Today I wanted to talk about a topic that has become one of my personal challenges over the last five years or so. Financial Independence.
So What is Financial Independence Exactly?
Much of the time, early retirement is tossed around in personal finance circles to refer to what I’m working towards as well. I’m not a big fan of the term early retirement due to the specific connotations that the term retirement carries with it. Talking about moving on from your day job tends to evoke the image of golfing or traveling around the country in an RV for the rest of one’s life.
Retirement, according to the average person, means that you simply do nothing or very little in the way of productive activity and enjoy a life of pure leisure outside of the labor force. It is the “reward” that comes at the end of a 40 or 50 year working career once you’ve scraped together enough resources to ride out the remaining time in your actuarial table.
I strongly prefer the concept of financial independence, which means that you’ve accumulated enough resources to essentially support whatever project you wish to work on. That project may very well be your golf swing, or extensive travel. It may also be something that fulfils a creative or academic need in one’s life. It could also be volunteering or taking a job that makes you very happy, but doesn’t pay very well. The ultimate take away is money is no longer a constraint on your daily pursuits, and you no longer need to be actively engaged in the labor force, but you very well may be.
Why You Should Work Towards a Debt-Free Financially Sound Life
It may not be immediately obvious to some people, but digging yourself out of debt and building up a financial cushion in your life should not be looked at as sacrifice or deprivation. Many people carry a lot of interest bearing debts and end up only making small payments on them. This is not wise at all.
Owing other people money means that you are essentially paying other people more than the price of the item or service that you bought over the course of many years. Outside of student loans or a mortgage, there isn’t even any component to the transaction that could justify the added cash outlay. Student loans can tentatively be justified in that they may allow one to get a better, high paying career than they otherwise would have. A mortgage does end up providing you with a house that could potentially be more valuable over time.
Carrying credit card debt for consumer items or vacations is even less wise, as you may end up paying considerably more for those things that you purchased a long time ago than the sticker price. If you put $2,000 on a credit card for say a vacation, and don’t pay it off for a year. You may end up adding hundreds of dollars to the price of that vacation, which will keep costing you even more money over the long run until you pay it off. 15% interest on a 2,000 vacation will end up being more than 300 dollars a year or so. If your vacation budget is $2,000 a year, then next year, you can really only afford a $1,600 vacation as your previous vacation is still costing you money.
The wise person would see that this is a situation that needs to be fixed as soon as possible. Carrying interest bearing debt actually makes it so that your budget for things that you enjoy doing is much less than you think it is. Interest is the silent destroyer of your ability to provide yourself with goods and services.
There Must Be a Better Way to Approach This
The good news is that if you start getting into investing and getting your financial house in order, you can actually get the paid for doing next to nothing. Investments provide you with interest and dividends that can improve your financial situation and get you more disposable income to fund things like vacations. Speaking from personal experience, making interest is far better and wiser than paying it.
Take the example of the previous vacation budget of $2,000. Let’s assume that instead of owing a credit card debt, we own some investments instead. We are invested in a position in stocks that pay out a 4% dividend to us. We’ve worked hard last year and invested $6,000 dollars of our savings into these stocks which is $500 a month. We end up making $240 a year in dividends from these stocks before taxes, so let’s call it $200. If we wanted, we could add this $200 a year to our vacation budget. Now we have a bigger vacation budget of $2,200 instead of the smaller one of $1,600 that we had when we had credit card debt.
The nice thing about investing is that you can scale it up as well. If you keep investing small amounts, you will start to see really positive changes to your income as well. Consider what happens if you were to make that same 4% from a larger position of $50,000 that you had accumulated over many years. You would add $2,000 to your income every year. You could spend or invest that $2,000 and improve your life in various ways only limited to your imagination.
Getting yourself into the position to invest and make money instead of into debt and paying other people money is the goal that the wise person should work towards.
You Want a Happy Life to Retire Into
As you can see, getting yourself out of debt and working towards saving and investing into sound financial instruments is the foundation for the march to a happy retirement. Getting interest to work for you instead of against you is the wise way to approach life.
I think that it’s very important for people to budget savings into their life and plan for the future. If you are carrying debt, I would work hard to reduce it as much as possible. Until you pay your debts, you are giving away your hard-earned dollars to someone else without getting any additional benefit from it. You could be earning interest instead of the debt lenders. Once you start earning interest yourself, you will start to find that it’s pretty easy to save, and still enjoy everything that you like doing as well.
I’ve worked towards structuring my life and expenses so that I could pay off my debts and once I became debt free, began my savings and investment journey and have been improving my budget and gaining more and more peace of mind every year, and more confidence that retirement will work out great for me.
Getting into the habit of saving will help you to make sure that you are ready for your retirement, and there’s no better time than the present to start making positive changes in your finances.