Steps To Your Financial Independence Plan
There are many ways to obtain the goal of early retirement, everyone has their own unique circumstances and thus should have an individual financial independence plan. There are best practices to help you get faster results. Many in Financial Independence, Retire Early (FIRE) community that religiously followed these best practices were able to retire in their 30’s. They were able to make sacrifices early to obtain their goal. For my wife and I, there were some sacrifices we were not willing to make. We didn’t believe in frugal living, we enjoyed exploring new restaurants and taking vacations. With that said we also put systems in place to automate savings. We also invested wisely to help us reach our early retirement goal.
Here are some best practices and how we approached each.
One of the most important, if not the most important, part of a financial independence plan is savings. You need to save more than you spend for investment purposes. That investment will allow you to either grow in value or provide cash flow (dividends, interest, rent etc). In turn, the cash flow increases your income and makes savings easier. If you don’t have any savings it will be difficult, if not impossible, to reach financial independence.
The conventional wisdom is to set up a monthly budget that tracks your expenses. Knowing where you spend your money allows you to determine where you can make cuts. This, in turn, helps you save more money. There are many good tools and mobile apps that can assist with budgeting.
My wife and I are not good with budgets. We’ve tried several times to implement a budget but after some time we quickly lose interest. I know logically it’s a great tool but who really enjoys tracking every expense. What we did instead was to automate our savings.
We made a commitment to save half of my wife’s salary right off the top. Since she was a self-employed consultant, we only transferred 50% of her pay from her business account to our joint account. We then set up a business investment account to invest in dividend paying stocks.
I have always worked for a large corporation. Large corporations have several automated savings programs that everyone should participate in. Companies often match 50% to 100% of your contribution up to a certain maximum every year (eg match up to $2500 per year). This is basically free money (although a taxable benefit); I couldn’t believe how many people did not participate in these programs. Even without stock appreciation, you’re getting 50 to 100% return on your money. If you add in DRIPS and capital appreciation these savings add up quickly. DON’T LEAVE MONEY ON THE TABLE!!
Company Pension Plan
I know some people argue that it’s better to forgo the plan and invest the difference yourself. This may or may not be true, but I always thought of this as a sort of diversification. Although the pension plan reduces an individual’s Registered Savings Plan (RSP) contribution room (401K for our US readers), I felt it was still worth participating in the program. It was automated and one less thing to worry about.
When we had a mortgage, we would set the mortgage to a 25-year amortization with rapid bi-weekly payments. The rapid payment resulted in one extra payment every year which reduces the amortization. We would then increase the payments; companies allow for increases of 10 to 20%. This increase would go directly into principal and again reduce the life of your mortgage. The reason we didn’t choose a lower amortization initially was because if there was ever a risk of having cashflow issues you can ask the mortgage company to ‘revert’ to the original mortgage payment. This provided us with the flexibility, which thankfully we didn’t need.
Annual bonuses were contributed directly to my RSP. I never saw this money so I never felt the need to spend it.
Tax returns were also deposited/contributed directly into our RSP accounts. Since I started on our FIRE journey late, I had sufficient room. If you have maxed out your contribution limit in your RSP, you can put it in a Tax-Free Savings Account (similar to a ROTH IRA) or towards your mortgage. Put it away before you can spend it!!
If savings is the most important aspect of a financial independence plan, then investing would be a close second. Investing is like planting trees, initially, the progress is slow and you may not see instant results. Eventually, these investments will grow and if you reinvest the cash flow your portfolio will grow even quicker. Ultimately, you’ll reach a point where the cash flow exceeds your expenses. That is when you officially reach Financial Independence.
Decide what type of investor you want to be. Do you want to be more hands-off or do you enjoy reading and analyzing stocks?
Hands off – If you prefer to be more hands off, investments in a low-cost index mutual funds or ETFs is the way to go. With mutual funds, you can set up an automated monthly purchase plan. This will allow you to take advantage of something called dollar cost averaging (DCA). DCA allows an investor to systematically purchase investments without having to worry about valuation. If prices are low the investor purchases more units. If the price increases their portfolio increases… it’s a win-win. The important part is to ignore the noise. There will be periods where the stock market is volatile, but be reassured you are buying more units at a reduced price.
I believe this is the best method for the majority of the people. It’s simple, effective and doesn’t require a lot of time.
If you prefer being more hands-on, there are many investment and trading styles to choose from. For example, Dividend Growth, Value, Swing Trading, Day Trading, etc… Here’s how I found my investment style Finding My Investment Style.
When I first got started in investing, I started with a systematic investment plan in a mutual fund. This was a time before index funds became popular. Since I didn’t know much about investing, I took the advice of a Financial Advisor and invested in some growth and balanced funds. Unfortunately, they put me in a rear-load fund. Loads are fees that mutual funds companies charge in addition to the management fee. This also increases the compensation to the advisor. Rear-load funds charge a fee when redemptions are made. The additional fee amount is reduced, the longer you hold the fund. This was a way for mutual fund companies to keep investors invested in the fund and collect the management fee.
Although I got burned with the load structure and high fees, the systematic investment did help me build capital. I eventually redeemed those funds and started searching for my investment style. It took many years of trial and error to find a style that was right for me. The investing style we landed on is dividend growth investing with selective options writing (both calls and puts) and tactical swing trading. Dividend growth investing provides consistent dividends which more than covers our expenses. The dividend income is the bread and butter of our portfolio and provides reliable income that helps to grow our portfolio even in retirement. The options writing and tactical swing trading provide additional premium and capital gains that are reinvested into dividend stocks. These tactics provide an extra boost to our portfolio.
Word of caution!!
Options writing can be seductive; it can be profitable for a long time in a bull market. This can make people think to use leverage to write larger positions (naked puts). I did that for several years generating six-figure premiums. However, when the market turned quickly, I pretty much gave back all those premiums. Now I only write covered calls or cash secured puts on dividend stocks I want to own.
Swing Trading – In my early days of trading, I felt the need to be in a trade. It felt like my money wasn’t working if it wasn’t invested. This led to some questionable trades. Over time, I’ve become more disciplined which improved my results. With that said I still have to remind myself to let the chart pattern present the trade, instead of looking for a trade. Trading (buying and selling a position) is also very difficult, over 90% of traders fail at this. Take care if this is something you want to learn. You’ll hear all about the winners from friends and colleagues but they will never tell you about their loses.
Conventional wisdom says if you want to become financially independent you must be very frugal. There are hundreds of stories of people being ultra frugal, who invested wisely and retired early.
My wife and I weren’t frugal at all. We enjoy going out to nice restaurants, owning nice things and taking vacations. We believe that life is about living. There must be a balance between enjoying life and saving for the future. I’ve had friends who passed early or had severe health issues (heart attack, cancer) who didn’t enjoy their life. They thought they would enjoy themselves in retirement. We didn’t want that to happen to us. Having a sound financial independence plan ensured our portfolio was growing even if we didn’t have a 50% savings rate.
From a financial independence perspective, everyone should strive for a career that gives them the most money. Increasing your income will allow for a larger savings rate which will increase your total investments. Obtaining industry designations or advance degrees may help accelerate your career.
From a practical perspective, maximizing career income may not be inline with your values. For some, a career needs to be meaningful and give purpose. This doesn’t always align with a high income. For others like myself, I didn’t feel the additional stress was worth the income at the executive level. I know of several people who reached those levels and suffered health issues or had relationship issues because of their careers. With that said, my wife and I did progress our career up to a certain level. We both made six figures and our investment was performing well. Sure we could’ve continued to work on our careers and retired earlier but it just wasn’t worth it for us.
Again, from a financial independence perspective, everyone should have a side hustle to maximize their total income. Some side hustles are similar to a job whereby you’re trading time for money. The preferred side hustle would be something that could grow into a business. If it grows large enough you may have the option to quit your 9 to 5.
For us, our side hustle was real estate investing and trading. As mentioned, in my previous post, Finding My Investment Style, in the past 15 years we’ve bought and sold 7 properties. We were moving homes almost every two years. Most people thought we were crazy, but I don’t think we would be where we are now if we didn’t have these real estate investments. In fairness, we probably could’ve added another side hustle each but then there wouldn’t be balance in our lives.
There’s an old Chinese proverb, “The best time to plant a tree was 20 years ago. The second best time is now”. This wisdom is also true for a financial independence plan. It would be great if all of us started our financial independence plan 20 years ago. But if you didn’t, NOW is the best time to start the plan. Remember, your financial independence plan will be unique to you. The key is to ensure you have some savings to invest. The more you can save (through increased income and/or reduced expenses) and invest, the quicker you’ll reach financial independence. The rules for financial independence is simple and the hard part is the execution. If you set up a system to automate some or all of your plan, you’ll have a better chance of achieving your goal.