“Bip-Bip… Bip-Bip… BIP-BIP…” The soulless alarm indicates that is Monday again. Therefore, the work week starts over again.
But this time, it is different: You get to decide whether staying under the puffy blankets or getting up to take a shower. You know that you have the possibility to work where and how you want to because your investments are passively working for you; Generating enough passive cash flow to cover all your bills.
For me, this is being financially independent.
Being financially independent doesn’t mean that you no longer work as an employee, it means that you can decide whether to work or not. If you really love you job, and you wouldn’t change it, congratulations: You’re financially independent!
However, if you don’t see yourself having a regular 9 to 5 job by the age of 55, you should start looking to generate passive cash flows that allows you to reach financial independence.
WARNING: In case you live paycheck to paycheck, I recommend before you continue reading to:
- Restructure your finances.
- Save at least 3 to 6 months of your monthly expenses.
If you’re already there: Greetings! You have made the first step towards financial independence.
Although we are going to decide whether to focus our energy on investments or side hustles, it’s EXTREMELY important to highlight that the combination of both is the best.
Still, knowing what to prioritize (investment or side hustle) is going to help us towards our financial independence goal.
The magic 4% rule
Based on historical investment data, a financial rule of the thumb says that: By withdrawing just 4% of your entire investments each year in retirement, you won’t incur in a risk of running out of money.
For instance, let’s suppose your annual expenses were $24.000 ($2.000 each month). If you managed to have a $600.000 investment portfolio, hypothetically, you could withdraw $24.000 (4% of $600.000) every year for the rest of your life.
Theoretically, you could count on the yearly 4% of your investment portfolio, forever.
Building cash flows towards your future
There are 3 options (usually they complement each other) for increasing the monthly available money for your retirement:
- Side Hustle: Leftover from your salary could not be enough. Capitalizing on side skills during your free time can be beneficial for your future.
- Higher yield: The bigger the interest rate of your investment, the better for your future cash flows. However, Be careful with the risk associated with greater yields though.
- Wait longer before start taking advantage of the 4%. In this case, you could amass a bigger lump of money.
- The numbers shown in the graphs of the following section are realistic for someone living in Western Europe.
However, the goal is not to look at the numbers, but to identify where to focus your energy: Whether it is in side hustling or investing.
- The yield of the investment studied herein is a hypothetical one. To make it realistic, the interest rate is based on the average yield that the S&P 500 has had throughout the years.
- The values of disposable money highlighted in the graphs represent monthly cash flows that allow you to live comfortably in countries like Portugal, Panama, Ecuador, or Indonesia. (For more information related to cost of living numbeo.com).
Running the numbers
John, our hypothetical average European worker, is 26 years old and works as a regular employee.
He is able to put aside $500 on average each month throughout the year. Then, he uses this money to invest in his investment portfolio with a 7% yield.
John knows how to capitalize on his language skills, so he teaches English 20 hours a month, producing a $200 extra cash flow.
From those $200, he spends $100 going out and saves the rest. Being able to save $1200 extra a year ($100 x 12 months) to later invest it in his investment portfolio.
In the end, John is able to invest $7200 each year.
Let’s take a look at the numbers, on a monthly basis.
If John is patient enough, he will be able to retire by his 58, taking advantage of his “eternal” monthly cash flow of $2.787 (4% of $836.088 divided by twelve months).
Savings from income don’t change throughout the years because as John’s salary increases so as well his expenses.
But what happens if John studies how to invest better and is able to rise the interest rate from 7% to 8%?
The disposable monthly cash flow increases by $625 (22,4%), from $2.787 to $3.412. Not bad for just 1% yield increase.
Let’s suppose that John doesn’t want to study how to invest better. That is too much of a burden for him.
However, he would like to retire with an “eternal” $3.412 monthly cash flow. So, he wonders: -How much more money should I save from my side hustle to reach that figure?-
John would have to work 2.53 times harder on his side hustle to compensate the 1% yield increase.
He thinks that putting $253 aside from his side hustling is too much of a burden. Instead, he would rather wait a couple more years to let the money pool grow.
How much longer should John wait to compensate the 1% yield increase or $153 monthly extra saving?
Working 2 or 3 more years would translate in an “eternal” monthly cash flow of $3.240 or $3.491, respectively.
In the last graph we can see how the phrase “Patience is bitter, but its fruit is sweet” from Aristotle comes in handy, financially speaking.
In case you really love your side hustle, or if it is scalable, focus on it and let the average market yield works on compounding your investment.
If you are uncertain about where focusing your energy, go for learning how to invest.
The second graph showed how powerful that 1% yield increased turned out to be. Imagine if you could rise it even higher, the sky’s the limit. However, remember that the higher the reward, the higher the risk.