Hi friends. I’d like to start this post by asking you the question: what does wealth mean to you? I think wealth can mean different things to different people. For example, a person might look at being wealthy as having a well funded retirement plan. Another person might think of wealthy as less about money and more about having a rich life filled with friends and family. In any of these cases a person could be considered wealthy depending on what his or her definition of wealth looks like. According to dictionary.com one definition listed says that wealthy is “rich in character, quality, or amount”. So, what’s your definition of wealth and how are you going to get there? I believe building wealth is about making smart choices with your money. Becoming wealthy might be a far off thought to you but I’d like you to realize that it’s closer to reality for you than you might think. My definition of wealth means being financially independent and this is what I would like to focus on in this post.
So, what is financial independence? To me, this is the point that your investments are making you more money than your expenses and can sustain your financial needs for life. Let’s dig into this a little deeper. My definition of financial independence has two components. The first component is that on some sort of time basis your income from your investments are making you more than the expenses that you accrued on that same time basis. For example, let’s say that your expenses on a monthly basis amount to $3000. This means that your investments would need to make at least $3000 per month to essentially break even. If you were getting an average of 8% annual return on an investment this would mean that you would need an investment worth at least $450,000. The second component has to do with sustainability. This means that your investment have the ability to continue to pay for your expenses indefinitely. Ok, this is where my definition of financial independence gets a little more complicated. Your investment must not only cover your expenses on a time bases in the present time but must also have the ability to cover your expenses in the future as well. This means that you are taking into consideration growing expenses due to inflation or other reasons for increase in costs. In order for your investment to compensate for inflation and these other growing costs it must be growing as well. Let’s say that you have that $3000 per month expense and as we pointed out you would need $450,000 growing at 8% to cover that. Well, what if inflation is at 2% per year? This means that you need your investments to also grow at 2% in order to be able to cover that future increase in expense. In this case you either need to seek an investment that gets 10% annual return or you need to save up more in your investment so that your investment return is not only covering your current expenses but is also causing your investment balance to grow over time so that it covers your increased future expenses as well.
This all sounds great but saving up a bunch of money sound hard. The amount that I would need invested is a huge number and how do I even get that much? I agree, building an investment portfolio that creates enough return to cover your monthly expense is a sizable feat but if you want to become financially independent you must build a large investment. So, how do we start to build an investment that will allow us to become financially independent? In short, the answer is to put away as much money each month as you can. This answer, however, does not give us an estimate on how much we need to put away or how much we’ll have considering given conditions. There’s a lot of different ways to calculate how much wealth you’ll need to amass in order to hit your financial goals so let’s take a look at the basic steps of this calculation. The first step is to estimate how much your expenses are now and how much they will be in the future. To do this create a budget. I have used Microsoft’s Excel to create my budget and to help me with my financial independence calculations. If you haven’t created a budget yet I highly recommend using Excel. The next step is to estimate how much of an investment you’ll need at a given rate of return to cover your expenses. Next, estimate how much you’ll need to cover the growing amount of expense in the future. These calculations can be done using different techniques. If you’re not comfortable doing these calculations ask your financial adviser for assistance. There are also numerous online calculators and YouTube videos that can help you with this as well. Once you have an investment amount that you will need in order to achieve financial independence you can calculate how long it will take you to save that much money by using your budget.
Call to action:
- I’d like to encourage you to look at what being financially independent looks like in your life. Do this by calculating how much you would need to invest in order for that investment to cover your current monthly expenses.
- Now create a budget that will show you how much you can put away each month to get you to reaching the investment amount to be financially independent.
- Work like crazy to build up that investment portfolio!
- Enjoy being financially independent 🙂