What is Financial Independence in 2022?

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Using assets and cash flow to achieve financial independence

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When I was a young boy, I had two dads. My poor dad could never answer the question, “How do you become financially independent?” My rich dad, however, showed me the answer…over time.

My poor dad was my natural father. He was not poor in the sense that he had no money. Rather he was poor in his mindset when it came to money. The superintendent of the Hawaii school system, my father was a well-paid employee. To many he was “rich”. Yet, he didn’t like money and often said things like, “We can’t afford that.” Towards the end of his life, one of the biggest regrets he shared was that he had very little to pass onto his kids.

My rich dad was by best-friend’s father. He had a rich mindset when it came to money and he went on to be very wealthy. He started by owning his own convenience store and ended up owning a number of hotels in Hawaii on the beach. Instead of saying, “We can’t afford that,” he asked, “How can we afford that?” At the end of his life, he left his kids a big business empire and a lot of wealth. He was financially independent and so were his kids.

The difference between my rich dad and my poor dad is that one was just “rich” while the other was wealthy.

As a young boy I knew that I wanted to be like my rich dad—wealthy and financially independent. There were many things I loved and appreciated about my poor dad, but I did not want his mindset on money, nor did I want the stress he lived most of his life around money.

So, what is financial independence?

This begs the question: What is financial independence? Is it having a high-paying job so that you can support yourself? Is it based on an anticipated inheritance? Or even an alimony? For many people, it translates to: “I’m going to work until I’m 65, and then I’m going to retire.”

These, unfortunately, are not good definitions. If you have a high-paying job, you can lose it. And waiting on an inheritance, alimony, or retirement (essentially, living on the hope others will take care of you) will not help you answer what is financial independence.

Savings must be financial independence then, right?

Many people assume that the path to financial independence is saving money. That’s because most so-called experts drill this into them from a young age. They hear it at school, from parents, in the books they read on money management…it’s everywhere. Save, save, save!

For many, the golden number for savings is $1 million. As far as round numbers go, it’s a good one. And $1 million is a lot more money than most people have. But it’s also not what it used to be…and it’s probably not enough to be financially independent for a lifetime.

And even if you could save $1 million and live the rest of your life on it, the mindset about how to get there—and how to stretch that money—is, well, depressing.

Financial sacrifice ≠ financial independence

A while back, I read an article about a couple, Carl and Minday, who woke up one day and decided they were going to save $1 million in four years. They had good instincts on why to do this:

“I was having this horrific day at work,” 42-year-old computer programmer Carl told Farnoosh Torabi on an episode of her podcast. “I was 38 at the time, and I’m like, ‘There’s no way I can do this until I’m 62 or 65 or whatever age people normally retire at.”

Many people feel trapped in their jobs but do nothing about it. Congrats to them for taking action. But in the end, it is still the action of a poor-person mindset about money.

The couple started by analyzing their spending habits. “My wife and I wrote all of our expenses in a book,” Carl explains on their blog. “Every time we returned from shopping or paid a bill, we logged it.”

Based on their logs, they determined they could live on $24,000 a year. To be safe, they added a $6,000 cushion and bumped that estimate up to $30,000 a year.

To get there, they decided they needed $1 million saved up to retire by age 42. To achieve this, they did the standard saver playbook: they downsized and cut expenses, while working side jobs and investing in their personal residence and the stock market.

While it was great for Carl and Mindy to retire—and having $1 million in the bank is certainly better than most—their retirement plan is not future proof in my mind.

They use what is called the 4% rule, assuming if they take out 4% of their retirement money per year, they won’t run out.

Perhaps this makes sense for them now while they are relatively young. But what will happen when they get older and require more medical attention? Or what if their property taxes go up significantly over the next twenty years? Or what if inflation continues to grow over the next forty to fifty years at 2% a year (or 6% or 7% as it has recently)? Or what if they get tired of living so frugally after all?

Without significant income, they won’t be able to stay afloat. They may enjoy life at $30,000 a year right now, but it will not be sustainable for their entire retirement.

A true test of financial independence

A very simple test—even if you have a high salary or lots of savings—to determine if you are financially independent is to take out a piece of paper and make two columns. In the left column write down how much money you make each month. In the right column write down all your monthly expenses. Now, cover the left column with your hand and pretend you are no longer making that money. How does the column on the right make you feel? If you’re like most people, you’re having a minor panic attack right now.

This holds true even if you live on savings. Because drawing from your savings is not the same as generating income. It’s simply pulling down your assets. And it’s a very poor mindset about money that sees the world as scarce, not abundant.

Take for instance an article I read a while back on Mic: “30 easy money hacks to get a little richer every single day this month”. They include things like:

  • Shop generic

  • Check for Health Savings Account eligibility

  • Review your 401(k) fees

  • Grow your own herbs

  • Transfer $10 a week to an IRA

  • Buy a slow cooker (on sale no less)

  • Use cloth napkins

Of the entire list of 30 ideas to get “rich”, only one has to do with generating income. The rest are all ways to do exactly what Carl and Mindy did: downsize and cut expenses.

So if having a high-paying job or saving lots of money isn’t financial independence, then what is?

Three types of income

Before I answer that question, I think it’s helpful to understand that there are three types of income.

  • Earned income: If you have a job and receive a paycheck, you make your money through earned income.

  • Portfolio income: Where earned income is acquired by exchanging time for money, portfolio income is made through capital gains.

  • Passive income: My rich dad used the formula of “four green houses, one red hotel,” in the game of Monopoly to describe how you can make passive income, that is by having your assets create income for you.

Many people think they can get rich with a high salary (earned income). But as I mentioned before, you can lose your job. What is more, you trade your time for money and that is finite.

Portfolio income is nice but you only make money on a sale, and it’s taxed higher than passive income. So you are at the mercy of the markets and you give more of what you earn to the market. It is not a predictable income for wealth.

It’s only passive income that provides true financial freedom. And it only takes three steps.

The three-step formula to achieve financial independence

The following formula is what Kim and I used to be financially free for nearly thirty years. The formula is this:

  1. I buy and create assets that generate cash flow

  2. The cash flow from my assets pay for my living expenses

  3. Once my monthly cash flow from my assets is equal to or greater than my monthly living expenses then I am financially free because my assets are cash flowing and are working for me.

When the formula is completed, I no longer have to work for money. When I no longer have to work for money, I’m financially independent.

The formula for financial independence in practice

Kim and I became financially free by investing in real estate. To be clear, we did not have the money to do this. Rather we created the money by paying ourselves first. What does this mean? It means that we treated investing as our first and most important expense. Each month we would pay our investing expense and then figure out how to pay all our other expenses. It was nerve-wracking at times, but we always figured out a way—and I got pretty good at negotiating with creditors!

Once we had enough money saved up to buy a property, we would find a great deal where the income from the property would cover our expenses as well as the debt we would take on in the form of a mortgage. We then continued to pay ourselves our investing expenses as well as adding the cash flow from the property to the pot. This accelerated our ability to purchase yet another property. This then led to more properties. Eventually we sold many of those and invested in even bigger projects like apartment buildings.

We also expanded out to other assets. For instance, my book, Rich Dad Poor Dad is the best-selling personal finance book of all time. It has sold over 32 million copies. I’m still getting large royalty checks to this day. And our business, Rich Dad, offers financial education in the form of books, coaching, seminars, and digital products. It also puts money in our pocket each month.

Kim and I never have to work a day again in our lives and the cash flow from our assets covers our expenses—and some. This is very different from savings, for instance. Savings can run out. Cash flow keeps coming no matter what. Savings can lose its value relative to inflation. Assets grow in value along with inflation. That is why the formula makes you truly financially independent.

Your mindset about money counts

As I mentioned at the beginning of this article, my poor dad would say, “We can’t afford that.” My rich dad asked a very different question. He would ask, “How can I afford that?”

The difference between my poor dad and my rich dad’s mindset about money was fundamentally one of saving versus earning.

My poor dad always looked to be saving money and cutting expenses. My rich dad always looked to be making money and investing in both his wealth and his quality of life.

Now, which person do you think lived a happier, fuller life? Unfortunately, it was my rich dad. I say unfortunately because it was very hard to watch my poor dad later in life when he had no money, struggled financially, and was very bitter. He worked hard his whole life, but his mindset about money did not serve him well in the end.

Savers are losers; spenders are winners

All of this goes to show that the Rich Dad mantra of “savers are losers” is a vital thing to understand if you want to be truly rich. In today’s financial world, spenders are winners and savers are still losers. Of course, by spenders, I mean those who use their money to build their business or invest in cash flowing assets. And to spend wisely this way, you need financial intelligence that goes beyond just downsizing and cutting expenses. You need to understand how to create wealth, and in your own way, actually make money grow on trees.

What is financial independence for you?

I showed you three steps Kim and I took. Though it didn’t happen overnight, it did happen. All it took was a plan to generate cash flow and determination to channel that cash flow to cover our expenses. Once our cash flow covered our monthly expenses, we became financially independent.

But that is the plan that works for us. What actions are you taking today to get you closer to achieving your definition of financial independence?

Original publish date:
May 06, 2014



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