I firmly believe that personal finance doesn’t have to be complicated. But, because we all have different situations, we can quickly get lost in the weeds figuring out what works best for every person’s specific scenario. So I wanted to write this to serve as a foundation for anyone who feels flooded by the deluge of financial jargon and money strategies marketed to us by banks and financial institutions.
If you’re ever feeling lost or overwhelmed with everything you feel like you’re supposed to be doing with your financial plan, come back here to review these basic three steps to financial freedom.
#1 – Live Below Your Means
If you’re able to consistently spend less money than you earn, you’ll be doing better than most. The bigger the gap between what you earn vs. what you spend will determine how quickly you can become financially independent. That difference is where wealth is made.
It’s so easy to spend money. Online shopping has never been easier or faster and leaving your wallet at home isn’t even an excuse because everyone has access to their money directly on their phones. Social media makes us think we need to have the latest tech or the trendiest fashion, and every one of us falls victim to needless spending at one point in time or another. I can’t even begin to explain to you how many sneakers I’ve come this close to buying because I’m so convinced I’ll be that much cooler and feel that much better about myself while wearing them. My virtual shopping cart has sneaker boxes stacked to the sky.
But I don’t buy them, because I know spending that $120 on new sneakers means I have to earn that $120 all over again, because my sneakers are only going to depreciate in value (and find their way to the back of my closet in 6-8 months-ish). Which kind of makes it feel like those sneakers actually cost me $240.
When you get a raise at work or score a big commission, one of the first things people ask you is how you’re going to spend it. Lifestyle creep feels unavoidable sometimes and it is very hard to not want to try to keep up with the Joneses. Moving up in the world feels like more than just raises and promotions, you’re supposed to have a bigger and bigger house and a series of fancier cars and all the other trappings of a successful life.
I’m definitely a victim of that societal pressure (I do own more pairs of sneakers than days in the week…) because as important as it is to live below your means, you also need to enjoy yourself and not feel guilty about spending your well deserved money.
This is where budgets come in. Make a plan for where your money will go every month and stick to it. I still have a budget, because it helps make sure I can see where I’m spending and cut back when things get out of control (helllloooo takeout). But more importantly for me, I always pay myself first by contributing a portion of my income every month to either a savings or brokerage account. That way I know I’m always putting money aside and not spending every dime I earn, because it’s in another account that takes at least 2-3 business days to access. Which has the psychological side benefit of making me feel like I don’t have enough money for everything I want to buy and I need to get out there and make some more!
So for me, I’m able to put living below my means into practice by reminding myself of what matters the most to me and only spending money on the things that I know will be necessary to my long term happiness. For example, I’m an introvert, I love real estate, and having a comfortable home is my safe space. I’ve always been willing to pay a premium to have a home that is mine and makes me happy, especially since I spend so much time there.
#2 – Become an Owner
The second building block in our financial foundation is becoming an owner. Ownership is what creates true wealth. You can own stocks, you can own real estate, you can even own your own intellectual property, like art or music. The key is to own assets that appreciate in value, like stocks and real estate, and not assets that will depreciate or lose value, like cars, boats, and most material objects.
Becoming an owner can be a lot simpler than most people might think. Investing in stocks is as easy as opening up an online account through Vanguard and funneling regular portions of your paycheck into index funds. A process that literally takes minutes.
One of the best habits I’ve gotten into is micro-investing. Sometimes I make unplanned, “impulse” stock purchases. Maybe I feel like I’ve had a good week of cooking from home and not making yet another Home Depot run, so instead, I’ll spend $50 or $100 to buy more shares of an index fund. I’ve found that these micro-investments add up quickly, and it gives me that little dopamine rush that might be familiar to you when you hit the Buy button on Amazon, or tear up the throw pillow section at HomeGoods (Guilty! Actually, the dog toy aisle might be worse for me). But instead of owning more material objects that will only bring me temporary happiness, I’m owning more shares of a collection of companies that will continue to bring me wealth for years to come.
Owning a house, ideally the one you live in and/or can rent out, is another type of ownership that can create wealth. For most of us, rent is a fixed expense, and it makes absolute sense to divert the money spent into our own pockets by building equity in your home. Here in the US, we also get significant tax breaks based on the interest you pay on your mortgage principal, which can be really beneficial come April 15th. I always make the caveat that homeownership may not be for everyone, but if you feel reasonably comfortable taking care of a property, homeownership is a fantastic way to build long term wealth. Not to mention the freedom of no longer having a landlord!
Yes, buying and owning a house can be quite a process, but if you’re not into that and still want to reap the financial rewards of real estate, you can buy a Real Estate Investment Trust (or a REIT, for short), which is essentially a real estate portfolio that has been securitized into a publicly traded stock. Or, you can invest in crowd-funded real estate online, like through Fundrise.
#3 – Sit Back, Relax, and Wait
This is both the easiest and the hardest part.
It’s easy because it requires you to literally do nothing. And it’s hard because most of us are impatient and want immediate gratification. A one or two year time horizon probably feels reasonable to most of us, but to truly reap financial gains from your investments, you need to wait at least 10 years, but ideally, much longer than that.
Let’s use an example. Let’s say you make a one time investment of $10,000 into a safe and reliable index fund. After 10 years, that original $10k has grown to just under $30,000, all for simply owning shares of all the active companies in the stock market. If you had made this investment in 1982, you would’ve tripled your money in 10 years***.
But now let’s say you’re able to hold on to your investments for another 30 years, until 2022. Let’s look at the same chart, expanded out to a 40 year time horizon. Wowza! Your initial $10k investment has ballooned to $800,000! That’s an 8,000% return on your original investment, compared to just 300% for 10 years.
That’s the crazy impact compounding can have on your portfolio and a perfect example of why patience will really pay off in the long run.
Real estate generally works the same way. The median home price in 1982 was somewhere in the neighborhood of $62,000, which would be around $188,000 after adjusting for inflation. The median home price so far in 2022 is up to approximately $380,000, which is over a 600% increase. Not a bad investment, especially once you remember most of us have to pay for housing one way or another.***
Financial freedom does not have to be a complicated series of steps and it certainly doesn’t require you to have any insider knowledge or pay a financial expert thousands of dollars a year to advise you on which trades to make or when. Whether you make $60k a year or $500k, I believe that financial freedom is possible for you if you can consistently execute on these three steps.
*** Historical S&P 500 performance data and median home value data sourced from https://dqydj.com/