This article about financial freedom originally appeared in some form on my other website Be Better Now. I’m starting to come to grips with the fact that I can’t write about all topics. Plus, since I already have a website that covers money, it makes sense to have this article here. I’ll have a talk with Be Better Now about endorsing Lazy Man and Money as it’s money partner (a mirror will be predominantly involved). Many of the links will take you Be Better Now while I slowly work to transfer the content. Hopefully that’s not too scary, especially for Halloween.
This guide is meant to be used as a spark. It’s up to you to turn it into a FIRE. If know someone who is having trouble with money, please email them a link to this article. Together we can inspire them to take control of their financial future.
The Ultimate Guide to Financial Freedom
I previously covered the importance of money and personal finance. I assume we are on the same page there, so I won’t waste any more words on the the “why.” I’ll need those words, because this guide of “how” to be financially free is long.
There are volumes of books devoted to personal finance and financial freedom. I wish it were possible to cover it all in a blog post you can read in fewer than 10 minutes, but it isn’t.
Instead, I’m presenting an outline. Think of it like a map across the country. This is the “zoomed-out” view where you can see the path through various states clearly. Each day, even each hour, of the journey can have its own twists and turns. You have to “zoom-in” to navigate those challenges.
Over the next few weeks, months, and even years, I’ll take this outline and fill it in with links that “zoom-in” on the important details.
I guarantee this outline will evolve over time. It’s not that it is inaccurate in its current form. I simply believe that I’ll be able to better express and organize the information over time.
Save More Money that You Spend
If you only take one piece of information from this article, please take the importance of saving more than you spend. The savings should then be invested until it grows enough that you have financial freedom. It really is as simple as those two steps. See, you got this!
In order to save money, you might have to sacrifice some luxuries. Fortunately, I wrote a little guide to on how to save money on anything. However, if you are looking to save money in one specific area, such as groceries, I’ve got you covered on my “save money” page
One of the best ways to save money is to use a budgeting system.
If saving isn’t your thing, you could learn to make more money. I recommend doing a little bit of both. If you spend wisely, you can live well on very little money.
The more money you can save… the more money you have available to invest… the faster you’ll get to financial freedom.
Where is “Destination: Financial Freedom”?
The destination will be different for everyone. For now, let’s focus on a couple of simple retirement math “rules.” Yes, we’re going to have to deal with math. Trust me it’s easier to learn a little math than spend years landscaping or some other hard labor that you may not enjoy.
- Rule of 4% – The rule of 4% is a guideline of how much one can safely spend without depleting his/her nest egg. If you have a $100,000 invested, the rule of 4% says that you can spend $4,000 a year forever, without reducing your nest egg. In recent years, various financial experts have said that 4% is too high and that 3.5% may be a safe number. That’s a detail that I’ll gloss over for now.
- Rule of 25 – This rule is derived from the above Rule of 4%. In fact, it is the inverse. If you know you need $50,000 a year to live on, you can multiply that by 25 to create a goal of amassing a $1,250,000 nest egg.
We can use that Rule of 4% to get a rough idea of how close to financial freedom we are. We can use the Rule of 25 to get a rough idea of what our goal should be. Just like our map metaphor, we now know where we are and where we are going.
Understand Retirement Expenses
Given the two rules above, the big question is “How much money do we need each year to live?” It varies from person to person. This is where, once again, it pays off to be able to spend wisely to live well on very little money. It’s doubly awesome.
If we go back to the Rule of 25 example above, someone who requires $100,000 to live needs a nest egg of $2.5 million. Because of compound interest, it is certainly possible. I’d much rather race to $1.25M in savings for my financial freedom than $2.5M in savings.
It is impossible to calculate exactly how much retirement is going to cost you. Circumstances tend to change. However, we can make estimates. We can predict when a mortgage will be paid off. We can guess how much our car is going to cost based on what we want to drive. We can estimate inflation itself.
The best place to start is with your monthly living expenses today. Put those in one column of a spreadsheet. Then create some columns for future years and estimate what they’ll be then. Don’t over do it by trying to calculate every year. At most do it 3-5 times with guesses that are 8-10 years in the future each time.
How Much Do You Need to Retire?
If you asked most people this question, they’d tell you they have no clue. Fortunately, you just did most of the math to figure it out. I’d say that in just a few minutes you’ve done more financial planning than 90% of the population. That’s a tremendous advantage in getting to your goal.
When I did the math of how much money I’d need to retire, I was pleasantly surprised. I found that $25,000 would generally cover my necessary expenses. Then I added some padding for discretionary unexpected expenses. Now I’m estimating needing we’ll need $35,000 a year. Using the Rule of 25, a nest-egg of $900,000 should be enough.
If that number seems low to you, it assumes that our home is paid off (10 years to go!). That’s a large expense that goes away.
Paths to Financial Freedom
There are basic two paths to financial freedom: 1) Grow a huge nest egg and 2) Create a passive income cash flow.
1. Grow a Huge Nest Egg
What I explained above with the Rule of 4% and the Rule of 25 is based on what I call “The Huge Nest Egg” theory of retirement. It’s the most well-known path… build up a ton of money and use it to fund your retirement.
Save and Invest Wisely
This article is long enough without covering the basics of investing. That’s a whole set of articles that we’ll get to eventually.
I will however say that you can make some basic investments that almost universally seen as wise choices.
The United States gives you some tax breaks to help you with retirement. You can defer taxes by using Roth IRAs and 401k (or 403b or TSP plans for certain employees). This is extremely helpful for a couple of reasons:
- Compound Interest is Your Friend – Deferring taxes and compounding interest can be a powerful combination.
- Automated Savings – These plans can be set up to take money out before you notice it. To borrow the Ronco phrase, you simply “set it and forget it.” Month after month, year after year, the accounts get bigger and bigger. There may be stock market crashes, but they always seem to rebound.
2. Create a Passive Income Cash Flow
The idea of building a nest egg of 1 or 2 million of dollars is a little daunting. Compound interest is a tremendous help, but what if we looked for another way… such as passive income.
In days of yore, there were things called pensions. They paid people an income in retirement. They aren’t very common nowadays, but you can find them in government and military jobs.
Income streams can dramatically reduce the amount we need to save in a nest egg. If you could create an income stream of $10,000 a year, you can use the Rule of 25 to reduce your nest egg requirement by $250,000.
Let’s pretend that I have a passive income stream of $15,000 a year. That means that I only need to generate another $20,000 to cover my expenses in retirement. Using the rule of 25, that’s only $500,000. You may quibble with my use of only, but it is certainly better than the $900,000 that I needed before, right?
Creating passive income is easier said written than done. People don’t just volunteer to give you $16,000 a year. So how do you get there?
The good news is that Social Security will likely provide some of that. Many people believe it will go away, but as long people are paying in, there will be money getting paid out. It just might not be as much as in the past. I like to presume that it is going to be zero and let Social Security be gravy in my financial freedom planning… much like how I purposely inflated my expected numbers.
1. Invest in Real Estate
I don’t know if anyone ever said, “I love being a landlord.” Perhaps someone has, but it was probably just a joke. It’s not the greatest of jobs. However, you don’t have to work that often, and it is more than possible to earn more than a $1,000 month with it. That adds up to more than $12,000 or the majority of the $15,000 in a somewhat passive income stream.
We personally have three income properties, and though they don’t make much money today, in a decade the mortgages will paid off. At that point, they’ll bring in over $4000/mo. in income… around $50,000 a year. Some 40% of that will go to taxes, vacancies, maintenance, etc. but the remaining $30,000 should be income we can use in retirement.
Potentially, the real estate and Social Security could be enough to sustain us indefinitely in retirement. It doesn’t leave a lot of wiggle room, but it doesn’t have to be the complete solution because we have savings too.
2. Start a Business
There are a number of great reasons to start a business. I’ll give you just a couple:
- When you do something you love, it doesn’t feel like work.
- You can defer even more taxes than people without businesses.
The first reason should strike you as common sense. The second reason is based on my understanding of how SEP-IRAs and Solo 401Ks work. As always, talk with your tax professional, but these vehicles can help you sock away even more money in tax-advantaged accounts than the average Joe for retirement.
Diversity is the Key
You don’t need to pick a single path to financial freedom. You aren’t required to go with either the Nest Egg or the Passive Income plan. In fact, I think you blend both approaches. Have some money coming from real estate. Have some money coming from a side business. Put money away in your tax-advantaged retirement accounts. Try to elect leaders who are going to keep Social Security well-funded and in place.
Can I Retire?
That’s the big question that everyone wants answered. It’s what we’ve been building up to. If you’ve done the above work, you should be able to answer this question almost as well as any financial planner. I want to stress that nothing is a 100% guarantee… the goal is to get as close to 100% as possible. The more money you have set aside and the bigger the streams of income, the larger your margin of error can be.
At this point, you should have:
- Good estimates of your annual expenses now and to a lessor degree in the future. (Take the numbers you calculated above and multiple by 12.)
- Your annual income now. Hint: Use the Rule of 4% on your savings.
- A goal of how much money you’ll need to have when you retire. Hint: Use the Rule of 25 on your expenses calculated in #1 above.
You want to be very conservative with these numbers planning for more expenses and earning less than you think. Remember that these are estimates. Real life has a way of throwing you a curve-ball when you least expect it.
Once you’ve laid out all the numbers, you should have a good view of where your income and expenses are. I like to leave the “Can I retire?” question to you and your certified financial professionals. There’s almost always going to be some amount risk. I can’t be the one dictating your risk tolerance, so that’s a road you’ll have to walk alone.
There’s a big difference between looking at a map and taking a journey. Information can only take you so far. This is enough information to get started. Now it’s time to put the information to work.
Further Reading: Your Money or Your Life – If you simply can’t wait for me to fill in all these details, this is a good book to start with.
Adrian- Investor Tuition says
I certainly enjoyed reading your post, you made some very good points. I was particularly interested in the section regarding real estate investment. I note your financials on the 3 properties will net you $30k pa. Would you consider this a good return when contrasted with the total value of the 3 properties? I have often heard many people advocate the rental property income stream for their retirements but I feel the low net returns and the effort to maintain them into old age, may make the strategy less appealing. Am I correct to think this way?
Lazy Man says
I don’t think I can say whether you are correct to think a certain way ;-).
Most people think of investing in real estate as their cash flow early on. The real money comes after the mortgage is paid off. That usually takes years and the tenant is subsidizing that.
If you apply the rule of 25, that $30K/year (a low estimate) from real estate is worth $750,000. That’s a big chunk of change right? Yes there is maintenance as you grow older, but that can be outsourced to a property manager. Because my estimate is so low, I could probably do it and still make $30K/year. Of course, my sons might be willing to do property management for a very good rate and they’ll stand to inherit the properties down the line.
Good stuff as usual. Kudos on your further reading suggestion.
I am approaching age 70 and was able to retire in my mid- 50s earning only a modest income from my job.
I used all of the strategies you recommend in your article. Rentals, small side-business, investing, living below my means, plus working a hell of a lot overtime the last 3 years prior to retiring.
I noted your reading recommendation because it was Vicky and Joe’s book that galvanized
my desire to be in control of my time (life.)
I followed many of the steps they suggested. I made graphs, tracked daily spending to the penny and invested conservatively. I knew to the year and month when I would reach what they referred to as the F.I. (financial independence) cross over point.
One important aspect of the whole early retirement discussion is the element of luck. Neither my wife nor I ever suffered from a serious illness or accident. Our children were relatively healthy and did not require expensive long term health care. We were fortunate enough to “work things out” during the difficult times that occur in all marriages, so we avoided a
costly divorce. And finally we were lucky enough to have stable, though modestly paying, employment during all of our earning years. Any of the afore mentioned good fortune could
have changed on a dime. In the end, it’s like the old saw says “Men plan and the gods laugh.”
Keep up your good work.
Lazy Man says
Thanks for the comment. I’m curious how much of your progress was made after reading the book and following the steps. It sounds like with the overtime and such, it could be really significant.
Luck does indeed play a huge role. There’s a very large percentage of the world born into a situation where F.I isn’t remotely possible. A very, very small percentage (I like call them the Paris Hiltons) are born into F.I. Most of the people in the United States (and some other developed countries) are probably in that big range in the middle. As you say, numerous things can go wrong along the way. Fortunately for me thus far, they’ve been pretty minor. Some of those minor ones may have really deep-sixed some people’s dreams of financial freedom, but all the strategies I mentioned have worked together to build a nice safety net during those times.