What is financial independence?
Using assets and cash flow to achieve financial independence
When it comes to business and investing, is important to note the financial words involved in the cash flow language. Just like any profession, each has its own vocabulary. Interesting words are free, and if we do not need money to make money, then getting wealthy the highest financial IQ way is free legally. Yes, because the number one job of an entrepreneur and investor is to raise capital; and the number one skill is to sell.
That is why learning about business and sales is critical to become a master investor. However, being a master investor means that we understand the power of knowledge and more in the Information Age, therefore, it is an ongoing devotion to studying and applying business knowledge. In other words, we do not graduate from entrepreneurship. We continue to learn as we apply the concepts into our real life. What is financial independence?
So, what is financial independence?
This begs the question: What is financial independence? Is it having a high-paying job so that we can support ourselves? Is it based on an anticipated inheritance? Or even an alimony? For many people, it translates too: “They are to work until I’m 65, and then I’m going to retire.”
These, unfortunately, are not good definitions. If we have a high-paying job, we can lose it. And waiting on an inheritance, alimony, or retirement (essentially, living on the hope others will take care of us) will not help us answer what is financial independence.
Savings must be financial independence then, right?
Many people assume that the path to financial independence is saving money. That’s because most so-called experts drill this into them from a young age. They hear it at school, from parents, in the books they read on money management…it’s everywhere. Save, save, save!
For many, the golden number for savings is $1 million. As far as round numbers go, it’s a good one. And $1 million is a lot more money than most people have. But it’s also not what it used to be…and it’s probably not enough to be financially independent for a lifetime.
And even if we could save $1 million and live the rest of our life on it, the mindset about how to get there—and how to stretch that money—is, well, depressing.
Financial sacrifice ≠ financial independence
A while back, we read an article about a couple, Carl and Minday, who woke up one day and decided they were going to save $1 million in four years. They had good instincts on why to do this:
“I was having this horrific day at work,” 42-year-old computer programmer Carl told Farnoosh Torabi on an episode of her podcast. “I was 38 at the time, and I'm like, 'There's no way I can do this until I'm 62 or 65 or whatever age people normally retire at.”
Many people feel trapped in their jobs but do nothing about it. Congrats to them for taking action. But in the end, it is still the action of a poor-person mindset about money.
The couple started by analyzing their spending habits. “My wife and I wrote all of our expenses in a book,” Carl explains on their blog. “Every time we returned from shopping or paid a bill, we logged it.”
Based on their logs, they determined they could live on $24,000 a year. To be safe, they added a $6,000 cushion and bumped that estimate up to $30,000 a year.
To get there, they decided they needed $1 million saved up to retire by age 42. To achieve this, they did the standard saver playbook: they downsized and cut expenses, while working side jobs and investing in their personal residence and the stock market.
While it was great for Carl and Mindy to retire—and having $1 million in the bank is certainly better than most—their retirement plan is not future proof in my mind.
They use what is called the 4% rule, assuming if they take out 4% of their retirement money per year, they won’t run out.
Perhaps this makes sense for them now while they are relatively young. But what will happen when they get older and require more medical attention? Or what if their property taxes go up significantly over the next twenty years? Or what if inflation continues to grow over the next forty to fifty years at 2% a year (or 6% or 7% as it has recently)? Or what if they get tired of living so frugally after all?
Without significant income, they won’t be able to stay afloat. They may enjoy life at $30,000 a year right now, but it will not be sustainable for their entire retirement.
A true test of financial independence
A very simple test—even if you have a high salary or lots of savings—to determine if we are financially independent is to take out a piece of paper and make two columns. In the left column write down how much money you make each month. In the right column write down all our monthly expenses. Now, cover the left column with your hand and pretend we are no longer making that money. How does the column on the right make we feel? If we are like most people, we are having a minor panic attack right now.
This holds true even if we live on savings. Because drawing from our savings is not the same as generating income. It’s simply pulling down our assets. And it’s a very poor mindset about money that sees the world as scarce, not abundant.
Take for instance an article I read a while back on Mic: “30 easy money hacks to get a little richer every single day this month”. They include things like:
Check for Health Savings Account eligibility
Review your 401(k) fees
Grow your own herbs
Transfer $10 a week to an IRA
Buy a slow cooker (on sale no less)
Use cloth napkins
Of the entire list of 30 ideas to get “rich”, only one has to do with generating income. The rest are all ways to do exactly what Carl and Mindy did: downsize and cut expenses.
So if having a high-paying job or saving lots of money isn’t financial independence, then what is?
Three types of income
Before I answer that question, I think it’s helpful to understand that there are three types of income.
Earned income: If we have a job and receive a paycheck, we make our money through earned income tractive income.
Portfolio income: Where earned income is acquired by exchanging time for money, portfolio income is made through capital gains.
Passive income: One formula of wealth “four green houses, one red hotel,” in the game of Monopoly to describe how we can make passive income, that is by having our assets create income for us.
Many people think they can get rich with a high salary (earned income). But as we mentioned before, we can lose our job. What is more, we trade our time for money and that is finite.
Portfolio income is nice but we only make money on a sale, and it’s taxed higher than passive income. So we are at the mercy of the markets and we give more of what we earn to the market. It is not a predictable income for wealth.
It’s only passive income that provides true financial freedom. And it only takes three steps.
The three-step formula to achieve financial independence
The following formula is wha we we used at Master Investor, LLC to be financially free and wealthy. The formula is this:
We buy and create assets that generate cash flow
The cash flow from our assets pay for my living expenses
Once my monthly cash flow from our assets is equal to or greater than our monthly living expenses then we are financially free because our assets are cash flowing and are working for us
When the formula is completed, we no longer have to work for money. When we no longer have to work for money, we are financially independent.
The formula for financial independence in practice
We can become financially free by investing in real estate and using the internet to acquire assets. To be clear, we did not have the money to do this. Rather we created the money by paying ourselves first. What does this mean? It means that we treated investing as our first and most important expense. Each month we would pay our investing expense and then figure out how to pay all our other expenses. It was nerve-wracking at times, but we always figured out a way—and we got pretty good at negotiating with creditors.
Once we had enough money saved up to buy a property, we would find a great deal where the income from the property would cover our expenses as well as the debt we would take on in the form of a mortgage. We then continued to pay ourselves our investing expenses as well as adding the cash flow from the property to the pot. This accelerated our ability to purchase yet another property. This then led to more properties. Eventually we sold many of those and invested in even bigger projects like apartment buildings
We also expanded out to other assets. For instance, our book, How to Build Cash Flow with the Internet? Turn Passive Income On - is the first finance book of Master Investor, LLC. Our company still gets large royalty checks to this day. And our investment management business, Master Investor, LLC offers financial education in the form of books, coaching, seminars, and digital products. It also puts money in our pocket each month.
We do not have to work a day again in our lives and the cash flow from our assets covers our expenses—and continues to grow as we grow our asset column. This is very different from savings, for instance. Savings can run out. Cash flow keeps coming no matter what. Savings can lose its value relative to inflation. Assets grow in value along with inflation. That is why the formula makes us truly financially independent.
Our mindset about money counts
As we mentioned at the beginning of this article, the poor mindset would say, “We can’t afford that.” The rich mindset asked a very different question. We would ask, “How can we afford that?”
The difference between the poor and rich's mindset about money was fundamentally one of saving versus earning.
The poor mind always looked to be saving money and cutting expenses. The rich mindset always looked to be making money and investing in both his wealth and his quality of life.
Now, which person do we think lived a happier, fuller life? Unfortunately, it was the rich mindset. We say unfortunately because it was very hard to watch the poor mindset people later in life when they have no money, struggled financially, and was very bitter. They end up working hard his whole life, but his mindset about money did not serve them well in the end.
We should pay attention to the lifestyle of the person we which to become. A master investor does not work for money, rather, we work to acquire assets in our asset column that truly cash flows in all economies.
Savers are losers; spenders are winners
All of this goes to show that the Rich Mind mantra of “savers are losers” is a vital thing to understand if we want to be truly wealthy. In today’s financial world, spenders are winners and savers are still losers. Of course, by spenders, I mean those who use their money to build their business or invest in cash flowing assets. And to spend wisely this way, we need financial intelligence that goes beyond just downsizing and cutting expenses. We need to understand how to create wealth, and in our own way, actually make money grow on trees.
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