The Ultimate Guide to Financial Freedom

Summary: Here's the ultimate guide to financial freedom. Learn how to create a passive income that lasts forever. (Tweet This)

Last week, I 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 has 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.

Your Financial Guide

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 can then be invested until it grows enough that you have financial freedom. Sometimes it really is that simple.

Financial Freedom makes me want to kiss my money.

Financial Freedom makes me want to kiss my money.

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. 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.

  • 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.

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 $28,379.52 would generally cover my expenses. I'll pretend it is $30,000 just to round up to an even number. Then I'll add some padding for unexpected expenses... let's go with 20%. So now I'm estimating needing $36,000 a year... or using the Rule of 25, a nest-egg of $900,000.

If that number seems low to you, it is I am assuming that home is paid off (13 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

Magnetize money

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:

  1. Compound Interest is Your Friend - Deferring taxes and compounding interest can be a powerful combination.
  2. 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 $16,000 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. 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 $1000 month with it. Yes, that adds up to more than $12,000 or the majority of $16,000 in a somewhat passive income stream.

We personally have three income properties, and though they don't make much money today, in a little more than 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.

2. Start a Business

There are a number of great reasons to start a business. I'll give you just a couple:

  1. When you do something you love, it doesn't feel like work.
  2. 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:

  1. 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.)
  2. Your annual income now. Hint: Use the Rule of 4% on your savings.
  3. 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.

Final Thoughts

There's a big difference between looking at a map and taking a journey. Information can only take you so far. You should have 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.

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