This post is from Xyz who writes over at Our Financial Path. He and his wife are aiming to reach financial independence and retire early in less than 10 years. They write about their travel adventures, their investments, budgeting, and their views about life over at ourfinancialpath.com.
Being free is a big word.
So big that most of us cannot describe it in a single sentence.
Freedom can actually mean a lot of things. To a prisoner, being at home might mean freedom. To a skydiver, a parachute that opens might mean freedom.
What is freedom when you live in a beautiful country with so many liberties? To me, freedom is having, not only the legal right, but the financial power to travel wherever I want, take whatever time off I want, and work on whatever I want. This kind of freedom can be reached through Financial Independence.
At the point where you can generate enough passive income to cover all of your spending, you can then work on projects you enjoy, or not. You can relax on a beach somewhere, or not.
So How To Get There?
Having a truly passive income is amazing! You do not need to get up in the morning and work for your money; your money will actually work for you. The key here is to get your money to work for you. Without that, it is just money.
By investing your money in real, concrete, companies, you can leave your money to build factories, buy inventory, or open new stores to produce profits and growth. This is the basic principle of investing. Companies raise capital through a stock market and when everything goes well, rewards its investors with a share of the profits through dividends or through reinvestments.
Of course, history has shown that not all companies will reward their investors and stock prices can go up and down like roller coasters. Many have devoted entire careers to find the best place to invest and how to earn the best returns but is the chase actually worth it?
Many “experts” have dedicated their life to investing and professionals are paid millions to beat the market. Unfortunately, very few can consistently beat the market over the long-term. The most flagrant example of this are hedge fund managers. They are paid fortunes to beat the market with the usual fee around 2% of all assets under management plus about 20% of the total profits!!! History has shown that even those said “professionals” cannot beat the market, over the long-term, after their exorbitant fees.
I think you are much better off with a low-cost index fund. To prove my point, back in 2008, investment legend Warren Buffet made a bet with money management firm Protégé Partners that an S&P 500 index fund would beat their top 5 hedge funds over the next 10 years.
The fund Buffett picked, Vanguard 500 Index Fund Admiral Shares (which invests in the S&P index) is up 65.67%. Protégé’s funds of funds – funds that own a portfolio of positions in a range of hedge funds – are up, on average, a paltry 21.87%.
The bet still has two years to go but it seems like the indexing, hands-off strategy, will beat the pros by a large margin.
What I suggest for anyone who is aiming for financial independence is a low-cost broad index fund. Many companies offer them but I stick with Vanguard for their low cost and simplicity. The S&P 500 index fund used in this bet is a good choice but I prefer the Vanguard Total Stock Market ETF (VTI) for its even broader diversification.
Once you have a clear goal and know how to get there, you can save a large part of your income towards that goal.
Where Is The Finish Line?
If you have been a good saver and have been investing in a low-cost index fund for a while, you can become financially independent surprisingly fast. Included below is a quick chart to illustrate the power of your savings rate. Basically, the more you save, the faster you can reach financial freedom. For example, if you can save 64% of your income, you will be able to generate enough passive income to live off your investments after only 10 years! Feel free to play around with it in this interactive version.
The basic principle is, for each year you are saving a large chunk of your income, you are buying yourself future years of freedom.
Once you amassed enough wealth to safely live off a very small portion of it (usually 4% withdrawal rate, see Trinity Study) then you can step down your race horse and choose to do whatever you please, or not. You will be free to choose to work or choose to travel the world; whatever you want to do!
Are You Free?
Being free is a big word.
Do you absolutely need to have millions saved up to be free? Of course not!
The journey to financial independence can be long and it is primordial to enjoy the ride along the way. Be happy with your career, family, and enjoy all moments of life along your path to freedom.
What are your thoughts? What does financial independence mean to you?
Xyz from Our Financial Path
[Photo Credit: pixel2013]