My one line answer is: invest money in cash paying assets. My answer is based on the assumption that your goal is to get financially independent. I will show you a structured step by step process that can give you financial freedom. Enjoy the answer and start building financial independence today.
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Financial independence defined
Financial Independence is a stage in life where you no longer trade time for money. You have assets that pay you cash and cover your expenses. Winning grand lottery prize is not Financial Independence (by the way, what are the chances). There is a structured process to follow. Anyone can do it. Most people want the convenience of financial freedom. Only a few go through the inconvenience of achieving it.
Your roadmap to Financial Independence
I have divided the investment journey that leads to Financial Independence into five stages. I have gone through each of the stages myself.
Stage 1 – POOR - this is where your annual expenses are equal your income
The first stage is called Poor because it represents a poor persons budget i. e. whatever you earn you spend. I am using poor here in a sense that does not necessarily mean that you work for the smallest salary possible. It represents a state of mind. You can earn hundreds of thousands of dollars and still be at that stage.
Key risks - there is a couple of key risks in this stage that you need to acknowledge and manage them along the way.
you do not have any reserves as you spent everything you got, in consequence, each unexpected life experience will lead to debt
this debt will lead to an increased cost which in turn will lead to moving you to an emergency situation where your income is smaller than your expenses.
Next best action - you need to follow those four baby steps and make sure that you start monitoring and controlling your personal finance
step 1 – start with having close look at all your spending. See what type of fixed cost you have. Look at what your variable costs are.
step 2 – you must start preparing and maintaining a budget – a budget will tell your money where to go instead of wondering where it went.
step 3 – look at your finances from a year’s perspective – you need to take a year as your budget period to factor in expenses that happen less frequently than monthly, for example, real estate taxes, car service, various memberships, etc. Without taking a year’s view on the budget, you may think in certain months of the year that you can save. It may turn out though, that you are not saving at all. You may also find out that you keep spending more than you earn.
step 4 – track critical metrics – regardless of what tool you will use you need to focus on these three metrics and aim to improve them over time: fixed expenses in relation to income, debt expenses in relation to income, investment expenses in relation to income
Stage 2 – COMFORT ZONE - this is where your annual expenses are lower than your income. As a result, you are running a surplus budget.
I have called the second stage a Comfort Zone because it gives you an illusion of comfort i. e. you earn more than you spend on an annual basis. You are happy with your current situation.
Key risks - there is a couple of key risks in this stage that you need to acknowledge and manage them along the way.
you work for someone else. You climb the corporate ladder. You are easily persuaded to change jobs if someone offers you more money. As quickly as you switch jobs, the job might switch you.
You are prone to grow fixed costs. You start buying cars and houses. You can easily forget about the key metrics that you have learned in the poor stage.
Next best action - you need to get yourself out of the comfort zone.
'Be willing to be uncomfortable. Be comfortable being uncomfortable. It may get tough, but it is a small price to pay for living a dream' Peter McWilliams
What makes you comfortable will ruin you. What makes you uncomfortable is the only way to grow. One of the most dangerous phases of lives of people is when they rich their comfort zone. The middle class often reaches it and never decides to leave it. It is great to have money to pay for your house. It is exciting to drive that brand new car. You think you have it all. Things are not going to change. It will always be this way. Wrong.
Step 1 - never stop learning, exploring and dreaming. The moment you settle in the comfort zone and stop learning, the same moment you decide not to succeed.
Step 2 - never stop setting ambitious goals. Living comfortable and setting safe goals will ruin you. Being independent and setting the bar high will get you where you want to be in the long term.
Step 3 - embrace progress. Not a single wealthy person stays in their comfort zone. They know progress is key. No wealthy person will take the risk of being where they are and waiting when circumstances change and surprise them.
Stage 3 – PREPARATION - this is where you generate a surplus budget, and you have managed to dispose of all or almost all your bad debt
The third stage is the preparation stage because there are certain things you need to do before you move on and start investing. A single most important thing here is to eliminate bad debt.
Key risks - there is a couple of key risks in this stage that you need to acknowledge and manage them along the way.
ever-growing temptation to use your money to buy different things that depreciate in value
lack of focus on paying off bad debt
lack of focus on building reserves
Next best action - you need to follow those three baby steps and make sure that you get prepared to investing
step 1 – look at your finances from a year’s perspective (again) – check how much your debt costs you annually and imagine what could be achieved with those funds if you could eliminate your debt completely
step 2 – avoid inefficient borrowing – the key mistake here is that the amounts borrowed are used for financing day-to-day expenses or for purchasing items that decrease in value over time. This is bad debt in its pure form. If you keep doing that your chances to become financially independent are scarce.
step 3 – aim at achieving a surplus budget and start making reserves– understanding your annual finance will help you in accumulating cash reserves. They can be used for unexpected life events as well as for financing necessary purchases. More importantly, cash reserves will help you avoid falling into bad debt trap as well as pay down your existing debt.
Stage 4 – ASSET BUILDING - Asset Building - this is where you have managed to use your surplus budget to buy assets that generate additional income over time
Stage number four is called asset building stage.
Key risks - there is a couple of key risks in this stage that you need to acknowledge and manage them along the way.
you probably still keep your day job and start building your financial freedom as an additional task
once you start receiving extra cash from your assets you will again be tempted to buy stuff. To transition to the last stage, you need to resist that urge and say no to various purchases except for assets. You need to repeat that cycle over and over again until your passive income matches all your fixed costs.
Next best action - you need to follow those three baby steps and make sure that you spend most of your money on assets and use your time to learn new skills
step 1 – use your budget surplus to acquire assets that generate cash over time – now that you have reached that critical milestone you need to make some right spending decisions. Financially responsible spending means that you use your extra cash to buy assets that generate additional cash, e.g., real estate. Do not get into doubts and do not use excuses like: I cannot buy real estate with what I currently have. Everyone needs to start somewhere.
step 2 – learn about efficient ways of using debt – good debt also referred to as leverage, can help you in building wealth and passive income. You can buy an asset such as rental property, finance it with a mortgage and grow your cash flow faster than with your own funds. You need to be careful and seek some additional guidance before you start using leverage.
step 3 – never stop developing your skills when it comes to personal finance
Stage 5 – FREEDOM - Stage Five - this is where you have acquired enough assets that they pay entirely for your expenses
The final stage is called freedom because you have the peace of mind to make decisions, to shape your future to choose whatever and whenever you want to do it.
Final thoughts - change your mindset
'Too many people spend money they have not earned to buy things they do not want to impress people they do not like' Will Rogers.
Do not let your emotions control you when it comes to spending money. Financially Independent people do not care if their neighbor changes car every year. It does not impress them if their friends have just build a new pool and hold parties every weekend.
Financially Independent people know for a fact that emotions are a bad advisor when it comes to money. They prefer not to follow general trends in their social cycles. They do not need to impress anyone with what they have bought because they know that you do not need to look wealthy to be wealthy.
Rich people are rich because they live like the poor. On the contrary, poor people are poor because they live like they are rich. Do you want to be rich or look rich? Think about it.
Further inspirations
One final thing I wanted to share. You need to become skilled at making, controlling and safeguarding your money. You need to start working on your financial IQ. This will help you to understand money, make money work for you instead of you working for money.