Sunday, May 27, 2007

Steps to Financial Freedom: How long a vacation can you take?

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How long a vacation can you take?

Financial security or financial independence or being independently wealthy ultimately means being able to pay your bills without working. This might seem like a fantasy for people who today are behind the eightball but almost anyone should be able to achieve financial independence by taking one achievable step at a time (the sequence is not exact and steps can overlap):

  • Stop the negative savings (reach the breakeven point of income=outgo).
  • Pay off all debts.
  • Build a financial buffer (have a week’s expenses set aside, then 2 weeks’, then a month’s, etc.). Do not stop when you have reached the “standard” 3-6-month buffer in savings. Keep going and extend how long you could go without “standard” income. You are on the right track when you can measure your buffer in years. After all, many people plan for a decades-long vacation and call it “retirement” but ignore the artificial barrier of “retirement age” and “retirement accounts.” Eventually, your buffer will extend into your golden years.
  • Minimize and eliminate the need for active income (going to work)—although it is smart to work more than you need to build your savings. Meanwhile, use the resulting savings to build passive income (interest), although remember that future interest income is uncertain, such as a few years ago when the Federal Reserve slashed rates. You will be fairly comfortable if current passive income meets current regular expenses and you have the principal for emergencies. Although nothing is 100% certain, accumulate wages and interest into a lump of principal that will cover a lifetime’s expenses.

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