Introduction
What is financial independence or also know as Financial Freedom? Financial independence (FI) is the status where an individual has sufficient personal wealth to live without having to work actively for basic necessities. When your assets generate enough income to cover your living expenses, you achieve financial independence. It means having the freedom to make life choices without being constrained by financial concerns. Let´s start with Financial Independence: How to Achieve It by 40.
Why achieving financial independence is a worthy goal. Achieving financial independence is a transformative goal. It provides freedom from financial stress, the ability to retire early, and the opportunity to pursue passions and interests without the constraints of needing a paycheck. Financial independence offers peace of mind and the luxury of time, enabling you to live a life aligned with your values and desires.
Let’s be honest. Not everyone wants to be retired by 40 years of age. Personally, I stopped working at the age of 45, after working in multinational companies since I was 23, sometimes working more than 12 hours a day, constant travel, uncertainties and a job that generally did not attract me. And another personal opinion, as you reach the 40´s, following the imperatives of “the bosses” becomes increasingly difficult to bear, as well as the fixed and inflexible schedule of today’s jobs. My desire to only want to be with whoever I want, where I want and how I want, led me to consider from a very early age that my goal was not to end up in a big company at the age of 67, but to be able to retire as soon as possible. And in my case, it arrived at 45 years old. At the end of this post, I will publish the link to the article where I explain better how I reached my goal.
1. Assessing Your Current Financial Situation
Calculating your net worth. Your net worth is a snapshot of your financial health. It is calculated by subtracting your total liabilities (debts) from your total assets (what you own). Assets include savings, investments, property, and valuable personal belongings. Liabilities include mortgages, car loans, credit card debt, and other obligations. Regularly calculating your net worth helps you track progress towards financial independence.
Understanding your income and expenses. To manage your finances effectively, you need a clear picture of your income and expenses. Track all sources of income, including salary, bonuses, and passive income. Then, list all your expenses, distinguishing between fixed expenses (rent, utilities) and variable expenses (entertainment, dining out). This awareness helps in creating a realistic budget and identifying areas to cut costs.
Especially control the so-called ant expenses. Those superfluous expenses that can easily be reduced, thus achieving considerable savings over time. And very importantly, get into the habit of saving those small expenses so that they produce a return through compound interest. You can read more about the magic of compound interest in the following article.
Or watch this short video from our @CarliaConsulting Youtube Channel:
2. Building a Financial Independence Plan
Setting your financial independence goal. Define what financial independence means to you and set a specific, measurable goal. Calculate how much money you need to achieve financial independence by considering your desired lifestyle and future expenses. This goal will serve as your target and motivate your financial decisions.
Personally, I decided that to live comfortably for the rest of my life and also leave resources for my children, I needed a 1 million euros in invested assets producing a 10% net annual return. That is, obtain about 100.000 euros/year (8.000 euros/month). This amount would be the equivalent in Spain of earning about 158.000 euros per year (each country has different tax burdens but to get an idea the salary of the President of the Government is 90.000 euros/year)
Creating a budget and savings plan. A budget is a financial roadmap that outlines your income, expenses, and savings. Start by allocating funds for essential expenses and savings, then plan for discretionary spending. Aim to save and invest a significant portion of your income, typically at least 20-30%. Automate your savings to ensure consistency.
Start as soon as possible to create your savings plan using compound interest on your principal and interest. Parents should start creating this savings plan from the moment their child is born or personally start as soon as they are able to save even 50 euros/month.
3. Increasing Your Income
Advancing in your career. Invest in your professional development to increase your earning potential. Seek additional training, certifications, or advanced degrees that can lead to promotions and higher salaries. Network within your industry, stay updated on job market trends, and be proactive in seeking career advancement opportunities.
My first working years I worked up to 14 hours/day. I changed countries several times and learned everything I could. This helped me, in the annual salary reviews, to request salary increases and when they did not occur, to look for another company that better valued my abilities. We all know that companies make an effort to attract talent but not so much to keep it. This made me change companies on average every 3 years, always seeking not to stagnate my career and accelerate it as much as possible, positions of greater responsibility with higher salaries.
Side hustles and passive income. Diversify your income streams by exploring side hustles and passive income opportunities. Side hustles can include freelancing, consulting, or starting a small business. Passive income sources, such as rental properties, dividend stocks, and royalties, generate ongoing income with minimal effort. These additional income streams accelerate your path to financial independence.
There are people who pursue their dream from the beginning, which is very commendable. I preferred to work for large companies and in parallel begin to generate sources of passive income that complemented my official salary. This meant that there were years when even my passive income (mainly buying, renovating and selling real estate) exceeded my official salary, despite dedicating 10% of my time and effort to it.
4. Debt Management
Strategies for paying off debt. Prioritize paying off high-interest debt, such as credit cards, as quickly as possible. Use strategies like the debt snowball (paying off smallest debts first) or debt avalanche (paying off highest interest debts first) to stay motivated. Consider refinancing or consolidating debts to lower interest rates and simplify payments.
Avoiding high-interest debt. Prevent future debt issues by living within your means and avoiding high-interest loans. Build an emergency fund to cover unexpected expenses and use credit cards responsibly. Focus on saving and investing rather than borrowing to fund lifestyle upgrades.
Despite being an economist, by education, I always preferred to avoid credit and only in my life did I request a mortgage loan to buy my primary home, a serious mistake. With the passage of time and experience I have learned that if I can get the bank to lend me money at 3% and with that money I can get returns of 10%, we should take the money, pay back the loan and make money with other people’s money. . But everything in moderation, I am not in favor of tightening the rope too much by having too much debt with the premise that all investments will always go well. Remember the real estate crisis of 2007/2008.
5. Investing for Financial Independence
Strategies for building wealth. Investing is crucial for building wealth and achieving financial independence. Diversify your investments across different asset classes, such as stocks, bonds, real estate, and mutual funds. Start early to take advantage of compound interest, and regularly contribute to your investment accounts. There are several ideas about passive income you can start to work according your hobbies or affinities.
Importance of asset allocation. Asset allocation is the strategy of dividing your investments among different categories to balance risk and reward. A diversified portfolio reduces the impact of market volatility. Adjust your asset allocation based on your risk tolerance, financial goals, and time horizon. Rebalance your portfolio periodically to maintain your desired allocation.
For example, speaking of crowdlending loans, where I currently invest a large part of my savings, there are more than 400 platforms available on all continents. On each platform you can find various loan originators that offer thousands of loans in which you can invest from 10 euros. That is to say, you can have the largest distribution of investments that I know of. You can have 10 euros invested in, for example, 50.000 different loans, and rest assured that some will fail, but the investments will be so spread out that a small percentage of those who fail are easily absorbed by the loans that are paid. In short, I prefer to leave 10 euros to 1.000 friends, than 10.000 euros to just one friend. If you want to know better the world of Crowdfunding loans, I invite you to read the following post: P2P Crowdfunding for Beginners or ask us about our services to help to manage your investment portfolio.
Some main P2P Loans Platforms:
Lendermarket, Swaper, Bondster, Nibble, Lande, Kviku Finance, Get Income, Brickstarter, Letsinvest, AxiaFunder, Coreestate, Nectaro, Nordstreet, Bullride, Viainvest, Crowdpear, Loanch, Twino, Indemo, Maclear, Crowdhero, Monefit, Mintos, Esketit, Hive5.
6. Reducing Expenses and Lifestyle Adjustments
Frugal living tips. Adopt a frugal lifestyle to save more money. Cook at home instead of dining out, shop for sales and discounts, and use public transportation. Limit discretionary spending and focus on low-cost or free entertainment options. Being frugal doesn’t mean sacrificing quality of life; it means making mindful spending choices.
Evaluating needs vs. wants. Differentiate between needs and wants to prioritize your spending. Needs are essential expenses, such as housing, food, and healthcare. Wants are non-essential and can be reduced or eliminated. Regularly evaluate your spending habits to ensure you are allocating money towards your financial goals rather than impulsive purchases.
7. Planning for Retirement
Understanding retirement accounts (e.g., 401(k), IRA). Retirement accounts like 401(k)s and IRAs at US or Pension Plans at other countries, offer tax advantages that help your savings grow. Contribute to your employer-sponsored 401(k) plan, especially if they match contributions. Consider opening an IRA for additional tax-advantaged savings. Understand the differences between traditional and Roth accounts to choose the best option for your situation.
Calculating your retirement needs. Estimate how much money you’ll need in retirement by considering your desired lifestyle, healthcare costs, and inflation. Use retirement calculators to project your future needs and determine how much you need to save each month. Regularly review and adjust your retirement plan to stay on track.
8. Achieving Financial Independence
How to know when you’ve reached financial independence. You’ve reached financial independence when your investments and passive income generate enough to cover your living expenses. Calculate your annual expenses and ensure your investment portfolio can sustainably support these costs. Achieving financial independence means having the flexibility to work by choice, not necessity.
Transitioning to retirement. Transitioning to retirement involves shifting from accumulating wealth to preserving it. Develop a withdrawal strategy to ensure your savings last throughout retirement. Consider factors like Social Security, healthcare, and potential lifestyle changes. Continue to monitor and adjust your financial plan to maintain your independence.
9. Common Pitfalls and How to Avoid Them
Lifestyle inflation. Lifestyle inflation occurs when increased income leads to increased spending on non-essential items. Avoid this trap by maintaining a modest lifestyle even as your income grows. Focus on saving and investing additional income rather than upgrading your lifestyle.
Not planning for emergencies. Unexpected expenses can derail your financial plans. Build an emergency fund with 3-6 months’ worth of living expenses to protect against financial setbacks. Regularly contribute to this fund and use it only for true emergencies.
Conclusion
Recap of key points. Achieving financial independence by 40 is an ambitious but attainable goal. Start by assessing your current financial situation, creating a detailed plan, and increasing your income through career advancement and side hustles. Manage debt effectively, invest wisely, and adopt a frugal lifestyle to reduce expenses. Plan for retirement early and avoid common pitfalls like lifestyle inflation and inadequate emergency savings.
Encouragement and motivation. The journey to financial independence requires discipline, patience, and determination. Stay focused on your goals, celebrate your progress, and remain adaptable to changing circumstances. Financial independence offers unparalleled freedom and the ability to live life on your own terms. Start today, and take control of your financial future.
As promissed, this is my personal history how I reached financial freedom through passive incomes: Passive Income the Naked Truth.
