My big, overarching dream is to achieve true financial independence. By that, I mean that I have enough money saved and invested that I can live off the interest and investment income – a point that I’ve discussed before as the crossover point.
This is a huge goal, one that I won’t achieve for many years no matter what path I choose. I dream about achieving this goal around the time my final child graduates from high school – roughly twenty five years from now.
What’s the exact goal? The first step in figuring things out is to determine exactly what I’ll need. Do I want to replace my living expenses alone – which would mean that I’d have enough to live, but wouldn’t be very protected against inflation – or if I want to replace my whole salary, giving me a lot of breathing room. The actual number I’ll probably need is somewhere in the middle – enough to maintain some growth, but not my current salary.
Let’s say I shoot for $50,000 a year in today’s dollars – in 25 years. Given 4% inflation between then and now, I’d need an income of $133,291.80 then. If I invest it in a stable fashion, I should be able to rely on returns of 7% annually. meaning I need to shoot for $1.9 million in investments in 25 years.
What tools do I have? I have a number of options at my disposal to reach that goal.
Retirement plans / 401(k)s If I actually retire at that point, I can start taking withdrawals earlier than the normal retirement age – that’s a 72(t) withdrawal. Thus, it makes a lot of sense to dump a big allotment into my retirement plan now. Given that the date I need is 25 years off and I’m targeting a very big number, I need to go pretty aggressive here – for now.
Standalone investment accounts A person can also put their after-tax money into investment vehicles like individual stocks, bonds, and mutual funds. There are many investment books that can help with this. My current plan is to adopt a portfolio from The Lazy Person’s Guide to Investing and add in a small piece for individual stock purchases – I plan on buying into a few individual companies eventually.
Paying off debts early Debt repayment is merely an investment at a known interest rate. For example, if my home mortgage has an interest rate of 6%, an extra payment on that debt is an investment that will return 6% through the end of the original mortgage – it’s interest you won’t have to pay on that money, so it’s investment returns in your pocket. Since this 6% is incredibly stable, it’s often useful to make it part of your investment portfolio. Of course, this does assume that when you’re done with that debt, you take both the original payment and the extra payment and roll it into some form of investment, but I plan on doing that.
This doesn’t mean that it makes sense to take out loans and then pay them off early. You’re better off not taking the loans at all and instead saving up for big purchases like automobiles. However, if you’re starting with pre-existing debts, it’s useful to look at them as opportunities.
Extra work Right now, I make some additional income from blogging, which I’m rolling into this plan. In addition, I’m also writing a book and working on a few other interesting items that can potentially put some money in my pocket over the long haul in a passive income sense. This basically generates more money to invest in this plan, making it easy to meet my investment goals each year and to perhaps exceed them – and do it consistently over time.
What do I need to do? Let’s say that each year I can earn an 8% return (on average) on my investments. I’m intentionally going low here so that I don’t underestimate the personal sacrifices I need to make to get it done. I need $1.9 million in investments in 25 years. What do I need to sock away each year to get to that level? Some simple Excel calculations show that I need to be socking away $26,000 per year to reach that goal.
Now, if I put the maximum allowed limit into my retirement plan ($15,500), I need to be investing $10,500 more on my own each year from here on out. This is a number I can actually reach fairly easily right now, but the real question is where should I be putting it? Right now, I’m paying off all of my debts with an interest level of 6.5% or above – basically, everything but my mortgage. I view that as an incredibly stable investment with a rate of return approaching what I need.
Once those are paid off, I’ll actually have a bit more to invest in a year – about $12,000 after my retirement plan, according to my math, and perhaps even more than that. This money will be used in a diverse portfolio that I’m still working on – one piece of it will be advance payments on my mortgage, which will provide an incredibly stable 5.875% component (there’s no tax implication because my standard deductions for all of my dependents are substantially more than the house interest). The rest will be in a portfolio, as I discussed above.
All of this adds up to one thing: reaching true financial independence is realistic – and it might happen sooner than I think.
In a nutshell, the idea is that you can only achieve audacious accomplishments if you set audacious goals to begin with. What are your biggest goals? What’s the game plan for getting there? If you’ve never thought about where you want to go, how do you know if you’re following the right path to get there?