What would you do tomorrow if you don’t need to work for money? Financial freedom, or early retirement — whatever you wish to call it — is a big dream to achieve. For me, financial freedom means having the flexibility to make the most out of my life without relying on a paying job.
In the lifecycle of financial freedom, you build an investment portfolio generating passive income exceeding your expenses, and you continue to grow your wealth in perpetuity. The power of compound interest works well in this scenario, as long as your investment stays invested.
How much do you need to be financially fee?
In theory, you need to have saved at least 25 times your annual expenses to be financially free after retirement.
For example, if you spend $50,000 per annum, you will need 1.25M ($50,000 x 25). Assuming your investment grows by 5 per cent (adjusted for inflation) over a year, you now have $1,312,500 invested. Imagine you’ll be withdrawing at the rate of 4 per cent a year (1.25M x 0.04 = $50,000).
The value of your investment would look like this a year after withdrawal: $1,312,500 – $ 50,000 = $1,262,500. Your investment will have grown by $12,500 after withdrawal. The key is to never touch your investment principal, and only withdraw less than your investment growth.
The Framework of financial freedom
Most people earn income from employment or business; they pay their taxes and living expenses; and repay their debts. Hopefully, they pay off their home and accumulate sufficient funds in superannuation for retirement.
If you want to be financially free, instead of spending all your income on living expenses and debt repayments, you acquire income-producing assets such as managed funds, ETF, property, shares, and superannuation. I call this your money-making machine. When passive income from the money-making machine exceeds your expenses, you will no longer rely on your earnings from your job or business and you will be financially free.
The steps to achieve financial freedom
Save to invest
You may say that you will invest when you have extra money one day, but that day may never come along. By the time you’ve paid for everything like mortgage, groceries, bills, and shopping, you’re left with nothing to contribute to investment. But there is another way.
Pay yourself first
The pay-yourself-first strategy is simple. Every payday, the first thing you do when the money hits your transaction account is transfer a percentage into your emergency fund, freedom account and retirement savings accounts. You save and spend what is left.
The ‘emergency fund’ is intended for unexpected expenses, such as unemployment or health emergencies. Advisers usually recommend you hold three to six months of living expenses in your emergency fund.
‘Retirement savings’ mainly include your superannuation in Australia. Your employer’s super guarantee is 10 per cent of your ordinary time earnings, paid into your superannuation. If you are self-employed, don’t forget to pay yourself superannuation as well.
Your ‘freedom account’ is the money you plan to invest for your financial freedom, ideally 20 per cent or more of your net income. If saving 20 per cent of your income may not be possible from the very beginning, you can start small and increase over time.
Control your debts
Appropriate debt management is imperative for all wealth creation strategies. The most critical element of debt is to ensure it is fit for purpose. Ask yourself whether your debts are serving you or holding you back from achieving financial freedom.
Eliminate bad debts – debt that is not serving a purpose. It costs money and does not improve your financial position. Consumer debts such as credit cards and car loans are examples of bad debt, so you need to pay them off as soon as possible.
Effectively manage your home loan. When looking at purchasing your dream home, you need to consider not only what you can handle financially, both now and in the future, but also make sure this commitment is not conflicting with your dreams to achieve financial freedom. I’ve seen many cases of excessive debts that cause unnecessary financial stress and anxiety on people, and place limits on their ability to fund their financial freedom or other goals.
Accelerate your wealth
Smart investing is not complex. It’s simple. It is about buying good quality products and being disciplined. Having a trusted adviser who can give you information about investment options and keep you on track and accountable can fast-track your financial success.
When is the best time to invest? The best time to invest was 10 years ago and the second-best time is now. You can benefit from compound interest by starting early with your investment. The best way to arrive early at your destination is to start early. Please find the following link to the compound interest calculator at moneysmart.gov.au. https://moneysmart.gov.au/budgeting/compound-interest-calculator
After you try the compound interest calculator and understand the power of compound interest, you will be amazed at how much wealth you can accumulate if you start early and make enough contributions to your investment over an extended period of time.
You can find out more information about the strategies to achieve financial freedom from our eBook – “The Guide to Financial Freedom”. Please download the eBook via the link – The Guide to Financial Freedom | Compound Freedom .
My job as an adviser is to guide you so you can unlock your life of freedom and pursue your dreams and passion. A free and abundant life offers you lots of options.
