for the Early Retirement Extreme RSS Feed.

Being wealthy means having lots of opportunities. It means that you can do whatever you want. You have connections to people, you know how to get things done, and you have all the resources to do so.

On the other hand, being rich merely means having a lot of money to spend. You can only be rich at a high level of income, and the only way for a rich person to accomplish anything is to pay for it. Obviously, paying for it makes the person less rich and therefore rich people have to work hard or eventually run out of money.

To make the distinction clear: You can make someone rich by giving them a lot of money, but there is nothing you can give to anyone to make them wealthy. Wealth only comes through your own effort.

Yet in our consumerist society, most people dream of being rich, or alternatively famous or powerful, although I suspect those are merely seen as short cuts to getting rich. Far fewer dream of being wealthy and even fewer dream of being wise. There exists now, in our society, a prevailing attitude that you can get something for nothing. Just witness the free lunch people expect in the stock market where anything below 10% APY is considered bad performance. Contrast this with the attitude of just two-three generations ago, where TANSTAAFL prevailed and successful money management was mainly about preserving principal rather than using money to magically make more money with no apparent effort.

No, you must give something to get something. In my experience as a blogger, the main points of resistance towards change, that is, where people argue the most that it is impossible for them to change, are their house, their driving habit, their food, and lately their cell phones. These are also the areas that make the biggest impacts on their life and prevent them from becoming wealthy.

Here's a sure-fire way to achieve financial independence in a handful of years.

  1. Go to craigslist.org and click on housing and enter $200 minimum and $400 maximum in the search form. Pick something that lies so close to your work that you can walk or ride a bike there. Also make sure that this also holds for the nearest supermarket.
  2. This place will likely be smaller than what you are currently living in, so get rid of everything which does not fit and that you are not using anyway on freecycle.org --- you might want to start this process early, since it is a lot harder to get rid of stuff than it is to buy it.
  3. Sell your car. You don't need it anymore.
  4. Stop buying stuff. Make the stuff you already own last. Trust me, by the time you wear it out, you will be financially independent.
  5. Decrease your other running expenses. First, learn to cook. If you think of meat and cheese as treats you can easily stay under $100/month. For instance, I eat meat about once a week (There's a reason they are at the top of the food pyramid along with candy). Drop superfluous insurance. Drop your expensive cell phone plan. Drop your cable TV.

Calculate your new monthly expense level (E) and compare it to your monthly after-tax income (I). Now, compute 25*E/(I-E). This is the number of years it takes you to reach financial independence).

Now this may seem harsh --- especially the thing about selling your car, right? ;-) --- and it is difficult when someone is completely inexperienced and used to spending money on everything and most people either say "that's fine for you, but I could never do it" (think of the children!) while others try for a little while but then give up because it feels too challenging. It is in many ways like taking the bottle away from an alcoholic. He does not know either how he could possibly be happy without being inebriated. The non-alcoholics are just fine without getting drunk on a daily basis, but for the alcoholic getting through the emotional hangover of preconceptions and prejudices about life as a sober person is hard.

However, after about a year (Hey, I said it was not going to be quick and easy), an amazing personal transformation takes places. What always happens is that you will think of your new home as home rather than a sacrifice, much like when you move into a place with a nice premium dollar view yet after two weeks, you hardly look out of the windows anymore. Too, at that point you will be used to walking and biking everywhere that such simple "exercise" does not seem like a strenuous and boring labor (the average American only walks 400 yards a day). A year of not running down to the mall to buy a gadget every time there is a problem and the accumulated experience successfully finding ways to bodge and improvise solutions, and you will see new problems as challenges to be overcome with the resulting feeling of accomplishment. Conversely, having to buy anything will be seen for what it is, a failure to competently solve your own problem; buying new things will feel positively bad.

Many, who has initially seen such extreme frugality as deprivation, will come to see that consumerism is merely another form of deprivation aimed at reducing personal creativity. For instance, buying a chemically treated 4 hour log at the store and lighting it with a Bic lighter prevents you from exercising your skill in stacking up a fire with kiln, twigs, and real logs, which you may also have use a maul to split yourself, and starting it with a cotton ball dipped in vaseline; or learning that trick in the first place.

Hence, first, you become wealthy in terms of experience. Do not confuse experience with experiences. Experiences is typically something you buy for money like flying to Africa to observe a tiger or two, going to a concert, or eating something at a fancy restaurant, but all those are merely events. The experience I am talking about is akin to when one speaks of an experienced engineer or an experienced carpenter, when a lot of experience means that the person have seen and successfully solved a lot of problems and that he or she can be expected to produce quality work.

Once you have that kind of low-impact frugal experience, you can expect to live a quality life with far fewer expenses than a regular consumer. If you are still working and saving 75% of your paycheck, savings go up rapidly. This means that financial independence is achieved in short order. For instance, after 5 years I was able to cover all my expenses with interest and dividend income from my savings and investments. This significantly increased my freedom and opportunities. As I was no longer tied to my income, I decided to focus more time on things that were more meaningful and interesting to me rather than spending most of my time building my resume and concentrating on my career. Thanks to this I replaced my stressful salaried job with an hourly but equally well-paid high-skill job that I work at for about 15 hours a month; I blog for fun rather than income which also gives a lot of freedom in terms of posting schedules and advertising; I spend a lot of time on sports (about 5 times a week); and I now have the pleasure of working with (no longer for) people from a wide array of interesting fields.

Although being frugal is the best way to attain your financial freedom decision making also plays a big role. Be sure to educate yourself regarding all investments you choose to make. Annuity Straight Talk's pros and cons of annuities is a great example of a site that helps its members make the right decision prior to any investment. This way of thinking will essential get you ahead on your path to financial freedom.

That is what I call wealth and there is no secret to it. Anyone can be wealthy, but not everyone can be rich.

Be sure to read more about How Jacob became Financially Independent in 5 Years.

Last updated on January 27, 2013.

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Frugal, Psychology

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33 Responses to “Financial Freedom in Five Years (and the Difference Between Rich and Wealthy)”

  1. Lazy Man says:

    I should mention that Jacob philosophy is a little like my own… just a bit more extreme.

    I think I’d prefer to go for the 15 year plan. Have a cheap, used car, have a modest home (not a room that I’d have to share with others).

    I’m looking forward to trying out Jacob’s formula for financial freedom this weekend. I think it’s pretty sound (I’m guessing the 25 comes from the 4% that most financial advisors suggest that you have).

    I just did a ballpark number for myself and it seems like I might be at 12.5 years. I need to add in my wife’s income and do the numbers more formally though.

  2. You’re right. The 25 is from the 4% withdrawal rule. The equation makes some assumptions (specifically, that compound interest only happens at the rate of inflation) which makes it overestimate the number of years at low savings rates. A good rule of thumb is that you will be off according to how close your savings rate compares to your rate of return above inflation. Suppose we take the typical 10% which is 6-7% over inflation. That is negligible to a savings rate of 75%, but it becomes relevant for a savings rate of 20%. Like IRR the solution that includes compound interest with PV and FV is not a closed form solution.

  3. Coupon Artist says:

    This is a great article, but unfortunately it only works quickly if you don’t have a lot of debt. If you start from $0, then it is easy (well, easier) to reduce your expenses, save money, and live on less. If you start at a negative though, well its a lot harder to get back to $0. Of course, that means you should never get into debt in the first place… but a lot of people (like me) are already there!

  4. Moneymonk says:

    “Sell your car. You don’t need it anymore”

    Yes on a beautiful day, but rain, sleet, snow. I can work wonders.

    I agree to not having a car note, but not a car.

    I agree with the rest, I am about 4 years away from breaking the 9-5 grind

  5. @coupon artist – Fighting against 20% APR is harder, but if you can manage to spend only a quarter of what you make it makes it lot easier. When I met my (now) wife, she had a debt load of 40%, but she managed to paid it off in less than two years.

    @moneymonk – I grew up in one of the most windy and rainy countries in the world. Spend 2-3% of what you’d normally spend on a car on goretex (especially the jacket, the pants are not that important if you stick to walking, since your legs are mostly under the jacket relative to the rain) and include a wide-brimmed hat or an umbrella if it’s not windy (get a small one, not a big and heavy one). I can literally (yes, I tried it) stand in the shower and not get wet if I got that on (I haven’t tried taking a bath with it though). Also tested down to 0F with the appropriate liners.

  6. Tyler says:

    Sorry, $200-400?? Maybe per week! Where in the country is it possible to pay this little for rent?

  7. Lazy Man says:

    I thought about it and I think you could get a room in the Boston suburbs for around $300/mo. when I was in college 10 years ago.

    Here in Silicon Valley it’s closer to $600-700 for a starting room. Of course the salaries are bigger, so it’s hard for me to comment on what the prices might be like elsewhere.

  8. kosmo says:

    $400 rents are possible in the midwest :) My wife and I had a 3 bedroom apartment for right around $400 (town of ~5000 in Iowa). We moved out in 2006 to buy a house.

    Simply being frugal with car purchases can help a lot, too. Would I like a BMW? Sure, why not? But I’d much prefer to buy something less expensive and put the saving toward retirement.

  9. @Tyler – I just went to craigslist and checked Atlanta, Austin, Boston, and Chicago. All had apartments for less than $400/month. It’s probably easier to find the few places where it’s impossible. I’m guessing NYC and SF; still here you can just live slightly outside and use public transportation.

  10. SaveBuyLive says:

    Although this is a very interesting approach to frugality and saving money, I really feel that it lacks balance.

    I don’t really want to live a life of constant self deprivation. There are things (e.g. travel) that I want to do with my life and these cost money. I’m not passionate about my 9-5 job but if it allows me to do create a life rich in experiences then that’s a decent trade off.

    ERE, could you comment on the social effects of your decision? Do your friends/family take you seriously? Do they think you’re just nuts? Does your lifestyle cause any problems with dating or relationships?

    ERE, would you be willing to disclose where you live? I think that having a super small apartment and walking everywhere might not be so bad if you live in a place with a decent climate. I live in the Midwest and the winters here are a harsh mistress. Long and brutally cold. Not very conducive to traveling, even in a car. And being cooped up in a small apartment for 4-6 months of the year is simply not good for one’s psyche.

    PS: Bravo for the Heinlein reference.

  11. NatalieMac says:

    I guess you’d have to move if you lived in an expensive area. The only thing available for rent on Craig’s List within 10 miles of my office for less than $400/month was a parking space.

    People freak out when you talk about living without a car, but it’s really not as hard as you think. I lived without a car for over 5 years. Once you learn public transporation and learn to carry an umbrella in your bag at all times, you’re fine.

  12. $400 isn’t possible here in the Bay Area. Maybe the number would be better expressed in terms of a percentage of income?

    For instance, my boyfriend and I currently pay 4.95% of our gross income in rent, or 7% of our net income. This is in San Jose, CA, and seems pretty low to me. Of course, we are definitely living below our means, and both of us sock a ton of savings away every month.


  13. Lazy Man says:


    I think that’s exactly right. Expenses should probably be in terms of percentages of income. Keep all the necessary expenses down and sock away a huge amount of income in savings…

    I’m wondering if Jacob went back, maybe he could say what percentage he had when he was done living the extremely frugal lifestyle.

  14. @SaveBuyLive – It does not feel like deprivation. Maybe it makes more sense to ask “What would MacGyver do?” and apply that mentality to the entire lifestyle. Well, he would build a solution of out what’s at hand rather than ordering gadgets from a catalogue or paying for expert advise. As such he would not need to spend the same amount of money and the money he earned, he could invest and live off of the dividends. Is MacGyver deprived? I think not :-)

    I’m not a big fan of traveling, but I’ve been to 14 countries and I never paid (conference travel). There are people out there, like Chris Guillebeau, who like traveling and also pay very little to do so. My sister has also been to a lot of countries (slightly more than me) either as a volunteer and traveling light and hard. She has also paid very little usually spending weeks or months in a given country.

    The social effects and consequences vary from a stockbroker going “wow” as he saw my liquid net-worth compared to my age (33) to the expected misunderstandings of the “oh, so you do this, then you must be like that too”. For instance, when I tell people I live on about $6000/year, that is, somewhat below the poverty line, they automatically think I live in squalor. I would say friends and family take me pretty seriously, for instance, I’m kinda the unofficial financial/investment advisor of the lot. Often when I start doing something “crazy”, some of them pick it up as well. For instance, my mother, who is in her early 50s now commute daily by bicycle rain or wind. In terms of dating and relationships, I’m married to a very understanding wife where I compromise as well. I know there are girls out there who won’t talk to you unless you drive a certain car, etc. Obviously, that would make it very easy for someone like me to weed them out of the dating pool.

    I currently live in the Bay Area (fairly expensive area, but nice weather). I used to live in the Midwest, so I know about the winters (there’s nothing like walking outside and you feel your eyeballs start freezing 8-) ). What was usually the case in case of heavy (lake effect) snowfall was that it was faster to just start walking, rather than first dig out the car, then drive it, find a parking spot, and walk from the parking spot. Hence the importance of living close to work and the supermarket. Our long term plan is either to move to New England or WA/OR.

  15. For Silicon Valley (we live either just on the northern edge or just outside depending on your definition) the cheapest option as far as I have found and what we do is to live in an RV park. Prior to quitting my job I was paying 3.8% of gross income in rent. After retiring it’s more like 25% of gross.

  16. I would say in terms of rent/income ratio. It seems to be easier to find a low rent in a high paying region than a high paying job in a low rent region (at least for me anyway).

  17. Moneymonk says:

    @early ret. extreme-

    you are a man, I doubt if the “no car” thing work with a woman and children.

    Some things are not possible

  18. Executioner says:

    Great article, and consistent with ERE as a whole.

    Jacob, you’d love it here in New England.

    I wouldn’t suggest that anyone fly to Africa with the expectation of seeing a tiger; I think that trip would be certain to end in disappointment, unless a zoo was on the itinerary.

  19. Or you could ask “What would McGruber do?”

    Or not.

  20. Anderson says:

    Fantastic post. I couldn’t agree more with you. It’s just a product of our culture. We want things right now…instantaneously. Patience seems to be a lost art form. I was reading a similar article the other day which dealt with the same topic. A lot of financial freedoms could be found if society were to tweak just a few bad habits.

  21. @Moneymonk – Haha, I think this is an old point of dispute, but women and children can use their legs to walk as well as men. Now, there may be some place where you would not want to walk (even if you are a man) and this is why you choose your place of living so you don’t have to. There are women and children out there doing the “impossible” without a car right now.

  22. Jim says:

    I personally prefer a 15 year plan style. 5 years and this kind of minimal living is not worth it to me.

    The only housing around here I see on Craigslist under $400 is shared housing / roommates. There are some condo’s listed for $350 or $385 rent but those are almost certainly scams. I see similar ads on other cities. So you may very well need to increase the housing budget some depending on where you live.

    Or simply consider moving elsewhere. If your job is portable and you can find cheaper housing in another city then it could be in your best benefit to move somewhere with lower cost of living.

  23. Tyler says:

    I looked in Boston on Craigslist and the only ads I found between 200 and 400 were scams (not real rentals), or were 200-400 per week. Not a realistic target for those of us in major metropolitan areas.

  24. @Tyler – How about
    subject to that those are not weekly rates, etc.
    I would say, if you’re single, the room mate option is not a bad idea, and if you’re “double” you can double your search range to 400-800.

  25. Robyn says:

    This article is a good example why I don’t write much about frugality, even tho I completely subscribe to this line of thinking – Jacob describes the philosopy much better than I ever could. Esp this – “Many, who has initially seen such extreme frugality as deprivation, will come to see that consumerism is merely another form of deprivation aimed at reducing personal creativity.” Beautiful.

    I find living frugally a fun challenge and not deprivation at all. Deprivation in this sense says “I want what the world and advertisers and my friends have but I can’t afford it.”

    Change your perception and thinking – don’t be like everyone else – be “radical” and set a new example. You are more creative than the typical consumerist standard wants you to believe.
    Empower yourself.

  26. Lazy Man says:

    Robyn, I’ll be sending my wife a link to your Worm Inn… seems great.

  27. sarah says:

    This is great. I totally agree with the argument that consumerism is deprivation!
    I can’t even approach a mall without some nausea.
    Luckily, I can sew and my hubby can build and we both love to cook.
    I’ve never heard about dipping a cotton ball in vaseline to start a fire…love it!

  28. This is really insightful and motivating to go frugal in short term to live life the way one wants in the long term. The key to getting wealthy is saving and not merely earning. And frugality goes along way in increasing your savings as is rightly explained in this article. I agree with most of what is suggested here.

  29. Yep, very much what I do in Miami, Florida. Low mortgage. Walking distance to grocery, bank, pharmacy, bookstore, art galleries, libraries & staples & office depot.

    I own no car. I use metro-rail, bus, trains.. and hired drivers for long distance gigs.

    I work for myself as an event entertainer, plus consult on business strategies and social media. I only work with people who I enjoy working with. I love what I do. I’ll never stop working. It just too much fun and a great self-esteem buster.

    I just read some place: “Are You Big Enough to Help Someone Become Greater Than Yourself?” And that is kind of how I feel.. Big.. I would be the first to admit, I love when people I consult, go: “Wow, now you got me thinking!”

    If I would have a nine-to-five job, I wouldn’t have any time to learn new things myself and no energy for anything else.

    Not only I earn enough to support myself while actually doing paid stuff only a few days a week, I also support my husband who no longer can work.

    The only regret I have I wish I knew what I know now 10 years ago. But I was busy then, working 9-5. I didn’t have any time to learn…

    And to tell you the truth, I am not doing anything revolutionary here. I just picked what I am relatively good at and stick with it until I discover some other ways to enjoy myself.

  30. I live in Austin, and while it’s possible to get an apartment for $400 a month, it’s not a safe option, particularly for a single female. I’ll pay extra on rent and enjoy the security. However, I like the rest of this, particularly the piece about you paying your monthly expenses from the dividends of your savings and investments. Now there’s a concept I like. What it would be like to have enough money earning interest to pay my bills so I can quite working at the credit union and write full-time. Hmm. I may need to sit down and seriously consider how I can make that a reality!

    Nice article, thanks for sharing!

  31. Here in the MW one could easily rent a nice apartment for about $500/month. When I was in college I was able to rent a room for as low as $100/month with roommates. If you would like to rent your own apartment however, consider going to a small college town in the MW where you could get a very nice place for $250-$300/month.
    And did I mention that there are so many things to do in college towns at almost no cost to you.

  32. Matt Jabs says:

    I must say that I am thoroughly motivated from this article, and from Jacob, his ideas, & his blog as a whole.

    I have been teetering on the edge of this line of thought for some time now, and think I may have just fallen over the cliff!

    I’m excited. Thank you.

  33. Paula says:

    Have you seen this article? It seems that you aren’t the only person willing to give up his car! :)
    I wish we had neighborhoods like this. There is a bus stop near my house, but it doesn’t go anywhere that I need to go. It takes an hour to get downtown, which is a 25 minute ride in the car (at rush hour). From there you can transfer to another bus which may or may not take you where you need to go. I figured out that my son would need almost 1.5 hours and three buses and two long walks to get to or from to his high school for activities not served by school buses. I can drive there in 20 minutes. We need better public transportation in our town!! Fortunately I can walk or bike to the grocery store, hardware store, and several other places I need to go.

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