5 Simple Steps To Financial Independence

What is Financial Independence?

Financial independence or freedom is your ability to leave the workforce while continuing to maintain your desired quality of life. You can achieve this through carefully created wealth and alternative income streams.

Why is Financial Independence important?

We often remain in jobs we don’t enjoy out of necessity. This often sucks the fun out of work. Imagine if you were not working out of compulsion but could choose the work you are passionate about or do absolutely nothing if chose to. Wouldn’t that be awesome? Achieving financial independence will enable you to do exactly this. This independence or freedom will change your entire approach to life and  will elevate your state of mind. At least is our case, this is true.

All it takes is a simple plan!

Why are we writing about it?

While there are thousands of articles out there on this topic, most of them are either from companies selling their products, generic advice, over simplified and too ambiguous or too complex to act upon.

When started to plan our financial independence, it seemed like a daunting task. We confronted overwhelming amounts of information, jargons, tons of advice, hundreds of financial products each promising us the best. In other words it was too much, complicated and got us all confused, we almost gave up! 

But the desire to achieve financial independence and retire early is so important to us that we decided to dive in, cut through the clutter, distill the facts and simplify it. 

Key Takeway for us – at the root of success lies a simple actionable plan. That is where we created our 5 simple steps to financial independence based on the idea of working backwards (Read more). 

Now having put our planning on cruise control, we want to share our 5 simple steps to financial independence that you can use for achieving the same.

To make it tangible we will walk you through the 5 simple steps with 3 Personas, each with a different target. This will show the impact of different factors in planning and lets you choose the one you can relate to. 

Taking it a step further we have created a simple online calculator for you to create your individual plan.

Let’s dive in!

Step 1/5: Define the Timeframe for Financial Independence

Divide the time from now until end-of-life into phases based on the key-activities, focus and financial situation for each. For planning we recommend the following 3 phases,

Preparation Phase: The only active phase in your planning, the effort you put in here will dictate your success. Key activities includes creating your wealth through savings, building sources for supplementary income and settling major liabilities like mortgages, car loans etc.

Bridging Phase: The 1st of 2 passive phases. Now you have stopped working but are under the legal age for availing retirement benefits such as pensions. This phase may require the most attention as you are relying completely on the wealth you created.

Pension Phase: The final phase. Here, you start receiving retirement benefits like pensions in addition to the wealth you built. In many countries you may also get other social or tax benefits.

Note: Be realistic. Choosing a realistic timeframe that allows you to prepare properly without  draining the fun out of your current life or jeopardising current obligations is crucial. You will see the impact of choosing phase durations in case of our Personas. Selection of the suitable timeframe is an iterative process play with different durations in the free calculator to see its impact. 

Step 2/5: Estimate The Needed Cashflows

Next step, let’s estimate the monthly cashflow you will need in your years of financial independence. Think about the money you need monthly to cover your bills, costs for living, insurances, leisure and for pursuing your passions. 

A simple way of doing it is by looking at your expenses from your previous bank statements and simply deducting the costs you will not have in the future such as payment for settled loans, cost of going to work etc. 

Even simpler way is taking 60-70% of your current gross income, statistically this should do the trick.  Surely this may vary depending on your desire of how you want to spend the passive years. You may want to read about our personal balance-sheet to gain insights into your current cashflows.

Since start of bridging and pension phases are in the future, you need to account for the little devil at play called inflation.  Long-term inflation for developed economies stands at 2% p.a. but you account for inflation in your country .

Don’t worry we have included the math in the free online calculator.

Note: Do not underestimate. Nothing would be worse than getting stuck in a life with loads of time but no money to spend.

Step 3/5: Define Your Status Quo

Moving on, let’s define your starting point i.e. the current situation of savings, investments and assets. Putting together this information will be easy if you maintain a personal balance sheet. For this you essentially need the following:

Current savings and corresponding annual returns generated through dividends or interests.

Any additional cashflows generated from other assets such as rentals, businesses etc.

Pension expected from state or employer at the time of its maturity i.e. in the pension phase.

Additional pensions from personal savings programs.

Note: The values of pension plans are often forecasted for certain maturity age assuming that you continue to contribute to them. Account for them accordingly if you stop paying into them at an earlier stage. Look at our Personas to see the impact of this factor. 

Step 4/5: Fill The Gaps to Financial Independence

You are almost there. Meanwhile you know the needed cashflows, the status quo that means – the difference is what stands between you and your financial independence. We call it the – The Gaps.

Idea is to build a simple financial framework in the preparation phase that can later fill these gaps through regular cashflows and/or withdrawals. It is interesting to note that the once complicated task is now down to just two numbers.

Filling the gap can be achieved through a combination of different ways such as:

Option 1: Creating an investment portfolio of highly diversified securities,

through regular recurring contributions and use the power of long-term compounding interests to work for you. You can choose a plan that has a stable appreciation and ideally generates annual returns through dividends.

Fun Fact: If the rate of appreciation is greater than the sum of your needed cashflow and inflation then you can live off it till the end of times without ever getting diminished.

Option 2: Invest in Cashflow generating Assets,

such as rental properties or acquire stakes in businesses that generate regular revenues. Most people consider residential properties for investing but often overlook the commercial property space. Depending on where you are located this can be a great option as well.

Option 3: Build additional sources of revenue,

through a business or side hustle. Depending on you chosen timeframe this could be simply monetising your hobby or passion which you want to pursue in the passive phases

Option 1 as this is the most passive way of building wealth. At the same time depending on the size of gaps to fill and the preparation time available it might require contributing a substantial part of the current income. Hence a combination of different options might be required to reach your financial independence. You can find out your gap and corresponding monthly contribution using our free online calculator.

Step 5/5: Stick To The Plan

If you followed the steps and used the calculator then you should know what needs to be done, you already have an idea of how you can achieve it. And yes, plans look enticing on paper but the only thing that will make a difference is – implementing it and sticking to the plan. 

The difficult part lies ahead. In order to keep going and giving yourself a pat on the back now and then – breakdown your goals into yearly targets. 

As you reach those milestones, you will feel the achievement. It will also remind you of the purpose and will motivate you to keep going.

Journey of the Personas