Financial independence can be defined as never having to work for a living. Most of us are so far away from that position that it appears to be an impossible dream. But as with most impossible dreams, it begins with a single step: saving regularly.
The process of moving toward financial independence is simple: get control of your cash flow, save money regularly, then put that money • and eventually the money and labor of others • to work for you. That’s how its been done since time immemorial.
So far in our series on the meaning and management of money, we’ve focused on getting control of our cash flow. We’ve recognized how controlling our cash flow begins with controlling our energy flow. Although some people are given more energy than others, we all eventually run out of steam. That limitation makes our time on earth very precious indeed.
How we choose to spend that time represents what Joe Dominguez and Vicki Robin call an expenditure of “life energy.” (Click here to order.) Given that we can’t expend our life energy forever, it behooves us to align this expenditure with our purpose, values, and gifts. This is the way to true fulfillment and success.
This is also the way to financial independence. Working in a position or on a project that does not align with our purpose, values, and gifts guarantees lackluster performance, negligible learning, profound unhappiness, and chronic money problems. The magic of money • attracting all that we need and more than we need • never happens. This is not a chicken and egg conundrum. Live passionately from your purpose, values, and gifts and the money will follow.
But what do we do with the money once the cash flow is in the black month after month? Early on, the key is to create safe liquid assets that earn a solid amount of interest, month after month. Too many people start saving a little money and immediately begin thinking of how they can double or triple it by investing in some high-risk, get-rich-quick scheme. Stay away from those, even if it’s a tip from a friend, until you have accumulated six months worth of living expenses in safe, liquid assets.
That, by the way, is the definition of financial independence. How long can you live without having to work? If you can live forever without ever having to work, then you are financially independent. If this seems like an impossible dream, break it down into steps. Start by putting a fixed percentage of your gross earnings every month into a high-interest bearing account such as a Certificate of Deposit or Money Market Fund. Do this in addition to whatever you are putting aside for retirement.
The point of the first step is to create liquid cash reserves that will enable you to live for at least six months without working • if necessary — before retirement. Having these reserves is the first step to financial independence.
The second step, which occurs concurrently with the first step, is to put a fixed percentage of your gross earnings every month into a retirement account that includes a mix of stocks and bonds. If your employer does not offer an acceptable retirement plan, you may need to devise your own portfolio of tax-deferred individual retirement accounts, as permitted by law. Since your retirement fund takes the long view, you will want more than 50% of that fund to be invested in stocks.
Take a good hard look at these first two steps to financial independence. They both involve taking a fixed percentage of your gross income and setting it aside on a monthly basis. Ideally, together with any employer matches, you are setting aside 14% of your gross income for retirement and 10% of your gross income for cash reserves. That’s practically a quarter of what you earn every month, being set aside in one savings plan or another.
Once the reality of that begins to sink in, you can see why we’ve spent so much time on the issue of controlling your cash flow. If your cash flow is consistently in the red, whether through an overblown lifestyle or frequent financial emergencies, it will never be possible to save and make money work for you. You’ll forever be working for and spending the money you make. If your cash flow is consistently in the black, however, you’ll be amazed as to what you can accumulate and accomplish over a period of years.