Today I am going to cover the main requirements that anyone needs in order to reach financial freedom.
In my previous post I explained the meaning of Financial Freedom. As a quick summary, it means reaching to a level where your assets can generate enough income to support your expenses. At that point, you can pack your bags and move down here
I know, I know, same picture as the blog’s cover, but what can I say? I really like it. It clearly reflects the beauty and peace that financial freedom can bring to you.
Ok, enough dreaming! Let’s get to work.
That’s it, now you are financially free!!……Unfortunately things are not so easy, but it would be great, right?
It’s important to note that I have listed them in chronological order. In my opinion, you need to master each point before you move to the next one.
Change your mindset
It’s not a coincidence that this is the first point in the financial freedom list. The most important thing for you to start this journey is to stop and think.
Money is just a tool to buy goods and services, nothing more, nothing less. It’s how we use this tool that will define whether we have success or not on our quest to financial freedom. You should not be emotional about money, I can assure you that money won’t have any feelings for you.
Once that’s clear, you need to understand the difference between asset and liability:
- Asset: it puts money into your pocket
- Liability: it takes money out of your pocket
Most of people think that their car, Iphone 11 or new laptop are their main assets. But that’s wrong. If you have to spend a lot of money to get it, it depreciates over time, and if you are going to pay it over several years, it’s definitively something that is taking money out of the pocket -> Liability.
Typical assets are stocks, bonds, loans (when you are the lender, and not the borrower), Real Estate (when you receive a monthly income through renting it).
Understanding the difference between Asset and Liability is critical in order to move forward.
Get out of debt
I believe this point is self-explanatory. There is no good reason why you should get into debt, except if you are buying a house (it’s very difficult to buy a house in cash 🙂 ).
Apart from that reason, you should never (and I repeat never) get into debt.
When you borrow money you have instantly become poorer. Even if the loan has 0% interest (which is likely not the case), you are making your future self poorer. Our purpose is to get wealthier, not the opposite.
If you want to buy something, you have to be able to purchase it with the money that you have right now. If you can’t, you will have to save and wait. Period.
Set up goals
One of the main requirements on your journey to financial freedom is setting up goals. Anything that you want to do is always easier when you set yourself a target. It helps you to focus towards it. Once you have it, you know you need to do everything in order to reach it.
It’s also important to set goals that are achievable, so they can motivate you. If your goal is to have one million, it will be much easier to first aim for 100 000, then 300 000, and then 1000 000. If your first target is 1 million, you will see it too far away, and this can demotivate you.
Review your expenses
You must review your monthly expenses. You would be surprised about how much money is leaking in “small stuff”. Check your budget and identify which of your expenses are needs and which ones are desires. Eating out, weekends shopping or getting the latest mobile phone/laptop can make your savings go to zero (or worse, go on debt).
Save as much as you can
Saving had to be in the list of financial freedom requirements. In order to build your way to wealth, you need to start by saving. As we have all heard before «you need money to make money».
This is fully related to our previous point. Once you have reviewed your expenses and cut them down, you will realise that you don’t need a lot to be happy. Many times we go shopping because we are bored and we need to have something new in order to feel excited. When you stop doing this, you can start focusing on what really makes you happy.
Well, if you have reached here, you deserve a pat on the back, so go on and ask someone to give it to you 🙂 Horray!!!
You are already used to saving, which means that every month a part of your income is piling up on the bank account. Saving is great, but if you are planning on saving enough money to cover your expenses for the rest of your life, you will have to save a lot…
Instead, you need to focus on getting decent returns on your money. This is where investing comes into play. Your goal is to achieve high returns while limiting the risks you are assuming. It’s time for you to look for returns on your money. Now it’s when the fun part starts!
Traditional investment vehicles are Stocks, Bonds and Real Estate. Recently we have seen new actors appearing, such as Crowdfunding and Crowdlending.
My favourite ones are Stocks and Crowdlending, check them out and let me know if you have any questions.
My target is to get 10% annual return. This is not a random goal. I did a deep research on the S&P500 index, and I discovered that it had an average of 9% annual return over the past 150 years. If you pick a period of 10 years or more, it usually gives you an annual return of 10%. You can check it yourself on this S&P500 return calculator.
Reinvest your profits
Now I am going to talk about the power of compound interest. This means that your investment profits from Year 1 will contribute to increase your investments on Year 2, and so on. Let’s look at below example to clarify the concept.
We have Jorge and Flavio, both with a net portfolio of 100 000 euros. They have invested their full portoflio, obtaining both 10% return per year. The only difference is that Flavio reinvests each year his profits, while Jorge decides to transfer them to the bank in order to reduce his risk.
Now let’s check below picture
After 18 years Flavio has 555 000 euros, while Jorge only has 280 000. Flavio has doubled Jorge.
If we move forward, by year 30 Flavio has reached 1.75 million, 4 times more than Jorge that is sitting at 400 000 euros.
Now remember, they both started with the same amount (100 000 euros) and they both got the same returns (10% per year). The only difference is that Flavio reinvested the profits and Jorge did not. I mean, isn’t it impressive how just reinvesting can be a total game changer?
This shows the strength of compound interest and time. Please mark these words in your mind. Compound Interest and Time are your best friends.
Evaluate your investments
After setting up your investment goals, its very important to review periodically how your investments are performing. If your target is to reach 5% return per year, you need to assess how your investment strategy is performing.
Imagine that you are investing in a Crowdlending platform which has a track record of 1% default projects. After 6 months you realise that you have 10 projects defaulted out of your total 100 projects. This represents a 10% default rate, which is much higher than the platform historic 1%. This means that the platform’s performance is degrading, and this should point you to re-balance your portfolio to other Crowdlending platforms that have better default rates.
Another example can be found in the stock market. Let’s assume that you are a stock picker, and you have invested in 10 US stocks. You should assess your performance comparing your aggregated returns with the S&P500 index. If after one year, S&P500 index averaged a 10% return and your 10 stocks obtained a -10% return, it’s time for you to check if your strategy for picking stocks is the best one.
In summary, reviewing our returns periodically help us identify potential flaws in our investment strategy, and we can take action in order to correct that.
I review the performance of my portfolio periodically. If you want to find out more, take a look at the analysis of my investment portfolio in April 2020.
I have talked a lot about setting up goals and re-evaluating them. One key financial freedom requirement is to put all your effort into it. You need to want it, I mean, really want it, in order to drive your actions and energy towards that. Once you are fully focused on something, everything just gets so much easier.
Also, it’s important not to be complacent. This means that if you achieve a target, that’s very good, you need to celebrate it!
But the following day you need to start thinking about your next aim, in order to keep on progressing. Let me give you an example.
I have said before that my goal is to get a 10% annual return on my investments. This is an ambitious goal, but I believe I will be able to achieve it. Honestly speaking, I am hoping to exceed it.
In 2019 I have achieved a 30% return!
This is my target for three years. It means that, my investments could stay still at the same value for 2 years, and I would still hit my 10% yearly target. Not bad right?
The way I see it is that 30% is an excellent return, but why not try to get a bit more? There is always room for improvement, and I am going to work hard to get it.
On a side note, it’s important to highlight that the stock market grew a lot during the first 3 months of 2019, and that will not happen every year. Other years the stock market might go down heavily, which is why it’s important to get the most out of the good years.
Ok, if you are here it means that you have mastered the strive, and you are giving everything you can to increase your wealth. Congrats! Another pat in the back 🙂
I am sure you have heard the say “Rome was not build in one day“. The same applies for wealth accumulation. You cannot expect to be wealthy in one week, one month or one year. It’s something that takes time.
Even if you do everything right, you won’t become rich quickly. This is not a sprint, it is a marathon. Keep this idea in your mind.
Rushing to implement an action because you are not getting rich fast enough only leads to disaster. Sometimes you just need to sit and wait for the wealth to be accumulated.
Increase your income
I know this sounds a bit obvious, but it plays a critical role in the financial freedom requirements list. Once you have reduced your expenses and you are saving constantly, the more you earn, the more you will be able to save every month. This will increase your investments, which in turn will boost your investment profits, and this will…. (I hope you have not forgotten about your best friend the compound interest) increase your investments again!
It is a wonderful loop that grows and grows without limit. It is what I call an unstoppable force.
Increasing your income is not easy, but here you can find some ideas:
- Salary increase: do your job the best you can, and ask your boss for a raise. If he/she is not willing to give it to you, you might consider looking for a better paid job
- Monetize your hobbies: we all have things that we feel passionate about. You can love travelling, going to the gym, board games, sailing, playing video games. Chances are you know much more about your hobbies than the average people, so you could think of a way to get some money out of your unique knowledge
- Create a youtube channel/ blog: if you are good at telling stories, or simply, if you like giving speeches (that’s me), you can consider going online to talk about anything in your own unique way. How do you think I ended up creating this blog? 🙂
I have already explained the wonders of compound interest and time. Just by reinvesting your investment profits every year, during 30 years, you can end up having 4 times more money.
Well, the idea is the same here. If you find a strategy that works, you just need to keep on doing it again and again.
Once you have mastered all the requirements to achieve financial freedom, all you have to do is go back to number 3, set a new goal, and start again, reviewing everything that you have done, to see what you can improve. Remember, there is always room for improvement!
If you want to learn more about financial freedom, take a look at:
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