Disclaimer: The statements made in this post are the opinion of the author. They should not be viewed as financial advice. Please consult with a financial specialist before making any financial decisions.
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Congratulations, if you’ve followed the advice of this blog and started to track your spending, make a conscious effort to spend less than you earn, and reduce your biggest three expenses then you should have some money left over each month. You’ve used that money to start building an emergency fund so you are now financially secure. But why are you doing this? That is up to you, but let me share what results you could expect depending on how you move forward.
1 You could end up right back where you started. I know this probably isn’t exactly what you wanted to hear, but if we let new habits slip, building up financial security could end up being worthless. We must change our habits long term. If you let life style creep slowly increase your expenses, or you let the phrase “low money down, easy monthly payments” tempt you back into debt, then you will be no better off than when you started. Don’t fall for this trap! The number one defense against this is to never lose the habit of tracking your spending.
2 You could stay in a financially secure spot that uses savings well, but doesn’t truly propel you forward. Let me explain what I mean. If you continue to spend less than you earn, and maintain a solid emergency fund, then you are financially secure. What you do with the excess income determines where you end up in the future. If you want to stay just financially secure, then you can save those extra funds in a bank account and use them to buy that vacation or that boat, etc. whenever you have enough funds saved up to pay cash. This is not a bad approach to life, and you will probably be ready to retire at 65 feeling good about yourself, but may I propose something better.
3 Work to become financially independent. Financial independence, or financial freedom, takes financial security to the next level. Instead of using your extra income to save up for a trip or new toy, you could invest that money in assets that produce passive income or money you don’t have to work for. As this passive income grows over time, it will eventually overcome your expenses. Once your passive income is higher than your expenses then you are no longer obligated to work full time for money.
Consider this quote from the classic book The Richest Man in Babylon (which you can read for free online here):
“‘I have paid myself faithfully,’ I replied, ‘and my savings I have entrusted to Agger the shieldmaker, to buy bronze, and each fourth month he does pay me the rental.'”
‘That is good. And what do you do with the rental?’ [Said Algamish]
” ‘I do have a great feast with honey and fine wine and spiced cake. Also I have bought me a scarlet tunic. And some day I shall buy me a young ass upon which to ride.’
“To which Algamish laughed, ‘You do eat the children of your savings. Then how do you expect them to work for you? And how can they have children that will also work for you? First get thee an army of golden slaves and then many a rich banquet may you enjoy without regret.’ So saying he again went away.” (Online PDF pages 13-14)
So why should you want financial independence? That is entirely up to you. Some people want to be financially free so they can quit the job they hate. Some people want it to spend their time doing what they love. Some people want to travel. Others want more time with their kids or spouse. It depends on what lights you up and inspires you!
If you’ve made the effort to track your spending, spend less than you earn, and build an emergency fund, then you’ve already done the hard work. The last step is simply to start investing and then wait for “the children of your savings” to do the rest.
If you never had to work again, what would you do with your time? What is your reason for wanting to be financially independent? Tell me about it in the comments below.
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Emergency Fund: Money set aside to be used in emergencies only. When you use money from your emergency fund you will need to replenish it as soon as you can.
Financially Secure (Financial Security): Being in a position to be able to cover expenses in case of emergencies, such as job loss, major medical event, or accidents. The foundation to financial security is an emergency fund. It is NOT having a secure job which is not in your control. What makes you feel financially secure is up to you.
Life Style Creep: Also called Life Style Inflation, it means that you increase your expenses exactly as much as your income increases (if not more), this is usually gradual or unnoticeable with each small raise and it gets people into debt or at least living paycheck to paycheck.
Financial independence: Being able to cover all of your expenses each month without having to work. This doesn’t mean you don’t work, and it comes in a variety of ways from investing in stocks to real estate to businesses, etc. Your path to financial freedom is your own.
Assets: Things that put money into your pocket every month (or year). Sometimes equity in your house is also included as an asset, but I prefer not to include it. A car loses value every year (depreciates) so it is NOT an asset.
Passive Income: Money created by assets that don’t you require you to trade your time for money. That is you aren’t paid an hourly wage OR a salary, but are paid just for owning something. Examples are rental income, stock dividends, bond interest, and business ownership (unless you are an employee of your business).