Before our upcoming posts on investing, we outline the foundations of building up your assets. While investing is a critical step, it is not the first step. Since you are here, we suspect you are interested in doing what it takes to get to financial independence.
You've probably heard... "save 10% of your income"... "invest in mutual funds"... but generally, if you do what most people do you will end up where they are: struggling to retire or retiring in their old age.
Below we layout the steps & some hacks to accelerate financial independence. The saving step is especially important for those in the early stage of their professional lives (20-30 years old) who have more flexibility with their living situation. It should be kept in mind that many of these suggestions are temporary, since as your assets increase you will be able to adjust your lifestyle as you see fit. Still, the younger you are the less assets & more time you have so its critical to use your time to increase your assets.
Step 1: Assess Your Situation & Learn the Basics
First, asses your current situation to understand your income, expenses, savings rate, debts, assets and net worth. This can be done very easily with our All in One Personal Financial Planner Tool. It should be your starting point and guiding compass. From there go over our guide on "The Baby Basics of Finance" to familiarize yourself with important terms and concepts. Consider optimizations like paying off high interest rate credit card debt or refinancing using lower interest lines of credit.
Step 2: Maximize your Income
This could be as extreme as switching careers, or as simple as requesting more hours at work, or starting a side hustle. Ideally, target 1.5 times the average income in your country (in Canada the average is ~$50,000 per year per person so aim for $75,000).
Most people in “high earning” professions (Healthcare, Engineering, Consulting, IT, Finance, Law, Skill Trades etc.) work 45 to 75+ hours per week, they might not have the free time to start a side hustle but its ok since they already earn 1.5 times to 3+ times the national average income. If you already do, skip to step 3!
If you are earning below 1.5 times the national average income, it is likely you are also working the average amount which is about 35 hours per week (in Canada). In this position you might have a good job that you are happy with, but you should consider dedicating an extra 15-30 hours per week on a side hustle. This could be a second job, participating in the "gig" economy (driving, delivery, personal services), teaching (music, tutoring) or anything else you can think of.
The goal here isn’t to become a workaholic but to increase your earnings by $10,000 to $25,000 per year by working similar amounts as the “high earners” already do.
If you have a low paying job, does that mean you can't achieve financial independence? - NO! If you earn 0.6 to 1.4 times the average you will still be able to do it, but instead of it taking as little as 4 to 5 years it might take perhaps 8 to 15 years and that’s ok! Everyone’s journey will be different.
Step 3: Minimize your Expenses = Maximize Savings
Next, its critical to control and lower your living expenses where possible in order to increase your savings rate. As stated in the Baby Basics of Finance: “Savings are engine of wealth creation”. When building out your income sheets on the Personal Financial Planner, track each expense carefully (in the full version there is an additional expense sheet you can utilize for more detail).
For general cost cutting keep track of expenses, reduce waste, substitute cheaper alternatives, take advantage of coupons or offers and try to be frugal.
Questions you should ask about each expense:
Do I really need it? Is there a cheaper alternative? Can I reduce the frequency of this purchase?
Some epic ways to hypercharge your savings:
Rent Hacking: The monthly rent or mortgage payment is typically the largest single expense. Reducing or eliminating it is the fastest way to hypercharge your savings and put you on the path to rapid independence. There are 3 general ways to do it:
- Sharing: Sharing a place with your partner, friends, or family; splitting the cost of renting and lowering monthly expenses. For example, if a one bedroom apartment is $1,000 per month living with a partner reduces the cost to $500 per person (saves $6,000 per year!). Likewise, a 3 bedroom that rents for $2,100 split among friends reduces the cost to $700 per month each (saves $3,600 per year!).
- Subletting a Larger Place: If you cannot get a mortgage yet, consider renting out a 2 to 4 bedroom place that you will then sublet to friends or strangers. Since you pay the rent in full you are able to set the rent for the spare rooms at the market rate (instead of an even split). For example, renting a 3 bedroom for $2,100 but then subletting the 2 extra rooms for $900 each. Now your total expense is just $300 per month! Compared to renting a 1 bedroom yourself for $1,000 you are saving $700 per month or $8,400 per year! Beware, with this option you take on more risk of a long vacancy or a bad roommate.
- Buying & Renting Out: This requires a down payment and a mortgage so it will be harder & riskier than the first two rent hacks. Ideally, you can buy a place with several extra rooms to rent out. Initially, the economics will be similar to the example in option 2 (just paying a mortgage instead of rent). In the long run, you also get to keep the appreciation of your property value as equity (increasing wealth further). You can analyze potential real estate purchases with our tool and even compare to renting! Read our detailed post on Real Estate Investing here.
Car Hacking: Cars are another big expense (lease/loan/upfront cost, gas, repairs, insurance) and they can be a blackhole for your money. One way is to avoid it all by not having a car, if you live in a city with great public transport, walkability and/or bike-ability not buying a car is likely the best way to go.
For most people public transport may not be practical, luckily there are ways to flip the economics of car ownership on its head:
- Buy used: Saves $10,000-$30,000+ usually lost to depreciation. Aim for buying a middle age 5-12 year old reliable car (Japanese brands). These can vary in cost from $6,000-$18,000. Average new car price is about $35,000 and a high end used car can still cost $20,000-$30,000, its best to pocket these thousands in savings.
- Finance it: If financing rates are low (0%-2%) it could be more prudent to invest your savings for the car into assets that earn a higher rate of return than the finance rate. This will increase your wealth over time.
- Earn passive income from your car: You can rent out your car when you do not need it (e.g. if you go on vacation) on apps such as “Turo”. Additionally, you can place ads on your car to earn income from local businesses.
- Earn hourly income: Join a driving or delivery app such as “Skip the Dishes” or “Uber” and turn that depreciating asset into income!
You do not have to do all four but even doing any two of the above will greatly improve the value of your car as an asset to you AND reduce its costs. You can analyze the costs of car ownership and loaning vs. leasing using our Loan Lease and Annuity Calculator!
Step 4: Re-Assess Your Situation
Steps 2 & 3 can be done simultaneously and can take as little as 2 weeks or as long as 12 months to implement depending on your situation. Hopefully, you are able to increase your income & savings rate significantly.
In your Personal Financial Planner, when you have a savings rate above 30% (the higher the better), a positive net worth, 3 to 6 months worth of expenses saved up (emergency fund), and have paid off or refinanced your high interest debts; you are in a strong financial position to begin investing nearly every dollar you save!
Step 5: Investing Effectively
Investing your hard earned savings is the most difficult step. Remember, there are no strict "rules" and even if your financial situation is not quite there, you can still start investing anytime but consider starting smaller & slower until you are on more secure financial footing! If your quality of life would be severely impacted by the loss of your investment than do not risk that!
Fundamentally, effective investing is diversification + the power of compound interest. Our future blogs will dive into great detail covering all types of investing, from financial investments to real estate and beyond.
It is critical to be diversified and "never have all your eggs in one basket". Consider Financial Investments, they should be divided between cash, passive funds (index ETFs/Mutual funds), active investments (stock/bond/ETF picks), foreign currencies, gold/silver and cryptocurrencies. If most of your money is in one fund, one market or in one savings account you are not diversified. The same logic goes for other assets like real estate. Its never a good idea to have most of your money in one thing: even too much cash is dangerous!! - Remember there's inflation!!
Finally, let the rental income, interest, dividends, equities and real estate compound overtime. The powers of long term compounding are an unmatched wealth generation machine.
The chart was generated with data from RBC showing average returns for the TSX (with dividends) and real estate over 25 years. Notice that the gain in value from year 9 to year 10 is roughly equal to the initial investment of $20,000, compared to the first year gain of $3,480. That's the power of compounding!
As your assets grow the passive income they generate will rise until one day it surpasses all of your expenses…on that day you will be financially independent!