Roadmap to Financial Independence - Part II: 6 Steps To Get to FI
Last week, we talked about choosing and refining a mindset for success. If you missed that article, please click here and read it in conjunction with the learning in this article. Like having two oars in the water on each side of a boat, The Math and The Mind have to work together to propel you forward.
This week, the rubber meets the road. We will explain our tactical approach to passive real estate investing.
Here are high level milestones we suggest to follow on your way to FI:
Find an additional $50K each year. Slowly increase that number by 10% annually. This can be achieved by:
Save at least 25% of your income
Picking up a side gig that pays you $1,000/year to start
Free up existing “lazy” cash
Invest and reinvest religiously into vehicles that ideally generate +12% cash-on-cash returns.
Have a plan to reduce taxes.
Protect your assets once your net worth is $1M.
Step 1: Create an Extra $50K/Year - Save 25% Of Your Income or More
In order to find an additional $50K/year, first look at your savings. This is the easiest and most difficult category. It's easy because most everyone will find something in their spending budget that they are able to trim and funnel into their savings account. It’s difficult, because the lifestyle and luxury that we may be used to may have to change. Changing habits can be a hard task. To save 25% is roughly $1000/month in savings for someone who has an income of $100K/year. Think of this an exercise in changing your mindset about expenditures rather than becoming a miser.
Financial Independence is all about the freedom of choice. You get to be the boss of your life and you get to decide what you want to let go of to get you closer to what you truly desire. This is called constraint or delayed gratification. And it’s a practice that will strengthen you in ways you never knew.
Savings follows the same philosophy. I personally hate budgeting. It feels so restrictive. This explained why I have always failed at budgeting. The moment I realized what I receive when I show some constraint, the savings started to add up. I love the Pause and Compare method at the moment of purchase. I also focus on monitoring my expenses and adjusting as I go.
You can use software such as Mint.com to track personal expenses. Observe your spending and saving habits for a few months to understand your patterns. Allow yourself to set weekly, monthly, and annual financial expectations with your FI in mind. Understand that delaying gratification on items that are not necessary will get you closer to your savings goal. Re-check your activity, celebrate the wins of saving more money, and re-commit yourself daily to keeping more of your money in your possession for your greater good.
While I don’t agree 100% with going on a financial diet for the long-term, I believe it is worthwhile to adopt some of the frugality habits that will accelerate your journey to FI, especially early on.
If you can change a behavior permanently such as getting a coffee at Starbucks everyday ($5/cup x 30 days=$150/month saved) or bringing your lunch daily ($10/meal x 22 workdays = $220/month saved) or eating out 2 less times a week ($50/meal for two x 2 times x 4 weeks = $400/month saved), you could save a surprisingly substantial amount of money ($770/month saving). These examples are the lower hanging fruits on the Tree of Savings.
Placing Marie Kondo’s suggestion on organization into the financial world, what sparks joy should be what you keep and celebrate. What is just excess should be removed to let you have more time and resources to enjoy what matters. Remember visualization of your FI dream? Use that in this exercise whenever you are making a purchase decision. “Will this item spark more joy for me? Or will realizing my FI dream spark more joy for me?” This is delayed gratification in action. Deep down, we know we will enjoy FI when we get there. The enjoyment brought on with a material item we are about to spend money on will be completely fleeting and the purchase of it will keep us in our old routines.
Once you save 25% and feel you can commit to constraint and delayed gratification, the good news is that you also have the additional 25% to invest. You don’t need the extra 25% in the future when you retire, thus, the sum you need to reach FI is less and you get there faster.
I want to introduce the 25X Rule, or the 4% Rule, used to calculate your FI number. It is the amount of money you need to sustain your lifestyle. We call it your Lean FI Number at EZ FI University. The 25X Rule states that you will need 25X your current annual spending to retire. Adjusted for inflation, if you withdraw 4% of that amount each year, you will be able to sustain your rate of withdrawal forever. You can read about the study behind this by reading DETERMINING WITHDRAWAL RATES USING HISTORICAL DATA - William Bengen
This means that if you are currently spending $50K/year. You can retire once you hit $1.25M in savings assuming you will withdraw 4% of that every year, which is magically $50K/year. If your rate of investment is higher than 4%, then your pot of gold will continue to grow which allows you to withdraw more. Consider that a bonus!
Does this example give you a different perspective on the importance of saving your own money? Here is another comparison to consider. If you make $100K a year and spend 50% of your income, you will save more than $25K/year after handing over a portion of it to the government in taxes. If your spending habits remain the same with an income of $150K a year, you will save more than $60K/year even after increased income taxes. At the $50K/year saving rate assuming you only need $50K/year for expenses, at a 12% investment yield rate, you can retire in 10 years. You can simply save your way to retirement without doing anything additional. Very powerful, right?
Step 2: Your Extra $50K/Year - Picking up a side gig that pays you $1,000/year to start
If you are like me and cannot sustain a prolonged financial diet, savings alone will NOT get us to FI in 10 years. After I intentionally cut out all the mindless spending in my life, I found myself still not where I needed to be. This was where picking up a side gig really helped. Choose a side gig that you have passion for and ideally one that is related to real estate in some way. This not only helps you create extra income to accelerate your journey to FI, but also gives you something to do once you reach FI.
Let’s face it, most of us do not want to just sit on our couch and watch TV all day after our retirement. Traveling is fun, but it gets old if we are traveling all the time. Likely we want to feel productive in one way or the other. In addition, when you have a side gig related to something you’d like to do once you have retired from your W2, you will begin learning about that industry or position, building relationships with others in that field and start with a strong foundation that will truly serve you at every stage of your designed life.
Choose a side gig that matches with your FI dream lifestyle. If you want to travel for a prolonged period of time, you should focus on a side gig that is remote. For a number of ideas of creating a side hustle, check out our article on 9 Side Gigs that Do Not Require you to Go Back to School.
In any side job you get into, I would recommend focusing on building systems, learning about marketing and learn how to read financials. After I created multiple businesses, I realized that these are the three skill sets that are foundational to being an entrepreneur. We help our EZ FI U students learn these skills as they create their ideal side gigs that generate additional income for savings and investing.
The goal is to generate $1,000/month profit from your side gig in the first two years. To put that into perspective, that is $26/hour pay with 20 hours/week. Or if you are a real estate agent, that is 3% commission on a deal sold at $833,333 purchase price ($416,334 purchase price if you are receiving full commission and representing both buyer and seller). Difficult? Yes. Achievable? Yes. Totally worth it? Hell yes.
Step 3: Another $50K/Year - Free Up Existing “Lazy” Cash
This part is my favorite when visiting with students. I can often find “lazy” cash somewhere by looking at their personal financial statements. By looking at cashflow or your net worth statement, you can often spot money that is sitting idle.
Some questions that come up are:
“Are your retirement savings dollars inside an investment vehicle?”
“Do you have cash that is just sitting around doing nothing that you could otherwise park at a higher yielding vehicle?”
“Do you have equity that is sitting in one of your properties that can be put to good use?”
To read a more detailed explanation of finding money that may already exist for you and putting it to work for your future, go over this article, 7 Ways To Finance A Multifamily Real Estate Deal. This will get you going in the right direction as you analyze your own current financials.
Step 4: Commit to Investing and Reinvesting
This topic can be expanded to an entire course. What is important to remember is that you are investing for the freedom to live the life you desire. It would not make sense to become a full-time investor and not enjoy what you are doing currently. You would just quit one job for another job you may not like. Your investment vehicle needs to match your personality and your FI goals.
Here’s a personal example I’d like to share. My grandmother lived frugally all her life. She used to eat leftovers that were borderline inedible. She put her money into a typical, low-yield savings account. When she passed away, her entire life savings amounted to no more than $20K. Why? Because she felt that the bank was the only safe place to store her money. Inflation ate up all her savings. And it was sad.
I have sat through investment presentations on stock market investing. In that hour, the only thing I learned was that people who invested incorrectly, most of the time, somehow came out on top compared to people who never invested. The lack of investing funds is the biggest risk people take with their money because there is no upside.
The discomfort of investing that we all experience at times is nothing compared to the discomfort of having next to nothing in our “Golden Years” when we are supposed to sit back and relax by the ocean.
Standard US inflation in recent years has been kept at a 2% rate. In the past, it has gone as high as double digits. As inflation happens, a dollar in savings is worth less and less each day. Thus, investing those dollars to help them grow is a must.
If we took the $50K/year scenario described above and put that money into savings to sit “safely” then that money would potentially only be $500K instead of $1.25M in an investment. You would have to trade hours for dollars, live like a miser and save most of your money for at least another 11 years to catch up with someone who invested in a +12% return investment vehicle.
Compound interest is a powerful concept. In order to get compound interest, you need to reinvest whatever you gain from your investments. If you are investing in an apartment syndication or single-family home rental, you will receive cash flow income. Before you reach FI, you should reinvest this back into an index fund or set up an infinite banking scenario, while waiting to save up for the next big investment. This way, your money is always working for you. And once we understand that we can set up the correct situation where our money will never get tired of working for us, we realize part of our FI dream which is to make money while we sleep. It’s a beautiful thing.
Where exactly do I find an investment vehicle with +12% returns? There are many ways to generate that through real estate. You can fix and hold to maximize your profit.
Step 5: Leverage Tax Benefits To Boost Your Return
We briefly touched on taxes in the previous step. Now imagine that you could save all your taxes and invest those funds instead. That is 15% to 30% of the income for most middle class families. In the case of someone making $150K a year, they can save at least $25K extra per year if they are smart in structuring their approach on paying taxes. That can reduce our trajectory to only 3-5 years before retirement.
The best thing about investing in real estate is that you can use many different strategies to reduce the amount of taxes we pay. There aren’t many other investment vehicles that do this. Read my article on How I Paid Zero Tax Through Real Estate Investing to learn my multi year planning to reach the Zero Tax Club.
Step 6: Protect your a$$ets and start wealth planning early
Once you have created your nest egg, you want to protect it.
As property owners, everyone thinks that we are rich and wants a piece of the pie. If you do not properly protect your asset, you can risk losing it all in an unfortunate turn of events. However, you also do not want to over-protect it by setting up over-complicated wealth protection. This could cost you 10s of thousands of dollars.
So choose a plan that is appropriate related to how much wealth you are protecting. It makes no sense to spend $10K to protect $100K of assets. At times, making your assets super secure can be a pain to deal with. It presents certain challenges with the lending required to purchase a future property. It is recommended to have your asset protection lawyer, CPA and lender work together to give you a comprehensive asset protection plan.
Using a living trust is a great idea to plan ahead for your family. It is taboo to talk about death. However, you are leaving your family in a better situation if they are aware of your wishes. Not only that, a living trust will make sure you have clear instructions on how the money will be allocated and spent. It can also skip probate which allows your loved ones to not have to go through the stress of not having money for a period of time to support them after you’ve passed away.
Once you are close to your FI goal, you will discover that you are back to square one to re-examine yourself and your life goals. This time your choices are truly yours and not someone else’s to determine. Remember, we do this for the control and freedom of our own time. All this work on the front end pays off in the end.
Schedule a 30 mins FREE consultation now to discuss designing your own path to financial independence.