The Best Way to Achieve Financial Independence
Words by: Bryon Gragg
Published September/October 2010
FINANCIAL INDEPENDENCE MEANS different things to different people. We normally define financial independence as the point when we can make a choice about going to work or not. To achieve financial independence, you must accumulate financial assets, such as stocks, bonds, cash and real estate which can produce a dependable income stream to meet or exceed your lifestyle needs. In accumulating these assets, there are hurdles that need to be overcome, including income taxes, inflation and estate taxes. You must not only build a diversified portfolio of financial assets but also consider risk management as a part of your safety net.
There are two rules for becoming wealthy. Rule number one is to live well below your means while saving money. Rule number two is to always remember rule number one. Building wealth takes discipline, sacrifice, hard work, and most of all – saving money. According to Thomas Stanley, Ph.D., and Thomas Danko, Ph.D., authors of The Millionaire Next Door, “It is seldom luck or inheritance or advanced degrees or even intelligence that enables people to amass fortunes. Wealth is more often the result of perseverance, planning, and, most of all, discipline.”
Some people go through life waiting for the big score, whether it is hitting the lottery, marrying up, waiting to be discovered or writing a bestseller. Others plan and work diligently to achieve financial independence. Another group does nothing, hoping for the best. Do you care to guess which group is more successful?
Hope and faith are nice, but they are not a financial strategy. To achieve financial independence, you must have a plan because it generally doesn’t happen accidentally. In addition to the plan, you must have focus and the diligence to stick with the plan. Everyone’s goals, values and situations are different, and thus every plan will reflect those differences… but there are several cornerstones that will apply to everyone.
One basic cornerstone of a financial plan is development of a safety net. Generally, this is anywhere from 9 to 12 months of living expenses held in cash reserves. This gives you the security to be able to meet your living expenses for that period of time should you lose your job or are unable to work. If you are retired and living off investments, a cash reserve gives you a cushion should there be a downturn in the markets. With this cushion, you won’t have to sell while your investments are down just to meet your living expenses.
The next part of a financial plan is having the appropriate asset allocation. This is one of the most important decisions you make as an investor. You may think security selection and market timing are the primary components driving a portfolio’s performance, but these are only important when combined with a strategic asset allocation policy. Having an allocation that is too conservative can result in you running out of money before you run out of life. Too aggressive and you may wipe out long before you get to retirement. The key is having an allocation that is proper and realistic for your needs and risk tolerance.
Debt management is also a vital part of the financial plan. It is important to have a plan to reduce or eliminate your debt. If you currently have debt, the first step is to stop digging and develop a schedule that works for you to eliminate it. A careful review of all your debt will help you to decide where the dollars should be appropriated first. While not all debt is bad, it must be used wisely and managed carefully.
Beyond building a diversified portfolio of financial assets, you should also consider risk management in building wealth. A well-designed life, health, disability and other insurance plan is an integral part of building a safety net to ensure financial plan success should unforeseen calamities occur. A review of your insurance policies should answer three questions: First, should you have it at all; second, if you should have it, how much should you have; and lastly, what is the right type of insurance for you.
By developing a cash safety net, determining proper asset allocation and appropriately managing your debt and risks, you will have good foundation to put your financial house in order. Add focus and discipline, and you are you well on your way to achieving financial independence.