Today’s post comes from Dominic, the Gen Y Finance Guy. Gen Y is one of the blogger who I’ve been fortunate enough to meet in person. At the end of 2015 in San Diego, Gen Y and I discussed plans to take over the world. Not really. Well, maybe…
Gen Y won’t need my help in his world domination plans. He’s a sharp guy who works his ass off. He has multi-million dollar dreams that I’m confident he’ll easily pull off.
I agree with almost everything Gen Y has to say. One thing I’d nitpick just a little is his statement that you need passive income to be FI. I may be in the minority, but I have no issue selling small amounts of assets very slowly to support my post-work days. In any case, this is a small nuance and if that is one of the only things that we disagree on, life is good. I’m on your side Gen Y. Please remember that when you do in fact, take over the world.
And don’t worry about the dinosaur collection (or lack of it). I’ll hook you up next time I’m in town…
Who wants to be a millionaire? Come on…don’t be shy, raise your hand.
Mr. 1500…please put your hands down (yes both of them), you’ve already been inducted to the all coveted double comma club more times than some people can count. And yes, we know…You get to put $55,000/year into your Solo 401K, and we’re all a little bit jealous (of your dinosaur collection?), or at least I am.
Look folks, reaching Financial Independence and Building Wealth is not that hard (or at least it doesn’t have to be). You don’t even have to be that smart. These days that most people would feel pretty wealthy and financially independent with $1M bucks (at least that’s the way it seems). Of course everyone has a number that’s unique to them. However, the mechanics of getting to your NUMBER remain constant. This post won’t spend much time figuring out what the right number is for you, instead it will cover 10 solid principals that if followed will help you reach your number, and thus FI in much less time than the “get rich slow” guys preach.
That’s not to say that there is anything wrong with the “get rich slow” approach, rather this is just the other side of the coin that isn’t talked about enough.
Before we get knee deep into the main content, we should probably agree on a few definitions and assumptions.
Financial Independence (FI): is reached when your wealth can generate enough passive income to support your lifestyle. Some would distinguish Financial Freedom as the point at which your wealth is generating more income than you spend. I will let you draw the line. I tend to think and use them synonymously (as you will read below).
Building Wealth: goes hand in hand with reaching FI. Unless you win the lottery or inherit your wealth you really can’t separate the two. Which if your plan is based on winning the lottery or inheriting your great uncle Scrooges fortune, this post probably isn’t for you.
From my vantage point there are two ways to become wealthy:
1 – The Slow Way = “Get Rich Slow”
2 – The Fast Way = “Get Rich Fast” (not to be mistaken with “Get Rich Quick.”
Notice I didn’t say “Get Rich Quick.” It’s a subtle change in words, but there’s a big difference. No, this is not another “Get Rich Quick” scam. I love a good scam as much as the next person, but we have some real solid material to cover on building wealth and reaching FI.
Most people don’t want to live below their means in order to reach FINANCIAL FREEDOM because that’s painful. They think it involves cutting out all the joy in life.
You know what I’m talking about, those financial gurus that tell you that in order to get rich you need to cut out the $4 lattes and stop eating out. Then after 40 years of diligent and above average savings and super low spending, you will be a millionaire. Basically, you have to live like a college student and suppress all the things you want to do in life and then, when you’re old, you will be rich (MAYBE).
Okay, that doesn’t sound like the plan for me either!!!
The good news is there is another way.
Which one do you prefer? This kind of seems like a no brainier question right? Our natural unfiltered response is likely “The Fast Way.” As my grandfather would say “we want to get there immediately, if not sooner.” There is no right or wrong answer and you may come to find out that “The Slow Way” is the right choice for you, and there is nothing wrong with that.
Before you answer, you need to know that “The Fast Way” is going to require more HUSTLE, DISCIPLINE, and FOCUS.
YOU need to ask yourself if you are willing to pay the price to ACHIEVE substantial wealth in 10-20 years instead of 40 years plus. Are you willing to be a non-conformist and go against the crowd?
Are you willing to live your life like most won’t for a couple years, so that you can live the rest of your life like most can’t?
If your answer is YES, here are the 10 guidelines that will allow you to reach financial freedom in 10-20 years:
When you start with nothing, or something much closer to nothing than that of a million bucks, things get pretty daunting. Don’t be intimidated, I truly believe that anyone can reach financial freedom, but only if you’re willing to do things differently (10 things specifically).
Whether you want to build a $1M Freedom Fund or a $10M Freedom Fund (like my $10M goal), below are the 10 principals that will ensure you arrive at your ultimate destination in 20 years or less. Rest assured, I practice what I preach, as these are the same guiding principles I am using to build my own wealth and ultimately reach FI.
The Tenacious Ten
1 – Spend Less Than You Earn and Invest the Difference Wisely
The reality is that if you want to build wealth and ultimately reach FI, you will need to create a gap between what you earn and what you spend. This is the most fundamental of fundamental truths. But it doesn’t stop there, you then need to invest the difference wisely. A little common sense will go a long way (see #10 below).
This is where most financial gurus would jump in and tell you to live below your means by living like a college student. Not me! Yes, you have to live below your means, but you have two ways to do it. Extreme frugality is one way. However, the way I am an advocate for is living below your means by expanding them. One way to live below your means by expanding them is to buy a house in a lower cost of living area and spending half of what the bank says you can afford like number 5 advocates below. Another way is to spend more effort on increasing your income than you do on reducing your expenses like number 7 advocates below.
The reality is that there is a natural floor to the amount you can save from cutting expenses, yet no limit on the amount of money you can earn.
2 – Avoid Consumer Debt at All Costs. Never Carry a Credit Card Balance
Don’t fall into the trap of spending future earnings. It will be impossible for you to create a surplus and be compliant with #1 above if you allow yourself to rack up credit card debt. This is not to say you should not have or use a credit card. I personally use a credit card to pay for almost every single purchase in my life. However, I never spend more than I can afford to pay in full every month. This method allows you to take advantage of rewards (i.e. get paid to spend what you were already going to spend anyways) and also provides additional protection on purchases.
Learn the difference between good debt and bad debt. Good debt is productive debt that either makes you money or saves you money. Bad debt not only takes money out of your pocket but buys things that depreciate in value (think cars, boats, cloths, electronics, etc).
3 – Maximize Tax Deferral to Pay the Least Amount of Taxes Legally Permitted
Don’t underestimate the power of tax deferral. Your goal should be to defer taxes on as much of your income as you can.
The first way to do this is to max out tax advantaged accounts like the 410K, IRA, HSA, etc. This one is a bit harder to demonstrate in an already lengthy post due to vastly different variables for each individual (maybe a future guest post). However, the other way that can defer taxes is by holding investments for the long term (or at least longer than a year). Below is a comparison of 3 different scenarios to convey the power of tax deferral:
Looking at the table above you can see over just a 1 year holding period tax deferral makes a huge difference when it comes to your compounded return (12.8% vs. 9.6%). It’s mostly due to the fact that investments held for a year or longer are taxed at more favorable capital gains rates vs. ordinary income. In all 3 scenarios above there was $500,000 invested. Over a 1 year period the gap is more than $400K. And over 10 years that gap grows to over $540K with a return of 13.6% vs. 9.6%.
Another way to defer taxes is talked about specifically in number 8 below, taking advantage of depreciation on real estate investments.
4 – Aim to Save 50% or More of Your After Tax Income
It is really amazing how applicable math is in almost any endeavor. It is especially applicable when it comes to building wealth. I am very fond of the following quote:
“The path is all math.” – Ryan Blair, Nothing to Lose Everything to Gain
Here is a summary of the simple math as related to your savings rate and translated into terms of FREEDOM:
If you save 5% of your income, you can take 1 year off every time you work 19 years. [That is a lot of time to put in to bank 1 year of freedom]
If you save 10% of your income, you can take 1 year off every time you work 9 years.
If you save 20% of your income, you can take 1 year off every time you work 4 years.
If you save 30% of your income, you can take 1 year off every time you work 2 years and 4 months.
If you save 40% of your income, you can take 1 year off every time you work 1 years and 6 months.
If you save 50% of your income, you can take 1 year off every time you work 1 year. [Where the GYFG house is currently at. I could see us between 50-60% long-term]
If you save 60% of your income, you can take 1 year and 6 months off every time you work 1 year.
If you save 70% of your income, you can take 2 years and 4 months off every time you work 1 year.
If you save 80% of your income, you can take 4 years off every time you work 1 year.
If you save 90% of your income, you can take 9 years off every time you work 1 year. [This seems pretty out of reach and extreme to me. I want to be able to have $200K/year of living/travel/fun expenses. This would imply a $2M after tax income and likely a $4M gross income assuming a 50% tax rate]
Now keep in mind that this doesn’t take into account any investment returns, but instead is to simply show you how powerful your savings rate can become in achieving FI. I have even touted your savings rate as the most important variable when it comes to rapid wealth building.
5 – Buy a House that is Half the Price the Bank Says You Can Afford
Most people make the mistake of buying as much house as the bank says they can afford. However, the last thing you want is to have all your money going to service a huge mortgage, a big lifestyle, and little if any left for saving and investing. Actually, this is an area where you can strategically live a bigger lifestyle, and save a significant amount of money if you get a mortgage that is way less than you can afford.
This also allows you the ability to pay off your mortgage much sooner than the typical 30 year term. The reality is that debt is the biggest dream killer for most people. You get the big mortgage and then you’re stuck, you can’t leave the job you hate. I won’t get into the argument of whether it makes financial sense to pay off your mortgage or not (which I am a big fan of), but I ask you to imagine life and the choices you could make without a mortgage hanging over your head?
Personally, my wife and I were approved for a $750,000 mortgage, but ended up taking one that was less than half ($355,000). Today the mortgage payment accounts for less than 15% of our gross income, and we are actually in year 2 of a 7 year plan to pay it off completely.
6 – Learn Two Basic Investment Strategies with Options
The covered call and short put. Use these strategies to invest in index ETF’s and Dividend paying stocks. They are a great vehicle to invest at significant discounts to market prices (i.e think Warren Buffett margin of safety). They can actually be used to reduce your risk, contrary to what the financial media would have you believe. My favorite feature is that they give you more than one way to profit!
If you want to read more about these strategies and how you might use them in your own portfolio, I have created a PDF of a guest post I wrote for Financial Samurai that you can download here.
7 – Focus 80% of your efforts on increasing your income.
Start a business, even if it is just a side hustle. I believe everyone should have a side hustle at all times, if only for the tax benefits. But there are also some awesome ways to earn extra money. In 2014 after learning about digital analytics and digital marketing for a job I was trying to get with the company I was working for at the time, I moonlighted by offering consulting services in this area and earned $100/hour (to learn and gain experience), and earned an extra $18,000 all in my spare time.
Rent out a room in your house. If you follow principal number 5 and buy a house that is less than you can afford and you happen to do it in an area where the cost of living is very cheap, you could strategically over buy in size (not price), in order to create excess capacity you could then rent out. That is exactly what my wife and I did. We have been consistently collecting $400 – $600 a month since we bought our 3,300 sqft house (which is way more house than any two people need).
Learn new skill sets that will make you more valuable in your career. I witness way too many people that stop learning once they are done with school (thus # 9 below), you always need to be refining and retooling. Don’t ever become content with your skill set. The reality is that the ladder to the top is never crowded because most people are never willing to pay the price (do the work) to climb the latter in the first place. The mistake I see most people make, even if they do learn new skill sets, is they never ask for what they have earned. Don’t ever rely on someone else to take care of you and your future. No one cares about your future more than you do. Ask for the raise!
Remember that you will never get what you don’t ask for. Sometimes you may find yourself in fortunate circumstances where you are taken care of without asking. Don’t settle for annual 2-3% cost of living adjustments. I would rather get a kick in the nuts. People that ask for more money, MAKE MORE MONEY!
The internet and the times we live in have made it easier than any other time in history to make money. You really have no excuse.
8 – Invest in Cash Flow Positive Real Estate. Take Advantage of Depreciation (people tend to miss this aspect of rental real estate)
Rental real estate is a great vehicle to build wealth. It is actually a much more dynamic asset class than most people realize and another great vehicle for deferring taxes due to the ability to depreciate the value of the property. You can actually have a scenario where most if not all of your positive cash flow is tax free. And you get the added benefit of being able to sell properties via a 1031 exchange without paying any taxes on profits due to appreciation as well. My buddy Brian over at Rental Mindset has actually already done a fantastic job describing the 5 dynamics of rental real estate (check it out if you have time).
9 – Never Stop Learning
The day you stop learning is the day you stop moving forward. The perpetual student will always have the knowledge edge.
10 – Run from Investments that Sound Too Good to Be True
If I have learned anything from the blunder of financial mistakes that I have made, it’s that if it sounds too good to be true….it is! Turn around and run the other way!!!
Remember, these are principals that you can grow into and work towards. It doesn’t matter where you are financially in your life right now. We all have to start somewhere.
I hope this post inspires and motivates you to action. Don’t take a passive role in your finances and hope for the best. Hope is not a strategy.
“If you don’t plan your future, somebody else will. And you know what they have planned for you? NOT MUCH!” – Jim Rohn
You have to be intentional with your finances if you ever want a fighting chance to make it to financial freedom. It doesn’t have to take 40-50 years of slaving away for the man before you have the option to retire. I personally think that 10-20 years is really all you need, and for the folks that are more aggressive (i.e. extremely frugal, not me) or very high earners you can probably reach financial independence in 10 years or less (maybe me, it’s yet to be seen but income is my focus vs. expenses).
I am looking forward to chatting with you all in the comments below.
Thanks Dominic for the guest post today!
Be sure to follow him over at:
In the meantime, I’ll be trying to stay ahead of Gen Y in the net worth column for as long as possible. Here is the current score:
- Gen Y: $363,000
- Me: $1,350,000
He’ll blow past me some day and that’s OK, as long as I get an invite to the vacation home on Maui. I wouldn’t turn down a ride in Gen Y 1 either (this is like Air Force 1, only Gen Y’s ride).
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