You have to spend less than you earn and save and invest the difference to accumulate wealth. You will have to save more or earn more. Financial freedom or financial independence means that you have enough money to cover your expenses without having to earn more money in the future. People reach financial freedom in many different ways.
Fundamentally there are two levers that you can pull. Either you reduce your expenses drastically so that you can save more. Or you earn so much that you have more than enough left over to save.
What is better save more or earn more for financial freedom? You will find advocates for both camps. But which one comes first? Which one is more important? Which one actually works? How do you achieve this?
I have lived through this during the last 5 years and even a bit before that. This whole blog is about that experience. In this post I’ll be a bit more specific about the interplay between expenses and income. So let me share my experience.
How much do you need?
Typically you need to aim at saving 50% or more of the money that you earn. If you can save more or earn more, you increase savings and achieve financial freedom sooner. The target is a pool of savings to cover your expenses. The higher your savings rate % (savings ratio vs expenses) the better.
The graph below shows the relationship between how long you need to work and how much you need to save. The calculation uses investment rate of 10% and inflation of 5% with a retirement number calculated using the 4% rule. If you only save 15% of your income you will need to work for over 40 years. If you save 53% of your income you only need to work for 15 years to reach financial freedom.
Right now on twitter I follow @route2fi and he blogs about exactly this point. He has managed to drastically save more and earn more to increase his savings rate and significantly shorten his FI journey.
The “Normal” Life
If you are anything like me then you live a pretty normal life. That normal includes a good job, bond, cars, family, pets, holidays, friends, weekends etc. It is a good life but average. Never really seem to have enough money, increases just cover expenses and sometimes not. You long for that comfortable lifestyle where money is not a concern and you can do what you want. Work is same same and you do what is needed. You don’t really have a plan and just kind of cruise along hoping that it will all work out. That was me.
Stuck in no man’s land
I would call this no man’s land. Like that piece of land in between a border crossing where nobody is in charge and you are not in any specific country. You are just in the middle having left somewhere and not arrived yet. Its basically that time between 30-50 years old for the normal working person.
At exactly 40 years old I found myself halfway through no man’s land. Salary hadn’t improved much mainly because I had left full time employment to start my own business. After becoming disillusioned with my job I decided to follow my passion. Before quitting my job I had been working for 11 years. In that time I never had a proper plan to increase income although it did increase but it was always met by increased spending.
Starting my own business I was more focused on following my passion and loving what I did. Starting your own business is how you make money, this was my belief and plan. As it turned out life was good but the money was not coming and this was a concern.
At 40 when my son was born many realities set in. I wasn’t getting younger and I wasn’t getting wealthier. I could no longer linger around in no man’s land I had to get to my next destination. That was a place of financial success.
The most obvious solution then was to earn more. I had followed my passion done what I loved but it was not sustainable. At least not for me. I wanted more financial security to create a future that I wanted. I turned back to my professional career and used the skills and contacts that I had.
This allowed me to re-enter corporate life on a better footing. Unlike when I left I had a clear plan and objectives in mind. I knew I wanted a work life balance and I had an earnings target. I was not scared to ask for this or negotiate for it. My focus was was to increase salary and have a high paying job.
Earning more is not enough
After a few years my plan was working. I had received salary increases and promotions. My wife had also started working again and we were earning good salaries. It took a while to make up for lost time but that was fine. At this point however I realise that we were still not getting wealthier. In fact we had huge debt that was not being paid off and we were accumulating more debt. All we had done was upgrade our lifestyle and added more cost.
So after all that effort and significantly increasing our income we were no better off. I could not understand this. That is when I had my financial freedom realisations.
I realised that there were two parts to this equation, income and expenses. In business it is completely obvious but you do not think of this in your own life. You never really question the expenses because you are just doing what everyone else does. If they can manage then why can’t you? Until you realise that they probably aren’t managing and the few that are have already worked this out.
I realised that we would never earn enough money if we kept on spending. I had to think differently and do something differently to spend less and save more. This is a large part of achieving financial freedom, being frugal and living within your means. Personally I think that this frugal part of financial freedom is the most effective and the most important. I had proved that to myself.
Cut the spending
Earning more money without a plan to reduce spending and manage it better will not get you closer to financial freedom. Have a look at these posts to see how I managed to eliminate debt and get the spending under control.
Once we focused on this we realised how much money we were wasting. You don’t have to spend all the money you are spending. You also don’t have to live in poverty by being frugal. It just means that you stop wasting money on less important items and focus your money in the areas that mean the most to you.
Besides getting the spending under control and saving money you have to have a plan to invest it. Up to that point my investing plan was restricted to whatever money I had left over. Since I was spending everything we had nothing left to invest. So even by earning reasonable salaries we still did not have enough money left over.
The truth though is that it is easier to spend money than it is to invest money. We all know how to spend it but few know how to invest it. So if you are earning enough money but you don’t know how to invest it, chances are you will end up spending it. If you don’t have a plan for your money, somebody else will.
Earn more invest more
Finally I was on the right track. I managed to come up with a plan to achieve financial freedom on our existing income. The plan included reduced spending, a manageable budget, maintaining a modest lifestyle and increased investments. We would be able to save 30-50% of our income over a 10 year period to achieve financial freedom.
Increased income – reduced spending + (investing)X = financial freedom
I finally had the formula worked out. However this does not mean that I can now sit back and watch the sunset. Instead I have been focussing on increasing my salary and decreasing expenses. This process never stops.
I have continued to be successful on both ends of this formula. When that happens then you start to accelerate the journey to financial freedom. Like everything in life you improve and gain experience from practice and doing.
Where to start and how to do this?
So back to our question how do you get out of this no mans land and onto the path to financial freedom?
Don’t be put off by all the different beliefs and opinions that you or other people have about financial freedom and retirement. Fact is that it is achievable for anyone earning a reasonable salary. Start by managing your spending and living within your means, that means spending less than you earn. Fix that first, it’s the easiest and the most controllable. Also you are going to need this discipline in the future anyway.
At the same time start to work out how you can earn more money. As a salaried person your best bet is to focus on your career and increase your salary. This is where you can make the most gains. For strategies around this have a look at my last post on how to increase salary and have a high paying job. You can also start side hustles or get involved in other businesses. It all depends on you and the opportunities that you have.
You can and should do both. Don’t underestimate the focus that a plan and goals can bring you. As soon as you have something to to aim for you see things differently. It brings calrity, focus and purpose and you will achieve success.
Let me know how you are doing in the comments below.