The Four Pillars of Financial Independence
Most of us are seeking some version of financial freedom, but what exactly is required in order to achieve it? Financial freedom, or financial independence as I like to call it, is a financial status where you generate more passive income than you need to cover your living expenses. This is a level where you can stop trading your time for money, and work becomes an option, rather than an obligation. It’s a goal that arguably every investor aspires to, and yet the path to financial independence can feel elusive and overwhelming to many. So what is required to become financially free? What investments can bring you closer to this type of freedom? How do you know when you’ve attained such a status?
While the answers to questions like these will be different for each person, the path to achieving financial independence can be more easily digestible when broken down into steps. In this article I will share what I call “The Four Pillars of Financial Independence” which are the 4 fundamental steps that worked for me. In sharing these, my hope is for you to gain practical insight so that you can pave your own path to your goals and optimal lifestyle.
Earn at Your Highest and Best Potential
The first pillar of financial independence is earning as much income (actively) as you can using your highest and best earning potential. I know, it sounds counterintuitive to the end goal, but the reality is, unless you marry into wealth, inherit wealth or find yourself in receiving a major windfall, the path to financial independence usually starts with active work. Your highest and best earning potential is a factor of two things:
- Your available time
- Your hourly rate or salary
In an ideal scenario, you want to make the most amount of money possible in the least amount of time. However, when you are just starting out, this can prove to be difficult. There’s only so much you can charge for your time, which is why the best way to expand your earning potential is to expand your time. We all have 168 hours every week.
Years ago, in the pursuit to financial independence, I was an active W2 employee in the oil and gas industry working literally 98 hours per week. I would work for 14 days in a row and 14 hours each day. I was determined to achieve financial freedom, so in the little spare time I had and my days off, I would flip homes to generate additional income. The extra income I made from flips was used to invest in long-term, buy and hold single-family rentals for cash flow. At that point in my life, my fullest potential was limited to the numbers of hours I could physically work, and the same may be true for you.
I want to be clear that I do not recommend working 98 hours per week as it is usually unsustainable over the long run, but perhaps you could pick up some additional hours, or consider a side hustle in your spare time.
If you feel like you’re already working too many hours, are there promotions that might be available in order to generate more income? Is it possible to pivot careers or companies to a position that pays better? Have you considered branching away from the W2 world to become a consultant or self-employed? These may be worth considering if you wish to take a less aggressive approach toward your end goal(s).
You Can Be Twice As Rich By Desiring Half As Much
The second pillar to achieving financial independence is to reduce your living expenses. If you can manage to live off as little of your income as possible for a set period of time (not forever) you can expedite the process drastically. I don't advocate using coupons and living well below your means until the day you die, but a little sacrifice is necessary.
In the first 7 years of my pursuit towards financial independence, saving as much money as I could played a critical role. I’ll share the numbers with you, but please note that these are rounded estimates for example purposes. If I made $100,000 working full time in oil and gas, plus $75,000 a year fixing and flipping properties, and $25,000 a year in passive income generated from my long-term rentals, then I had a total of $200,000 in annual income. This is nearly double my salary on its own, which is the power of having a side hustle. Rather than increasing my expenses and lifestyle in the short run, I kept my overall expenses around $50,000 per year, so I could invest the remaining $150,000 a year. I am not including taxes in this example for simplicity purposes. Thankfully, investing in real estate is tax-advantaged, and something to keep in mind as taxes play a larger role as your income increases.
A 75% savings rate is certainly extreme, and you should go with the best option for you. However, it was this discipline that allowed me to kickstart the journey to financial independence.
Invest For Passive Income
The third pillar of achieving financial independence is investing the difference between your earnings and expenses into something that produces passive income. The margin between your income and living expenses is not something you want to have sitting on the sidelines. Rather it can be used to generate additional income that you don’t have to trade your time for.
This is where so many fall short. Many of us are taught to be savers, by simply putting our money in the bank for a rainy day or hoping for the right opportunity to pop up. The problem with this strategy is that your money loses value against inflation and the opportunity cost is substantial over the long run. Additionally, most of us are taught by financial media, friends and family that investing is all about buying low and selling high.
While this can work when market conditions are right, we all know that markets experience recessions, corrections and spontaneous pullbacks from time to time. There’s no worse feeling as an investor than watching your investment portfolio grow and grow and then an unforeseen market event pulls your portfolio back 50%. And worse, without passive income, you may be forced to sell your investments at a loss to generate cash to live on. Something to consider…
In conclusion, the key to becoming a successful long-term investor is focusing on acquiring passive income assets that can replace your earned income. The goal when seeking financial independence is to acquire assets that will “work” for you.
Avoid Bad Debt
The fourth and final pillar of financial independence is to avoid bad debt. For the sake of this conversation, I consider bad debt anything that has a higher interest rate than you could otherwise achieve by investing for passive income. Two examples could be credit cards and personal loans. Here’s the simplest approach: If I can reasonably and conservatively invest in something that produces passive income and that investment has a higher yield than the interest I owe on my debt, then I'm not focused on paying off the debt. This would be considered “good” debt in my book.
Let’s assume that I have student loan debt with 3% annual interest and let's say that I can reasonably and conservatively invest in a real estate project that provides a 7% annualized yield. Given the positive spread, I’d rather place my money into the real estate because I can potentially earn 4% more than what I owe on the debt.
On the flip side, if I have credit card debt at 15% annualized and I can only achieve a potential 7% yield reasonably and conservatively speaking, I'd rather pay down the credit card debt. Why take the additional risk? There are no guarantees in investing, but there is a guaranteed savings of 15% by paying down the credit card.
In Conclusion
To recap, the Four Pillars of Financial Independence are:
- Earning at your highest and best earning potential
- Living on as little as possible (for a period of time)
- Investing the difference in assets that produce passive income
- Minimizing high interest debt
This should not be construed as financial or tax advice, nor a guaranty of success. What worked for me may not be right for you, but hopefully there are a few practical takeaways for you, nonetheless.
To Your Success
Travis Watts
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