Reaching financial independence is a pretty straight forward formula. Spend less than you earn. Invest what is left over into cash flowing assets. Repeat until the cash flow covers your expenses. That’s it.
WARNING: I am going to use trigonometry in this post because I love math and cool charts.
You can achieve this with a job, discipline around your spending, and conservative long term investing. The only problem with that is that it will likely take a lifetime to achieve. You only make real noticeable progress toward financial independence when you get a spike of income. A spike is any amount of money that is far enough above your regular income that you have to make a decision about what to do with it. This income doesn’t fall into your automatic categorizations. Without the spikes you are going to wait a while. Access to those spikes lies in performance based pay.
Having a lowest common denominator income is like a security blanket. No matter what, you have to pay for housing, food, and insurance. There is a great amount of fear around not being able to cover your basic expenses which is why most employment arrangements are linear. They cover your expenses. Your base income may creep up a little each year, but your lifestyle tends to follow suit because the difference is so small. A job will pay you just enough to cover your expenses, but not enough so you don’t need the job. Salary income is a linear function.
f(x) = c
In the case above, this person is making and spending $50,000 a year. They can save whatever they don’t spend. If they are really frugal, after taxes and expenses maybe they can put aside $10,000 a year, $20,000 if they really tighten their belt or house hack. Year over year their salary will increase, but likely no more than 10% per year. After 10 years their salary will be $130,000 assuming a 10% raise every year which is not typical. Their expenses are likely to go up as well as families tend to arrive in that amount of time. A second earner could be added to the equation as well which can really increase that line, but it is still flat.
Growth is in the spikes
Performance income tends to be sinusoidal. Sales people and businesses tend to have income that is irregular. It isn’t being dolled out at two week intervals. It comes in with each new sale or customer. When the money comes in you’re serving your customers. When it’s not, you are out getting new business, hence the classical sin wave. The person in the chart below is making up to $100k per year, but not consistently and is spending $50k per year.
f(x) = sin(x) + c
Many salespersons or those who earn an inconsistent or spiky income make the same mistake employees do which is to set their living expenses to be approximately a linear model of their income curve. The area under the sin wave and the line is about the same. It’s feast or famine. In our example above, this earner is making either nothing or double their income which averages out to our previous earner. This guy is probably a little bipolar or has accommodated to saving some surplus during high sales times to prepare for the low tides. The person in the chart below makes between $25k and $75k per year and spends $25k per yer.
f(x) = sin(x) + c
Now this is what I would call a preferred income curve. It is the same as the previous one except this person’s expenses (red line) line up with the bottom of the sinusoidal income curve. This could be the same sales person, but they spend about what they make during their low period of income. In this case, even when business is bad, they aren’t spending more than they make. This earner is covering his expenses when their performance is at their worst.
This gives the earner the opportunity to invest everything between their spending and their spiky income. So when they are killing it in sales, that money makes a major move in the ability for them to invest.
Learn to Invest
Investing and managing assets is what will give you time and freedom. It is the single most important skill you will need to replace a job with cash flowing assets. This doesn’t mean you have to be a stock market wizard. It does mean that you will need to learn and become very competent at managing one type of investment asset that has cash flow. It could be a type of business, real estate, or any number of things. Ultimately it’s likely to be a business. Choose one to become an expert in and focus on it. I like real estate because it is everywhere and 25% of the economy is in that industry, so it’s not likely to go away. Once you understand how to reliably make more than $1 in income per $1 invested, you will have the math to become financially independent.
I like to think of every $240 as $1 per month. $240 at a 5% rate of return is $12, or $1 per month. Take your desired monthly budget, multiply it by $240 and that is what you would need with a 5% annual return to be independent. Every time you go to spend $240, think to yourself, this is a $1/month for life. Will this thing I’m about to buy give me that?
The chances of running into those spare $240 go way up with spiky income. With flat income, you will have a fixed number per month and you can draw a pretty good line on when you will hit your number. When you have an income spike, you get a bunch of them all at once. This increases your passive revenue which accelerates your journey. Psychologically you make a spike in progress as well. This gives you more resolve and motivation to get to that next spike. Sales and side hustles generate income spikes. What are yours?