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Basics of financial independence
What is financial independence?
Financial independence is the idea that you can achieve freedom from work by changing the way you think about life and money.
Most people get a good job, buy an expensive house, buy a nice car, have a few kids, then spend their life paying it all off. If they've slaved away enough, and nothing goes wrong during their 40 years of work, they might just be able to enjoy a few quiet years of retirement.
But that's not the only way to go through life. You could choose to live more thoughtfully, cut expenses where you're comfortable, and quietly invest your savings into income-generating assets. Then through the magic of patience and compound interest, those assets will generate enough income to cover your living expenses. And then you’ll be liberated from paid work forever.
Then the question becomes 'what do you do with all your free time?' ...and the answer is always 'whatever the hell you want'. Because now you are the master of your own destiny. You could keep working, spend time with loved ones, travel, build a small business of your own, or just sit around eating Doritos and playing video games. You be you.
How much do I need to save and how long will it take?
A bunch of research has converged on the idea that a retiree can withdraw about 3.75% of their retirement portfolio without running out of money during retirement. If you run the numbers, this implies that you only need to save about 28x your annual expenses to retire.
Sure, that sounds like a lot. In some ways it is. But compound interest will accelerate you to that number faster than you think.
Assuming your expenses today will be the same when you retire, it's quite simple to calculate. Here are some indicative figures. If you save 25% of your income every year, you can retire in 32 years. If you save 50%, then you can retire in 16.5 years. And if you save 75%, then you can retire in 7 years.
Seriously... you can retire in 7 years. Take a moment and imagine that.
Reduce your expenses
Are there different philosophies of financial independence? How do I pick one?
Broadly speaking, the approach is the same. Spend less, invest more, retire early. But, yes, there are some differences in philosophy.
Early financial independence gurus generally advocated for a thrifty lifestyle that is low on consumerism, social impact and environmental impact. Some of these guys live off less than $25,000 per year and live in a car like a homeless person.
More recent gurus have started to advocate for retiring with more money, so that you don't have to forego any luxuries. I tend to relate more to these guys. They argue that money can ensure your freedom and enable you to do the things that you truly enjoy.
Obviously neither is intrinsically better than the other. Some people find more joy in a minimalist footprint. Others want to travel and do things that require a bit of money. Your job is to think long and hard to figure out which one you are. When you’ve done that, you’re ready to start changing your approach to money.
Ok, I think I need a money makeover. How exactly do I reduce my expenses?
The first thing you need to do is to take a realistic look at where all your money goes. You’d be surprised to discover how much spending on things like food, alcohol and your favourite Japanese manga collection really adds up.
Personally, I use budgeting software called YNAB to track every cent that comes in and out of my bank account. This helped me identify my big expense categories. And now it only takes 15 minutes per week to keep it up to date. Every month I can review my spending to make sure I'm not doing anything stupid.
By the way, the link above is a referral code. I'll get a month of YNAB for free. It doesn't cost you anything to use it. C'mon, help a bloke out.
Anyway, you're likely to find that you spend money on a bunch of useless junk (stop buying manga). You now have to decide what you’re willing to go without versus what is important to keep. In other words, go full Marie Kondo on that junk and see if it sparks joy.
But all my friends are spending money. I feel left out!
Get new friends, remind yourself what's important, or just give up. This isn't a cult, you're free to live your life however you please.
Investing the difference
I have no idea about investing. Where should I put my money?
Now that you’ve cut your useless spending, you should have a bunch of extra money that you can put to good use. The general philosophy of financial independence is that you use that money to buy appreciating assets.
In Australia we’re very big on property ownership and that’s one way to achieve financial independence. However, the more common approach is to buy into low cost index funds. These are funds that will generate the same returns as the index that they are tracking (e.g. the ASX200 or Australian Government bonds).
Our research suggests that one good approach is to purchase an equal split of an Australian stock market index fund like VAS and an international stock index fund like VGAD. If you’re risk averse, you can buy a bonds index fund to smooth out the volatility. You can read more about that here.
How on Earth does the money get from my bank into the stock market?
Buying stocks isn't actually difficult. It only takes a few clicks of a button, you just need to find the right online broker.
Our philosophy with online brokers is that we should strive to minimise fees. After all, you're buying the same thing (index funds) no matter which broker you use. You’d be pretty stupid to use a broker that charges you more for the same thing.
The best broker that I've found is an Aussie outfit called SelfWealth. The offer $9.50 flat-fee trades, none of this fees-as-a-percentage crap. They're also very easy to use. All you need to do is sign up, bank transfer some money from your bank account into your new brokerage account, then start buying index funds.
Again, the link above is a referral code. It will get us both 5 free trades (worth almost $50) if you decide to use it. Rest assured, I do believe this is best online broker. But if you have doubts, do a bit of research yourself. I think you'll end up with SelfWealth anyway, so consider using the damn referral code and those free trades.
I've been investing but the market is crashing. Should I stop and take my money out?
You need to calm down. We have had market crashes before and we can be sure that we will have them again. They tend to happen about every 10 years.
The problem is that we can’t avoid it. Nobody, not even the most experienced investors, has shown that they can reliably pick the top or bottom of a market. And the problem is that trying to time the market almost always results in a bad outcome. Please, don’t try and time the market.
The trick with market crashes is to ignore them. Keeping pumping money into your index funds like champ, irrespective of whether it’s moving up, down or sideways. If that’s too hard for you to rationalise, then think of crashes like a great opportunity to purchase your index funds at a discount. Buy the damn dip. And when the recovery comes – and it will come – start counting that skrilla.