On
my daily walks (~2.5 to 3 miles a day), I enjoy listening to various
podcasts. One podcast I enjoy listening
to from time to time is the ChooseFI
podcast. While most of the concepts presented
on the show are not new to me, it’s interesting to hear the various ideas of
financial independence (FI) presented as well as interviews with notable
financial bloggers. One episode I
recently heard and really enjoyed is called The Pillars of FI. I think the hosts of this episode did a great
summary of the fundamentals of financial independence. It’s a great reminder of the things we need
to focus on as we pursue our financial freedom.
Here are the pillars of financial independence discussed on the episode.
1. Low cost index fund investing
It
is consistently proven time and time again that financial experts cannot
consistently pick stocks or funds that will beat the average market returns
over time. Actively managed funds may on
occasion beat passive index fund investing, but they don’t usually earn enough
to make up for their expensive fees. While
an individual stock may skyrocket in value, it may also plummet in value. I wouldn’t trust our entire retirement
portfolio to a few hand picked individual stocks. If you really want to make money on
individual stocks, you need to take high risks and put a lot of money (and
risk) into those stocks. On the other
hand, index fund investing has low costs, broad diversification, and reliable
long term growth. Read Jim Collin’s stock series for more
information on index fund investing.
Early
in my investing career, I made the mistake of not investing as early as
possible. My first full time job did not
offer a 401K retirement plan; I responded by not bothering to invest. I kept telling myself that there would be
plenty of time to invest once I started making more money. When I finally opened a Roth IRA, I went with
Edward Jones. My Edward Jones financial
advisor sold me on expensive funds with high expense ratios and a 5% front load
expense. For every $100 I contributed,
the firm took $5 off the top. I’m glad
that I learned about Vanguard and low cost index funds. I was charged a $40 fee for closing my Edward
Jones account to transfer all of my money into a better place.
2. Do not try to time the stock market
Studies consistently find that investors that try to dance in and out of the
stock market and time their purchases and sales tend to lose more money than
investors that stay invested. Fidelity
investments did a study of the portfolios that performed the best from 2003
to 2013 and they found out that the best performing accounts were from
investors who were dead! Since they
didn’t touch their accounts, the balances were left to grow over time. The second best performing accounts were from
investors who had forgotten that they even had accounts at Fidelity. Investors who try to chase performance or
those that buy high and then sell low when their investments don’t perform do
not earn as much as those who simply buy and hold. When trying to time the market, you need to
be right two times: when to sell and then when to buy. It’s a loser’s game.
3. Affordable housing
Since your rent or mortgage is likely the largest expense, it is important to
keep your housing expenses low. I made a
mistake of buying a house that was too large for my needs. When I first started making good income, I
bought the most expensive house that my income allowed me to get financing
for. This made me feel house poor for
several years. This is when I got
creative and decided to rent out the extra rooms in my home to bring in
additional monthly income. Once my wife
moved in and we combined our income, I finally felt much better about owning
our home. Our house is on track to be
completely paid off in 13 years.
For
those looking for housing in high cost of living areas, consider having a
roommate to cut down on costs and share expenses. Do you want to be financially free or live in
a nice place you can’t spend time in since you have to work hard to afford the
payments? If I could go back in time, I
would have looked to purchase a smaller home with less space to build up
clutter, lower mortgage payments, and less property taxes and insurance costs.
4. Car ownership
Monthly
auto loan or lease payments can hold you back from achieving financial
independence. One of the pillars of
financial independence is buying a used fuel-efficient vehicle and driving it
as long as possible. Owning a car has
many extra expenses such as regular maintenance, fuel costs, repairs, vehicle
registration fees and auto insurance. Higher end luxury vehicles need more expensive fuel, have more expensive upkeeps, and have higher insurance and registration costs. Having a car can be a huge money pit.
This is why many financial bloggers recommend biking / walking to work
if possible, completely eliminating the need for a vehicle and its related
expenses.
Years
ago, my wife and I both sold our paid off cars to buy new ones. Looking back, I definitely regret selling
those vehicles. They still had many
years of life left in them. While many
financial bloggers recommend buying used, I bought a brand new Lexus IS250 in
2008. We leased a Prius for my wife in
2013. I definitely regret leasing the Prius - what a waste of money. At $342 a month for 36 months, that’s $12,312
that could have gone towards investments or even a high quality used
vehicle. When it was time to return the
Prius lease, we decided to purchase a new car in cash – and be completely done
with car payments. We expect many years
out of our paid off cars.
My
dream is actually to be car free. If
public transportation were more feasible in our area, I would be all over
it. I’m looking forward to a time when
self-driving vehicles can bring us where we want to go; I personally hate
driving.
5. Food expenses
I
have to admit, we love eating out. We
consider it a special treat to go out to eat at a restaurant. That being said, we really don’t eat out that
often, maybe 1-2 times a week. We pretty
much bring
our lunch to work every single day. Most
of the time, we enjoy a home cooked meal.
Good food doesn’t take long to make, and you can be sure all the
ingredients are fresh and healthy. There’s
no need to get into your vehicle, drive to a restaurant, wait to get served,
and then tip at the end. Preparing your
own food is faster, cheaper, and much healthier than eating out. Did anyone else catch the story about a frog
found in a BJ’s Restaurant salad?
6. Tax optimization
Many
financial experts recommend maxing out a 401K since it lowers your adjusted
gross income (reducing your taxes), and also allows you to invest more money up
front pre-tax. Without getting into all
the details now, there are strategies of withdrawing money from your 401K
before the standard withdrawal age of 59.5.
There are even methods to keep your tax rate of withdrawals very
low.
The
best part of investing in your 401K is that your 401K pre-tax deposits happen
automatically. You are dollar cost
averaging your investments consistently with each paycheck. Over time, you just get used to living off the
remainder of what your paycheck provides – you won’t miss those
contributions. If you can’t afford to
max out your 401K right away, slowly increase your contributions as your pay
increases.
7. College education
With the help of scholarships, financial aid and cheaper college tuition due to
attending public schools, my wife and I were both lucky to graduate college
with very little debt. College and
higher education costs have skyrocketed today.
I hope there is some type of college costs reform in the future by the
time our son is ready to attend college.
In the meanwhile, we have already started a 529
account for him at Vanguard. While
we feel it is important to help our son with his future college expenses, we
also know that it is even more important to make sure we secure our own financial
freedom. As the saying goes: you can
take out loans for school, but you can’t take out a loan for retirement.
8. Travel rewards maximization
This is a big one for me and my family.
Properly utilizing credit cards, rewards points and airline miles have
been a huge part of our financial journey.
While I love my job, I love my 7 weeks paid time off even more. Going on vacations helps to keep us sane and
breaks up the monotony of our weekly work routines. Credit card points and miles have allowed us
to travel the world without breaking the bank.
We’ve even had the chance to fly Cathay
Pacific First Class and Singapore
Airlines Business Class – experiences we would never pay for with
cash.
We’ve used our points on
ourselves, and have also shared them with family. Thanks to extra miles we had, we will get to treat
my father to his first business class flights – he’s quite excited. I regularly write about how much money we save by paying for flights and hotel rooms with points.
9. Cancel cable subscription
While
canceling your cable or satellite television won’t make you rich, it may reduce
your monthly expenses by $50 to $150 per month, which can go towards
investing. The most important part about
canceling your cable (or any other subscription) is that it keeps you mindful
of where your money is going. If your
cable bill is $150 a month, are you getting $150 worth of value from the
expense? With streaming services such as
Netflix, Amazon Prime, and HBO Now, it’s easy to activate and suspend service
as needed. With Amazon Prime, you can
watch television and movies a la carte and if you really want to watch
something specific that you can’t stream for free. $100 a month invested at a 7% rate over 10
years will return over $17,700.
10. Reducing your cell phone bill
We
get our phone bill covered through my employer since I occasionally need to be
on call for the hospital when my patients need access. If I didn’t have our $100 a month cell phone
bill covered, I would look into cheaper cell phone plans such as those offered
by Republic Wireless.
11. Unconventional thinking
Striving for financial freedom involves attitudes and actions that go against
the grain of mainstream consumerism culture.
Society tells us spend on money on material things. Clothing designers try to sell consumers on
fast fashion - style trends that come and go in a matter of months. Traditional financial pundits recommend
saving 10% of your income for 30-40 years, and you might get a chance to retire
at age 65. Traditional financial
advisors talk about focusing your retirement goal on replacing 80% of your
income, when only your yearly expenses should be used as a guideline.
I
first learned about financial freedom when I stumbled upon the Mr. Money Mustache blog. Start by reading this post, titled Getting
Rich: from Zero to Hero in One Blog Post. Mr. Money Mustache has opened my mindset up
to the unconventional thinking involved with truly getting rich quickly. No fancy stock trading tips or gimmicks, just
cutting back on expenses, saving much more than traditional financial pundits
recommend (at least 50% of your income), and investing the difference. Being frugal doesn’t mean being cheap – to me
it means cutting out wasteful spending and consciously choosing to spend your
money on experiences or quality things that truly make you happy or add to your
life. Striving to reach for financial
independence involves thinking outside the box.
So
there you have it, the pillars of financial freedom. What are you working on to move closer
towards your own financial freedom?
