Financial independence is the state of having a sufficient inflow of money to cover your living expenses without actively doing anything to have such funds flow to you.
It goes without saying that a lot of work, planning and well execution is required to reach financial independence. Many individuals never get to become financially independent due insufficient/no financial planning and where there is a financial plan, many don’t become financially independent due to ill execution.
Being financially independent is not necessarily about having a lot of money nor does it mean that one sits at home and does nothing the whole day while their bank account is flooded with money. It is a more of a lifestyle, one that requires careful planning, maintenance and execution.
One can be financially independent because their total monthly living expenses are R10 000.00 and they have figured out a way of passively earning R10 000.00 or even more. They may keep their normal job and use their active income to build more wealth-creating assets. The wealth-creating assets will bring in more passive income and that is where they may adjust their lifestyle accordingly.
There are several steps that need to be well executed in order to become financially independent. They need to be followed in sequential order because if one step is skipped, the entire plan will collapse. South Africans also need to realize that this is a journey that often takes a while to materialize.
One needs to have a realistic budget and know their financial position. Your budget should take into account your monthly income, living expenses and debt commitments. Once you have set up your budget, you will be in a position to evaluate your financial position. If the money coming out of your bank account is greater than the money coming in, you are in a negative cash flow position. This means that you are financially over-committed.
On the other hand, if you are in a positive cash flow position, you are financially stable. Financial stability (positive net cash flow) should not be confused with financial independence (earning enough passive income to cover all living expenses).
The second step os to become debt free.
Debt keeps may people from ever becoming financially independent. There are arguments that there is “good” and “bad” debt, however, any debt will cost you money rather than give you money. You pay compound interest as opposed to earning it. On your journey to financial independence and after developing a budget as per Step 1, make it your goal to become completely debt free. Debt takes from you as opposed to bringing more towards you.
Once you have completely ridden yourself of debt, you then need to start building your savings.
Having sufficient savings will enable you to be able to tackle life’s unexpected events without running to the bank to borrow money. This could be done through a money market account.
In this way, you are sure that once you have saved enough for rainy days, you will are unlikely to run to the bank to borrow money.
Once you have saved sufficient money, perhaps in a money market account, you are at a point where you can start building your wealth.
Since the idea is to earn passive income in order to become financially independent, you can start looking at buying listed shares on the stock exchange.
You don’t need a lot of money to do this. You can buy ETFs (exchange-traded funds) which will track the performance of a selected portfolio of shares and give you the same returns. The added advantage is that you can set up a debit order to go off monthly based on the amount that you can afford. As the shares increase in value, so will your ETF portfolio. When dividends are declared, you also get dividends in accordance with your portfolio size.
As your EFT portfolio grows, ultimately you will be in a position to further diversify your investment portfolio. If there is a specific company in the stock exchange that has caught your attention, you could then use the inflowing funds to invest directly into that company.
As your investment portfolio grows, the returns that flow to you will also increase. Ultimately, you will be in a position to cover all of your living expenses from the funds that you receive from your investments. Law and behold... you have attained financial independence!
You have a realistic budget that you constantly work and adjust accordingly, you have no debt, you have sufficient savings in a money market account to cover any unexpected events and you are earning enough passive income to cover all of your living expenses. You are financially independent.
Simple Strategy: Budget, become debt free, build your savings and build your investments.