August 31

Financial Independence in 5 Simple Steps

Let’s face it. Almost all of us at least thought about reaching a new level of financial freedom – financial independence. It’s not surprising, considering the options it provides you – including the most scarce resource in our lives – time.

While there are many resources available outlining the path to financial independence – they typically overcomplicate or oversimplify what it truly takes. Here, I spell out 5, simple – but quantifiable – steps to ensure you’re moving methodically in the right direction.

Step 1 – Expenses

The first step is to track your expenses. How much do you spend each year?

You’ll want into take into account your essential expenses such as housing, transportation and food consumption costs (which are arguably also some of the highest line-item costs on your annual list of expenses).

You’ll also want to take into account discretionary expenses such as your subscription services, vacation, and all that fun stuff that you may consider leisure.

Now – the following are fictional numbers to illustrate an example but hopefully you’ll get the idea. You may have rent, utilities and associated housing costs that that add up to $2,000 a month.

Let’s also assume you have transportation costs inclusive of car payment, gas, insurance etc at about $400 a month.

Let’s then assume we have Food expenses monthly at a very moderate $150 a month.

This brings our ESSENTIAL expenses to $2,000 each month.

However, we must also take into account our Discretionary expenses. Let’s round up everything under this bucket to about $450 a month.

The total for our current monthly expenses, accounting for both essential and discretionary expenses – now comes to $3,000 a month.

Step 2 – Calculate your Required Nest Egg

Now, we need to calculate what net worth we need to have in investible assets to effectively cover these expenses with just returns. This is when something called the Safe Withdrawal Rate (SWR) comes in handy. Check out my other article on Safe Withdrawal Rate if you’d like to learn more about what it is.

The widely adopted SWR is 4% – meaning that when you retire, it’s safe to assume that you can survive annually off the 4% returns and your invested capital will not deplete to 0 for as long as you’re alive.

Using my example in Step 1, if my monthly expenses are $3,000, that is $36,000 annualized. To calculate what networth I need to be financially independent, Divide 36,000 by 4% or .04 and I get the number 900,000. So now I know that I need $900,000 invested into assets to be financially independent at a SWR of 4%.

Step 3 – Calculate the Difference

In this step, you must calculate the difference. How much MORE assets do you need to reach that $900,000 example “FIRE Number”?

To do that, first calculate your existing net worth.

This should be all your investible assets, such as your checking and savings accounts, brokerage accounts, IRAs, 401Ks, investment properties, among any other assets where you store any type of equity.

For the sake of our example, let’s say I have $120,000 saved up already in the form of investments. Now, I know I need to make $780,000 to reach my FIRE number, since 900,000 – 120,000 is 780,000.

Step 4 – Calculate when you’ll reach FIRE

In this step, we compute how many years it will take from now to reach that FIRE Number, given our current trajectory.

We know we need 780,000 to retire in this example. But how quickly can we reach that number? Let’s we save $50,000 a year (through savings accounts as well as 401k contributions). We divide our “difference” number in the last step by our annual savings number, or 780,000 / 50,000 = 15.6 years.

Comment down below how long it will take you guys! I’m very curious to see what everyone’s horizon looks like.

Step 5 – Work Towards FIRE

Now here’s the kicker, it will actually take you much less time to retire than 15.6 years. Here’s why: you might decide to reduce your expenses now so that you can save money more quickly – especially your discretionary expenses. Additionally, your income may go up in upcoming years as you progress in your career or develop other supplemental streams of income, further enabling you to save more money. Finally, let’s not forget – if you’re putting your savings to work each year, investing it wisely, it will compound and help you grow your net worth much FASTER than initially planned. It’s really that simple…optimize your lifestyle so that your income goes up, your expenses go down and your investments compound.

Once again, this is just an example but pretty much a guaranteed way for anyone to achieve financial independence using quantifiable and very controllable measures. As with any goal in life, the first step is to quantify the what and when which we’ve done here.

I hope you found this helpful and enjoy your path to financial independence.

Category: Income, Investing, Retirement/FIRE | LEAVE A COMMENT
July 31

The Best Dividend Portfolio for Building Wealth

10,973 Dividends Stock Photos | Free & Royalty-free Dividends Images | Depositphotos

I often get asked (by 20 and 30-something old’s) what the optimal dividend portfolio looks like for acquiring wealth.

While this is a matter of personal opinion, this seems like the wrong question to be asking. The reason being is that using a dividend strategy will likely cripple your path to wealth, if anything.

I wrote some other article here on the topic of why dividend stocks can be good or bad.

My Opinion

My answer to those asking me the question above is, none. There is no optimal dividend portfolio I would advocate for if building wealth is the goal. Dividends are taxable events, and by explicitly employing them in your portfolio, you are forcing a taxable event.

By forcing a taxable event, you’re foregoing extra capital you could have used to further propel or compound your returns (in the form of growth stocks, for example). Investing in an Index fund such as the S&P500, for example, will return insignificant dividends but moderate returns in the form of growth (about 7-8%) that will compound. In contrast, by opting for dividend stocks, you lessen the compounding effect since you pay taxes on each year’s dividend returns, and as a result have less capital to invest the following year compared to having invested in the index fund in the first place.

To reiterate, for the “building wealth” stage of your career, employing a dividend portfolio strategy is not recommended as it is not as effective as simply going the growth portfolio route.

However, if you are adamant on using a dividend-only portfolio, I would highly recommend picking only value-based stocks from a diverse variety of industries that have yields, in aggregate, that average out to something close to your Safe Withdrawal Rate (SWR) (probably around 4-5%). To get the most bang for your buck, you’ll likely find your best opportunities when the stock value undergoes temporary market corrections/dips, making it a cheap acquisition with a moderate dividend yield.

This way, you have less to lose and more to gain.

Category: Income, Investing, Retirement/FIRE, Stocks | LEAVE A COMMENT
June 30

The Hidden Dangers of a 9-5 Job

Having a 9-5 job is the millennial standard source of income. It is often seen as the steadiest way to get rich slowly. This is absolutely true, to an extent. Having a job is more stable than starting a business for example, but a job may be at a disadvantage in some aspects:

Risk

Again, a 9-5 job is a great way to build and grow your career in an organized fashion. Unlike a business, there is generally less personal risk involved (from what we’re told). Unless, of course, you consider the possibility of the company going bankrupt, or your position at the company being terminated. Especially if you were the breadwinner of the household or the sole provider and this had happened, it would be extremely devastating. The fate of your financial future and family wellbeing may be strictly at the mercy of your company or team leader. Talk about risk, huh?

Costs

Historically, it has been advised that starting a business is more expensive than just joining the work-force. Though, the tables have turned. A full-time corporate job has higher start-up costs than a business in our modern society. Don’t believe me? How much did that bachelor’s degree qualification cost you again? $60,000 you say? Oh, and it took 4 years to complete? What if you started an e-commerce business? A webhosting service can cost lower than $5 per month to set up. A full-service e-commerce platform with all the bells and whistles can cost $30 per month, and this can be instantly up and running within hours, not years. While you won’t be netting the average $56,000 annual income U.S. from your business as of Day 1, the return on investment and growth prospects can be more rewarding long term.

Impact

Bluntly put, A 9-5 job alone isn’t enough to build wealth optimally. You will likely spend a great portion of your income on living expenses, and those expenses will increase at a faster rate than your income unless you really know how to navigate and climb the income ladder to create a bigger saving surplus. Remember, even then, money is not an asset. You can save all the money you want, but 10 years later you will note that the buying power of the monies has diminished due to inflation. The point to grasp here is that while a 9-5 job certainly serves as a strong foundation to wealth upon, it really should be supplemented by other avenues such as additional income streams (such as a side-gig or business or rental income), or through acquiring appreciating assets such as stocks and real-estate. While your savings or cash do store value, additional income and assets are what will propel you faster through the journey.

Income Ceiling

Not to mention, your annual income from a day job will eventually reach a ceiling. There may be some exceptions such as some positions in tech, or a high-end sales role. In contrast, investment returns are generally calculated and sought as a percentage of the asset value. This causes a snowball effect and actually compounds your income higher rather than constraining you to a ceiling. For example, owning the VOO (Vanguard 500 Index Fund ETF) can yield 7-10% growth, on average, each year. When the stock is worth $300, expect $21 growth. When it’s worth $400, expect $28 growth. Your net worth grows faster over time as a result.

The benefits of a 9-5 job are endless. However, in this day in age, it cannot optimally grow your wealth unless you have a supplementary source or plan of action.

Category: General, Income, Investing, Retirement/FIRE, Stocks | LEAVE A COMMENT
May 31

Tax Deferral – Order of Operations

Have you ever wondered if you’re doing everything possible to maximize your long term financial outlook by taking advantage of tax deferred programs? There are many to choose from, and some are provided by the fed, whereas others are provided by the state and even your employer!

Tax planning and optimization is a huge component to building wealth long term by reducing your current tax liability. Below are several of the most popular such programs that the majority of the working mass-population can employ, and the sequence in which I recommend using them, with corresponding reasoning. I strongly suggest you first read about how each program works through my write-ups and also research on your own which programs work best for your scenario and limitations.

Order of operations:

401k – up to company match only. The company is giving you free money, sometimes dollar for dollar up to a certain percentage. For example, if your company matches 3%, you should certainly elect to at least contribute 3% of your income to the 401k, as, with the company match, your 3% automatically becomes 6% when vested. This is a 100% return on your investment! You can use this account to elect which investment opportunities are best for your goals further grow your contributions. This ranks 1st due to the nature of the 100% return on investment instantaneously.

HSA/FSA – up to annual maximum. I would recommend maximizing this account as a second priority if it is an HSA account, as it is exempt from income taxation. You can make purchases using pre-tax dollars! FSA accounts are a little different since that money may evaporate if you don’t use it In the same year, so I wouldn’t consider maxing out to the annual limit unless you anticipate using it all. You can use this account to elect which investment opportunities are best for your goals to further grow your contributions. This ranks 2nd due to the valuable nature of it being completely tax-free.

401k – up to annual maximum. If you don’t need the extra money right away, consider stashing as much as possible as a 3rd priority, up to the annual maximum, into your 401k. This is especially useful if you are a high income earner and want to reduce your current tax liability while having the belief that your tax liability will be lower when you’re ready to retire and take distributions. You can use this account to elect which investment opportunities are best for your goals to further grow your contributions. This ranks 3rd due to the nature of having the greatest ability to exponentially grow your contributions over time, utilizing the power of compounding with pre-tax dollars ($100 Pre-tax can grow faster than $100-tax post-tax dollars).

529 Plans – up to the annual maximum. Consider this as a 4th priority if your state allows you to. By funding it with after-tax dollars, you can then use this as a brokerage account to grow your contributions. You can then use these funds for educational purposes for yourself or assigned beneficiaries. The returns from the investments are tax-free and penalty-free as long as they are used for approved, educational purposes. This ranks 4th, preceding the Roth IRA as you can use the funds without any age restrictions.

Roth IRA – up to the annual maximum. This should be your 5th priority as it is a powerful way to use your post-tax dollars to invest into stocks or other instruments with tax-free growth. This means regardless of how much money you put in and how much it grows, you will never have to pay any taxes withdrawing the contributions or returns of this account, ever! This ranks 5th because you do need to meet the age criteria to be able to withdraw the “earnings” or profits without a penalty, as it is meant to be a retirement account.

Category: General, Income, Investing, Retirement/FIRE, Stocks | LEAVE A COMMENT
April 30

Why Realized Income is Bad for Building Wealth

Money, Finance, Mortgage, Loan, Real-Estate, Business

Do you like having income?

Let’s face it – we all like income, and more of it is always better.

After all, income is what helps us grow our wealth overtime. This is why we’re often fixated on growing our income. Right…?

Nope

On the contrary, higher income results in diminishing marginal benefit. The sole reason for this is the associated tax liability. The more you earn or realize in income, the more you pay in taxes not just in terms of dollars but in terms of the percentage of that income subject to taxes. In certain states in the United States, an income of $1,000,000 may be subject to over $500,000 (or 50%) in taxes. This is bad for wealth building.

Optimizing wealth building requires that you treat every dollar as an employee, and fully deploy that “workforce” to work for you. The problem with realized income is that in contrast to unrealized income, it is subject to taxes and thus it reduces your net proceeds (take-home pay) and as a result, you now have less available dollars to work for you. This is one of the reasons why the wealthiest folks tend to find ways to reduce tax liability – they grow their unrealized income (such as holding onto invested stocks or real estate that have gained value instead of selling them) and minimize their realized income (which would otherwise be subject to taxes).

What Can I Do?

Much like the wealthy, what are some things you can do to reduce your realized income while maximizing your unrealized income/net worth? Here are just a few ideas, especially if you are employed.

  1. Take advantage of a 401K or equivalent plan if your employer offers it. This will set aside funds in a tax-deferred account for you, so you don’t pay taxes on them now and can let them compound until you are ready to withdraw them.
  2. Take advantage of an HSA (Health Savings Account) or equivalent plan if your employer offers it. This will set aside funds for health related expenses based on your election, and those funds will be contributed to with pre-tax dollars, and still not be subject to taxes while expended.
  3. Hold your investments for the long-haul. Do not sell stocks or real estate investments that have substantial capital gains from growing in value – especially not short term gains which are subject to higher taxation rates.
  4. Minimize Dividend Income. If you hold stocks that pay out dividends, they are usually subject to income taxes even though you still hold the stock itself, and even if you opt to reinvest the dividends. This is because you are being paid distributions. It may be more favorable to hold stocks that grow in value but pay little to no dividends instead.

All of these are some powerful strategies even the average American can utilize to reduce realized income. You may be reducing your take-home checks by doing so, but in the grand scheme of things your net worth is poised to grow much faster as a result.

Remember, this is something most wealthy people do. It is not tax evasion, it is tax planning.

Have you realized all the disadvantages of realized income now?

Category: General, Income, Investing, Retirement/FIRE, Stocks | LEAVE A COMMENT
December 31

The Safe Withdrawal Rate (SWR)

Let’s just get right to it. The SWR is a theoretical, projected percentage of your investments that you can safely withdraw each year (based on the rate of return of your investments) with the peace of mind that your portfolio will maintain its value.

In layman’s terms, let’s assume you have $1,000,000 saved. The standard, conservative SWR assumed in the FIRE community is 4%. What this means is that on average, your portfolio will return 4% or $40,000 a year, and so you can safely assume that you can withdraw and use that $40,000 while your portfolio remains around that $1,000,000 mark, in perpetuity. Your portfolio basically becomes this machine that spits out 4% a year (SWR) to you while it keeps its value.

This is why the SWR is so important. This is typically one of the key metrics used to determine the investment portfolio at which an individual can retire and live off of returns. I recommend you reverse calculate by starting with your expected annual expenses in retirement, figuring out what SWR you expect (since it doesn’t have to be 4%. It could be more or less but is just used as a guideline of your expectations. The stock market has returned 7-8% on average annually, so you might be able to get away with 7%, but 4% is recommended to avoid bad surprises and to remain conservative), and then finally dividing those expenses by the rate of return to figure out what investment is required to achieve that SWR.

As an example, perhaps you want to live a comfortable life, and in the area you expect to live, a comfortable life costs about $80,000. You don’t like surprises, so you conservatively assume you’ll get about a 4% return on your investments. Now, compute $80,000/.04 and you should get $2,000,000. That is your FIRE number with a SWR of 4%.

Alternatively, if your average rate of return was 8% instead, and you were comfortable with 8% being your SWR, you’d compute $80,000/.08 to see that you would need $1,000,000 of assets invested to retire.

In a nutshell, that is SWR. I hope you found this little blurb on SWR helpful!

But this poses another question. Using your SWR and expected returns, what is your FIRE number? Let me know your thoughts.

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