Early Decisions on the Road to Financial Independence

Introduction

I am entirely lacking in the professional qualifications that you might look for when seeking a financial advisor.  And so, take the following as one guy’s opinion.  But, I have spent the last 20 years or so working to make myself financially independent.  Over that time, I’ve made note of the concepts that have worked for me, mistakes that I have made, and the many many conversations I have had with people who either have or have not followed a similar path.  These ideas are exactly contrary to the “spend-what-you-make” approach that almost everybody else accepts.  I believe entirely that taking control of your financial decisions early in your adult life has real advantages, many of which will not be really poignant until you are much older.

I have a strong bias toward a strategy of creating cash flow through real estate investing, but these concepts are intended to put you in a position to be in charge of your financial future regardless of the investment mechanism you might prefer.  In order to be financially independent, the strategy you choose will eventually need to generate cash flow.  Cash flow doesn’t necessarily have to be goal one on day one, however.

Every concept listed below I share with my kids pretty much every day.  The list is nothing like comprehensive, but covers some big-picture ideas that can have significant influence on your financial future.

I, like many before me, was moved by Robert Kiyosaki’s original book Rich Dad Poor Dad– if you have not read it yet, make that item one on your to-do list.

In no particular order:

Start Early

Every signal in our society pulls us into spending all of the money that we make – or, in many cases, more money than we make.  And, the initial steps in the sequence of events that ties most of us to a salary for our entire lives can seem unavoidable.  Even more so if nobody cautions you to avoid it.  Culturally, we are programmed to complete our education, get a job, and start spending.  The sequence can shuffle; but, we buy the car (on credit), get married and start a family, rent or buy a house (on credit), and the treadmill starts.  Every paycheck is already spent before we get up in the morning.  And, every time our salary goes up, we match the new income with new spending on a nicer car, bigger house, etc.  And, the temptation to spend is reinforced by the unrelenting marketing and advertising programs that are literally everywhere we look.

It is hard to avoid getting pulled into that vortex.  Even friends and family may not understand why you are still driving that 10 year old car, living in that modest apartment and so on.  But, those things are critical to your bigger purpose.  By the way, if you invested a “car payment” of $400 each month for 6 years at 4% interest, you would have over $32,000 in savings.  Enough to contemplate purchasing real estate in most markets in the US.

Start early with a commitment to save rather than spend, and build yourself a foundation for financial success.  The early start is critical because just a couple of early mistakes – like one too-expensive new car - can take years to repair.  And, money earns money.  The more time you have to capitalize on the compounding effect of your investments, the more potential you will have to reach your goals.

I chat with people every week who are many years into the treadmill experience, and have no realistic hope of ever getting off.  Truly, their possessions own them rather than the other way around.  You can flip that formula by starting early, creating savings, and eventually building a cash flow portfolio.

Have Kids Later

I have a wife and three kids, and I am crazy about the whole clan.  I don’t mean to suggest that you not have a family, just delay the decision to have children until you have had a chance to build some financial momentum.

Your individual situation and preferences will color this scenario, but having kids may reduce your earning potential.  This could be as straightforward as one parent deciding to leave the workplace and stay home with the family, reducing actual income.  More subtly, either of you might be less eager to sacrifice stability at home to take the job opportunity that requires more hours away from the home or a physical relocation. Taking a risk on some start-up in a different state is more tolerable before kids for any number of reasons. I’m not suggesting that taking a risk on a new job is always a terrific idea, but you may be more willing to give it an honest look if you don’t have to consider the impact on a your kids.

And, kids are expensive.  Traditional expenses of course, doctor bills, day care, babysitters, but maybe more importantly, you are going to want/need the bigger apartment and the larger and safer car.  All of these things add up, and could have a deleterious effect on your efforts to achieve your financial objectives.

Work hard early, get a couple of rungs higher on the ladder and a few assets in your cashe before starting the family.  I didn’t have my first child until I was forty-one years old.  I don’t necessarily suggest that you wait that long, but there are benefits to having put in the long hours and cross-country moves before they arrive.

Get The Big Expenses Right

One quirky thing that ultimately helped me to make good spending decisions was a distaste for daily budgeting.I never wanted to have to think too much about going out for Sunday breakfast or getting a beer with friends after work. There are folks who focus on budgeting on the daily expenses level with great results, it just wasn’t for me.  Instead, I focused on the big expenses, figuring that if I didn’t have a $400 car payment and a big rent bill every month, I could splurge a bit day to day.  Now, looking back, that approach created habits that helped me to build wealth.  Avoiding the $400 car payment had the added benefit of eliminating the rapid depreciation of the new car (often repeated every four years).  And, I could put most of that $400 into the bank every month.  Scale this up or down to your taste in cars, but if you can buy a quality used car and drive it for 10 years, you are likely to be well ahead as compared to the new car every four years model.  Similarly, housing expenses are a long-term commitment that have the potential to significantly affect your financial future.  If you rent, work to minimize the expense. Owning a home is obviously very different from owning a car, but a large mortgage still represents a significant expense.  Many families get trapped in the scenario where two car payments and a large house payment eat up a very large portion of their monthly income, leaving little room for savings and no path off of the spend-what-you-make treadmill.

Cash Is King

Cash is an enormously beneficial asset.  I don’t mean specifically currency, but liquid assets that are available for your use when needed.  Saving a significant sum of money is hard to do.  And so, very few people have cash available to support an investment, or even to buy a home.  Having saved cash opens those investment opportunities to you.  And, once you start to accumulate assets, that money starts to generate income, either through simple interest or potentially as appreciation of equities investments.  An early objective is to accumulate cash through savings as rapidly as possible, and to protect that growing asset assiduously.  Resist the temptation to spend it, even on necessities, because it often is very difficult to replace the funds.  I talk with folks who are interested in investing in real estate, and the majority of them have one common attribute – they don’t have the cash to make the down payment on a property.  Or, I often meet people who rent year after year for the same reason, they haven’t saved enough to satisfy the down payment and qualify for the loan.  Cash is the engine that empowers the financial strategy.  Accumulate as much of it as you can as early as you can.

Buy As Soon As Feasible

There are reasons to rent rather than buy your home.  The 2008 recession devastated many homeowners who were not able (or chose not) to continue to pay for a home that decreased in value significantly after they had purchased the property.  It is possible, through no fault of your own, to get stung badly by home ownership.  But, if you are planning to be in one place for more than five years and have a stable job, you are likely to be very much better off financially if you buy a modest home rather than rent.  Assume that you rent housing for $2,500 per month for five years, and the rent increases by 3% each year (roughly the recent rate of growth in California).  You would pay $159,274 in total rent, and over those five years, and your rent payment will increase to $2,925 per month.  If you were to purchase a $500k home, and make payments on the mortgage for those same five years, your monthly payment would remain essentially unchanged for the period at approximately $2,684 per month (assuming 4% interest rate and 10% down payment, including property tax and insurance, but without PMI), and you would acquire equity in the home of $123,415 (not including the down payment, and assuming only a 3% annual increase in the value of the home).  The total of all mortgage payments for that five year period would be $161,040, similar to the amount that you would have spent in rent. But, at the end of the five-year period of home ownership, that equity would provide you with options.  This scenario works equally well if you are comparing a $1,500/month apartment to a $250,000 home rather than the $500,000 home in the example above, and becomes extremely attractive if you can purchase a small multi-family property and live in one of the apartments.

Conclusion

These suggestions are generalities, and can’t consider every eventuality – I would not recommend that you carry high-interest debt while accumulating cash, or drive an unsafe vehicle, go without health insurance, live in substandard housing, or take on any unreasonable risk.  Nor would I accept the idea that you can’t live the plan and be happy.  You might even sleep better at night not worrying about the next car payment.  If you can embrace the delayed gratification required, the ultimate reward of financial independence is enormously satisfying.

I welcome your comments.