When I started planning to do this blog, 6 months ago, the main topic was going to be Financial Freedom, as it was (and still is) one of my main goals in life. But I ended up changing it so I could cover more topics I was interested in.
And now, after 33 posts, I haven’t talked about it yet so I’ll fix it.
Let’s start with the definition of Financial Freedom by the Wikipedia:
Financial independence (or Financial Freedom) is generally used to describe the state of having sufficient personal wealth to live, without having to work actively for basic necessities.
For financially independent people, their assets generate passive income that is greater than their expenses.
So basically, is earning money without working, or working very little. An early retirement.
The first time I heard the term Financial Freedom was in the book Rich Dad, Poor Dad by** Robert Kiyosaki**. (I highly recommend this book, it totally makes you rethink your attitude toward money and work)
This author also created the term “The Rat Race”, which is the situation in which spending increases as income increases, therefore, you are never satisfied and keep running and running in your wheel unable to leave it.
This makes people obsessed with money, work, material goods, get in huge debt to buy a house, a car, etc. And never become happy or do what they really want to.
The following sentence from Tim Jackson (see TED talk) sums it up nicely :
“We have built a system that pushes us to spend money we do not have on things we do not need, to impress people we do not care about.”
Reasons to pursue Financial Freedom
- Forget about worries, no stress. Your health will improve.
No deadlines, meeting impossible objectives, being the target of angry directors/ customers, getting less sleep than what you need…
Furthermore, we have already seen that working for others doesn’t mean safety anymore. Job insecurity is getting higher and higher.
- Free time. You can do whatever you want.
Normally we tend to put aside the things we like and make us happy either because of lack of time or because we could not live on them only.
This also applies to the people who can not spend all the time we want with.
- More money.
If you reach financial freedom but want to keep working on your job, you will have more money to whims, travel, luxury, etc.
You might think (like me at first) that this is impossible or that you need to be born rich or win the lottery or inherit a fortune… But no, you don’t need any of that.
What is needed is an initial effort to establish your passive income streams.
Sources of Passive Income
- Interests earned on bank accounts or deposits.
First you have to earn a lot of money and not keep it static but move it between different deposits to get always the highest return possible.
Take always into account the inflation (increased value of money) and the taxes you have to pay for the benefits.
For example, if you have $500,000 and get into a 4% deposit, it will give $20,000 gross per year passively. But on those $20,000 you have to pay taxes and keep in mind that as you get older, your savings are worth less and less.
Advantages: low risk.
Disadvantages: You need a large sum of money to live on the interest it generates, low profitability.
- Dividends from stocks, bonds, ETFs and other financial instruments.
You also need to accumulate a large amount of money initially (although less than by interest) to invest it (knowingly or with professional help) in these financial instruments.
As with interests, you must take into account taxes and inflation.
Advantages: more profit than by interests.
Disadvantages: the same as the interests added to higher risk if you do not have good knowledge or help.
- Income from renting real estate.
If you don’t own the property by inheritance or donation, you will have to purchase it with savings or through debt.
Even if you have enough savings, it is sometimes preferable to borrow if the interest payable is less than what you get by investing the savings in other instruments.
Keep in mind that if you haven’t payed any company to be responsible for supporting any inconvenience arising the tenants, you as the landlord will have to take care of it so it won’t be passive income, it depends.
Advantages: it is a tangible asset. (I’m not sure this is a plus)
Disadvantages : high risk, variations in the market price, maintenance costs and taxes… (see post: Advantages & drawbacks of owning vs renting a house)
- Intellectual Property.
Royalties that corresponds you for the creation of patents, books, songs, games, etc.
This does not require a large initial investment, at least of money, of time usually a lot. What you mostly need is your knowledge and creativity.
Advantages: This is a way to leave your mark for posterity.
Disadvantages : difficult, expensive if you have to maintain a patent and prosecute those who take advantage of it, unprofitable for the rise of piracy and the “I want everything for free” wave…
- Business/es set in automatic.
You can automate all the processes in a business by outsourcing them, using dropshipping, personal assistants, etc. So it ill be effortless to maintain the business and expand it.
This is the most “feasible” method, since no large initial investment is needed (hundreds of online businesses crop up every day) and neither great knowledge or creativity as in the intellectual property income is necessary.
You have to know how to delegate well or you’ll end up like most entrepreneurs doing everything by themselves 24/7 and being slaves to their business.
Advantages: relatively easy to find a profitable niche market.
Disadvantages: bureaucracy, stupid laws, totally false entrepreneurial culture (in Spain) with high costs to undertake.
These are the ways I can think of to make money automatically, but sure there are people who benefit from others.
How to Achieve Financial Freedom by saving?
To do this we will make use of index funds (not actively managed, just replicate an index) that until today have reported an average 10% annual interest.
They are quite safe, with very low fees, and do not require a large investigation of choice or maintenance.
This methodology is called “Bogleheads Investment Philosophy” and I will talk about it more in future posts.
To find the amount of money we need in these funds you must first calculate the amount of money we want to spend per year .
Suppose we want to $35,000 per year or** $2,900 per month.** (As I said earlier, you will not be rich in terms of money)
Then, assuming that the average interest earned on the funds is 10%, the average price increase (inflation ) is 2% , and a 25% tax on profits, we make the following formula:
(10% – 2% ) * (1 – 25% ) * Savings = 35,000
Savings = 35,000 / ( ( 0.1 – 0.02 ) * (1 – 0.25) )
Savings = ~ $585,000
Therefore, investing less than $600,000 in these funds would provide us $2,900 per month (adjusted for inflation) for the rest of our lives.
The problem is that investment markets doesn’t have linear growth, the capitalist system suffers cyclical crisis (also huge growths) so we will have to use a tool to take the risks into account and that is the Monte Carlo simulation.
We can do it with a calculator like Vanguard’s.
What the Monte Carlo simulation does is to calculate 5,000 simulations of what hypothetically could happen to our investment due to market conditions, both downs and ups of different durations and intensities.
That means that in 2,700 scenarios out of 5000, our investment survives.
It may seem a low probability but not so low considering that you are trying to live 50 years with the same level of income without working.
If you are less optimistic than me, you will get much safer probabilities lowering the years and increasing the savings a little bit.
Be very aware of the following, if instead of $35,000 per year we just want $30,000 ($5,000 less), the savings needed go from $585,000 to $500,000 ($85,000 less!). So being able to live with less has a tremendous impact on the investment amount needed.
My Road to Financial Freedom
The path I am following for Financial Freedom is as follows:
1. Learning to live with little, frugally
Be happy without wasting money on unnecessary things or things I can do by myself .
Do not get carried away by temporary trends.
2 . Create internet businesses
Blogs, forums, online shops, applications (still learning)… The possibilities are endless and at minimum cost .
Each attempt costs me $10 of the domain (website name) and the allocation of the $120 per yer that cost me the server where I host all my projects.
To do these sites you don’t need technical skills (although they are simple and will save you money, see: 3 important skills for an entrepreneur“) as there are many online services that do them for you.
3. Writing books
When I get a year or two of writing for this blog, I would like to collect my most useful information in book form, and publish it online (in Amazon for example) very cheap and without publishers involved.
I would also like to write a novel.
4. Part time employment/freelance
Temporary jobs to live while the online businesses succeed, with no excessive physical or mental demand.
5. Investing in index funds
The benefits I get from the above activities will go to different investment funds, of the type discussed before.
Travel, learn and see the world .
“On the way to Financial Freedom” was going to be the title of this blog.
If you want to read further about the topic of financial independance or living frugally, visit the Mr. Money Mustache and Early Retirement Extreme blogs.
I hope this has been helpful information and if you didn’t know the possibility of this way of life, you now know it is possible.
This post was written more than 6 months ago, maybe things have changed or I don't think the same way anymore