Milestones to Financial Freedom

[Jake]

I'd be interested to hear feedback on this recent podcast I did on milestones to financial freedom. You can hear the podcast here http://thevoluntarylife.com/TVL_E080_fi ... stones.mp3 and I've posted a summary of all the main points below from the accompanying blog post http://thevoluntarylife.blogspot.co.uk/ ... tones.html

This episode is a about the significant milestones along the way towards achieving financial freedom. In my opinion, reaching each of these milestones brings you closer to being financially free and it is useful to take a step back and consider what the steps along the way of your journey will be. Some milestones to consider are suggested:

Financial independence or "paying your own way", whereby you are sustaining yourself from your job or work income on a month to month basis. You are not living off parents, not living from significant subsidies from your family, not accumulating student debt and not accumulating credit card debt. It's important to note role how going to college significantly delays reaching this milestone and how many people do not achieve this milestone until they are in their 30s or later.

Achieving positive net worth, whereby your assets are greater than your liabilities. This is often what people mean when they talk about "getting out of debt" (although that is not exactly the same). It is important to be aware that consumer credit and mortgate debt can significantly hinder or delay you reaching this goal.

Making your first investment, for example by purchasing an income producing asset like shares or bonds.  The key distinction is that this is not just money you haven't used yet which you are putting aside until  you spend it, it is money you do not intend to ever spend. You are putting this money to work for you creating income. Although a lot of people consider purchasing a house with a mortgage as their first big investment, a property for your own use is really a consumption item.

Net worth surpasses annual expenses- in other words, your savings (assets) could keep you going for 1 year if you needed to. This means you have a significant safety buffer, but if you did have to use your savings it would mean that you consume your capital and you would be back to square 1.

Annual passive investment income becomes larger than your annual expenses: this is real financial freedom, as  you can now live off your passive income. For this to be sustainable it needs to take into account the effect of inflation, taxes etc. However, once you can sustainably live from your passive income, you are financially free.

This podcast and blog summary contains only my personal opinions, it does not constitute financial advice and I am not a financial advisor.

Do you think these are the relevant milestones? Any others you think are more important? Feedback welcome.

[stone]

The crazy thing is though that in some ways you become less financially free the further you go along that path. When in debt, you can just use any excess income to pay it down. You don't need to bother with how financial stuff works. My impression is that people with money waste more time over financial matters than people without

[Jake]

The crazy thing is though that in some ways you become less financially free the further you go along that path. When in debt, you can just use any excess income to pay it down. You don't need to bother with how financial stuff works. My impression is that people with money waste more time over financial matters than people without

I suppose it all depends what we mean by being financially free. I see it as being free of the necessity to work (unless you want to) to pay your living expenses. But it could also mean being free of worries about money. In that case, I agree that with increasing income, many people become more worried about money not less.

I wonder what proportion of people in each income bracket have such high expense lifestyles that they are living paycheck to paycheck. You would expect that the higher a person's income the bigger the gap between income and expenses (and therefore the more financially free they are) but it certainly isn't a clean correlation.

[stone]

I can remembering hearing of a study that asked an extremely diverse bunch of people from all over the world how much money would be  "enough". It was typically 1.5x what they currently had irrespective of whether they were extremely wealthy or very poor.

[Pointedstick]

Stone, I think it's pretty well established that we're a weird bunch here. I don't care about what other people think financial freedom means; it's only relevant to what I consider it, and I'm more with Jake in that to me it represents work being optional. It means being able to choose whether I want to spend my time earning more money, or playing with my son, or building a house for my in-laws, or having a picnic with friends.

[Pointedstick]

Excellent podcast episode, Jake. I strongly agree with you on all points. Bringing up ERE was nice to hear. It's really amazing how powerful it is to be able to live happily on less money. The difference between being happy at $12k a year and $15k a year is an extra $99,000 you need to save (@ 3% SWR)! Unless you have a very very high-powered income stream, I think most would find it easier to cut $3,000 from their yearly budget than sock away 100 grand in inflation-protected investments that are constantly growing or emitting dividends or interest payments.

Right now I'm between phase 4 and 5 on your timeline. My net worth is between 6 and 8 years of expenses (depending on the year) and I'm working flat-out to raise that number. It will fall once I purchase a house, but I intend to buy it free and clear with cash, and the money saved on rent will be plowed right back into savings, just like I did when I paid off all my loans. I expect that living rent-free will be very liberating since it will dramatically cut down the mandatory monthly expenditures, which, in turn, enables greater flexibility in your required income level.

[MachineGhost]

Right now I'm between phase 4 and 5 on your timeline. My net worth is between 6 and 8 years of expenses (depending on the year) and I'm working flat-out to raise that number. It will fall once I purchase a house, but I intend to buy it free and clear with cash, and the money saved on rent will be plowed right back into savings, just like I did when I paid off all my loans. I expect that living rent-free will be very liberating since it will dramatically cut down the mandatory monthly expenditures, which, in turn, enables greater flexibility in your required income level.

Did you compare inflation depreciation of mortgage debt vs inflation hedge of being 100% invested in the house?  What if you got an interest-only mortgage so you avoided the "forced savings" component?  That seems like a win-win to me.

[Pointedstick]

I did not, because I don't really understand interest-only mortgages, and my goal is to have as few monthly payments as possible. Taking on another loan is contrary to that goal.

I paid off my wife and my student loans that ranged from between 2.75% and 6.7% by selling shares of AAPL that have gained 50% in the last year. The numbers might say that was a foolish decision, but it was the right thing for us. And getting rid of those monthly loan payments freed up about $900 a month for making more investments in our permanent portfolios!

[MachineGhost]

I did not, because I don't really understand interest-only mortgages, and my goal is to have as few monthly payments as possible. Taking on another loan is contrary to that goal.

I paid off my wife and my student loans that ranged from between 2.75% and 6.7% by selling shares of AAPL that have gained 50% in the last year. The numbers might say that was a foolish decision, but it was the right thing for us. And getting rid of those monthly loan payments freed up about $900 a month for making more investments in our permanent portfolios!

Debt it just a tool, its not intrinsically good or bad.

An interest-only mortgage just means you're not forced to pay the principal portion down in an amortization over time, i.e. "forced savings plan".  So you would be essentially renting without living in an apartment, while the outstanding principal stays fixed and degrades at a rate of inflation while the house goes up in inflation.  If you were forced to pay the principal portion akin to your student loans, etc., you're stuck with that money invested in the house rather than in the PP or much better investments.

However, I seriously doubt there are 30-year, interest-only mortgages, but I could be wrong.  I don't think there would be much profit in it for the banks to offer that rather than adjustable rate, x-year resets.  Which is odd considering they don't really benefit from the "forced savings", but perhaps its "skin in the game" to them.

Another smart way of doing it is to invest a sufficient amount of capital and use the resulting cash flow to pay down the mortgage, whether interest-only or amortized.

[Pointedstick]

Debt is indeed just a tool, but it's one I'm not too fond of. It increases the amount of time I need to work and the quantity of money I need to save.

I don't disagree with your logic, but it's just a different way of thinking about the problem from the one we're using. Here's our thinking: if I rent for (say) $900 a month, it would take $354,400 in savings to pay that expense every month at a 3% SWR. If I were to buy a modest possibly fixer-upper house for $90,000, then I can eliminate that $900 per month expense for substantially less than the $354,400. In effect, I've removed the need for an extra 350 grand in savings without impacting my ability to live off investments. The "forced savings" in the house are irrelevant to me. I just want a place to live without monthly payments. If I can later sell the house when I move, well then that's just a nice bonus! 

[MachineGhost]

I don't disagree with your logic, but it's just a different way of thinking about the problem from the one we're using. Here's our thinking: if I rent for (say) $900 a month, it would take $354,400 in savings to pay that expense every month at a 3% SWR. If I were to buy a modest possibly fixer-upper house for $90,000, then I can eliminate that $900 per month expense for substantially less than the $354,400. In effect, I've removed the need for an extra 350 grand in savings without impacting my ability to live off investments. The "forced savings" in the house are irrelevant to me. I just want a place to live without monthly payments. If I can later sell the house when I move, well then that's just a nice bonus! 

That's different.  You're talking about buying value and I'm talking about financial engineering.  Most people don't buy value! 

BTW, I keep forgetting to ask, but is that Frederick Douglass in your avatar?

[Pointedstick]

It's CEO Nwabudike Morgan, from the Alpha Centauri video game! Check out the video in my signature.

[AgAuMoney]

Financial independence or "paying your own way", whereby you are sustaining yourself from your job or work income on a month to month basis. You are not living off parents, not living from significant subsidies from your family, not accumulating student debt and not accumulating credit card debt. It's important to note role how going to college significantly delays reaching this milestone and how many people do not achieve this milestone until they are in their 30s or later.

I think this one is critical and it establishes a foundation for everything after.  Of course, probably earning and saving as a child and teenager establishes a foundation for "paying your own way" later.

I'm not sure I buy the college argument.

I lived at home my first two years of college and paid my own tuition and books.  Transferred to an out of state school for year 3 and lived in a dorm with a kitchen (no meal plan or cafeteria).  That first semester I lived on savings.  Found a job I started in January and from that point I was "paying my own way."  No loans, no grants.  Lived in cheap housing, drove an old car.  I did change majors and took the minimal credit load for a full-time student.  It took me an additional 3-1/2 years (instead of 2) to get my 4 year degree.  Graduated from college with no debt, an old car, $5000 in the bank and a wife.  (Financed her wedding ring '90 days same as cash' and made each payment with my discover card, receiving cash back, and paying no interest.)

Some say that isn't possible now.

My oldest finished his first year of college last spring at an out of state school.  He did have some family there, but he was pretty much on his own.  I paid tuition, he paid everything else: housing, food, books, his laptop and minutes for his prepaid android phone ($100 HS graduation gift from my inlaws).  He found a job his first month that met his expenses plus allowed him to accumulate capital.  He has a couple of dividend stocks and some silver along with cash.  Looks like he may graduate college better equipped than I did.

College has gotten phenomenally more expensive.  But I'm inclined to think there is much about your argument that is just an excuse or rationalization.  If you cannot afford it, don't go or choose a cheaper school.  Just like with anything you cannot afford -- do without or substitute something cheaper.

[AgAuMoney]

I can remembering hearing of a study that asked an extremely diverse bunch of people from all over the world how much money would be  "enough". It was typically 1.5x what they currently had irrespective of whether they were extremely wealthy or very poor.

Now I feel bad. 

I want 2x what I have.

[Pointedstick]

College has gotten phenomenally more expensive.  But I'm inclined to think there is much about your argument that is just an excuse or rationalization.  If you cannot afford it, don't go or choose a cheaper school.  Just like with anything you cannot afford -- do without or substitute something cheaper.

If only this attitude was more widespread! It's so true. If you can't afford it... don't buy it or find something cheaper than you can afford. What a concept!

I'm heartened by your son's college experience and the wisdom he clearly possesses already. Good for him! Sounds like you and the missus did a good job. 

[MediumTex]

I paid off my wife and my student loans that ranged from between 2.75% and 6.7% by selling shares of AAPL that have gained 50% in the last year.

How much did that set you back?

Paying off your wife AND your student loans is quite a feat!

[Pointedstick]

How much did that set you back?

Paying off your wife AND your student loans is quite a feat!

We had a total of $67,000. The first $40,000 or so was paid off with good old fashioned cash thrown at it every month in whatever quantity we had available. Every bonus and salary raise went right into the debt.  Then I sold some stock to pay off the remaining balance over the course of a few months earlier this year, because I really didn't want to be in debt when my son was born. It was a highly emotional decision, but I didn't want to be still making payments on a previous stage of life while I was looking forward toward such an amazing new one. I have no regrets at all, even though I would have been a few thousand dollars richer today if I had waited a few more months to sell. Can't complain; I didn't know that future at the time! 

It kills me how preventable our debt was. Each year one of us had been an RA, we could have cut down the principal by 10 grand! And we had those low-wage make-work college jobs but didn't put a penny of the money toward paying down the principal while we were enrolled. Even after I got a Real Job in my junior year, I barely saved any of it and again failed to make a dent in my loan. Lessons learned.

[Jake]

College has gotten phenomenally more expensive.  But I'm inclined to think there is much about your argument that is just an excuse or rationalization.  If you cannot afford it, don't go or choose a cheaper school.  Just like with anything you cannot afford -- do without or substitute something cheaper.

Oh I'm with  you 100% on this. I do think it is a lot harder to graduate without debt today, but I don't say that as an excuse or justification for getting into massive debt or even for going to college in the first place. I was in college for years (I did an undergrad, Masters and PhD) but I still graduated debt free. Also, despite having done all that college time, I don't view college is a necessity. It's treated as a right of passage for many families, but the cost benefit these days looks very different to when I did it over 20 years ago.

[gizmo_rat]

I still graduated debt free. Also, despite having done all that college time, I don't view college is a necessity. [...] the cost benefit these days looks very different to when I did it over 20 years ago.

It's an interesting one, 20 years ago I came out of post grad education with more cash than I went in with (thanks EPSRC), clearly not remotely possible now. Despite all the undoubted benefits of hiding in education for as long as possible, I strongly doubt that I'd do it now.

Which does make me suspect there's a last milestone around trying to budget for any dependants choices 10 years in the future... which is not as quantifiable as the other milestones.

On reflection, maybe this is just an example of Stones 1.5 x. 

[WildAboutHarry]

Also, despite having done all that college time, I don't view college is a necessity. It's treated as a right of passage for many families, but the cost benefit these days looks very different to when I did it over 20 years ago.

The book Shop Class as Soulcraft explores the "college is not a necessity" angle.  Not a bad read.

[MediumTex]

Also, despite having done all that college time, I don't view college is a necessity. It's treated as a right of passage for many families, but the cost benefit these days looks very different to when I did it over 20 years ago.

The book Shop Class as Soulcraft explores the "college is not a necessity" angle.  Not a bad read.

The paper that preceded the book is available online for free if anyone wants to check it out.

I used to read his paper at least once a year I found it so interesting and stimulating.  I haven't read the book.

[Lone Wolf]

I really like the descriptions of these milestones.  That final "financial freedom" phase perfectly matches the criteria that I use.  While it's not the "last stop" (since you could always add a "filthy rich" or "more money than you know how to spend" phase), I think that this is the phase all of us think of when we talk about achieving our life financial goals.

I'll be sure to check out the podcast!

The book Shop Class as Soulcraft explores the "college is not a necessity" angle.  Not a bad read.

The paper that preceded the book is available online for free if anyone wants to check it out.

I used to read his paper at least once a year I found it so interesting and stimulating.  I haven't read the book.

I believe that this is the essay version that MT's referring to: http://www.thenewatlantis.com/publicati ... -soulcraft

I'll have to check it out.  Sounds like it'll be a very interesting read, although I'll be approaching it with a skeptical bias.  I think it'll be a very interesting read for me because on one hand, I get a natural thrill out of tinkering.  On the other hand, I find the "cubicle work" of software engineering to be an exceptionally fulfilling line of work, which sounds like it might cut against the thrust of this essay.

[hoost]

I believe that this is the essay version that MT's referring to: http://www.thenewatlantis.com/publicati ... -soulcraft

I'll have to check it out.  Sounds like it'll be a very interesting read, although I'll be approaching it with a skeptical bias.  I think it'll be a very interesting read for me because on one hand, I get a natural thrill out of tinkering.  On the other hand, I find the "cubicle work" of software engineering to be an exceptionally fulfilling line of work, which sounds like it might cut against the thrust of this essay.

I'm not sure what the day-to-day requirements of a software engineer are, but I think most types of engineering are probably more of a "craft" than a typical white collar job.  A lot of what the author discusses is the thought that goes into craftsmanship, and I think most engineering jobs require that same level of thought that a blue collar craftsman would utilize.

I am also an engineer (not software) and find my work quite fulfilling, although my role is probably more hands-on than most.

[Pointedstick]

I wonder how many of us are engineers (I am too). It's sort of interesting how many engineer types are attracted to mastering money and adopting small government/libertarian ideals. The INTJ profile strikes again!

[stone]

Jake and Gizmo Rat, I also feel somewhat sheepish about all of these tales of massive student debt. Like you guys I too was a recipient of the previous  UK education system benevolence and finished a PhD debt free.