Where are you on the financial freedom journey?
Visualising Financial Freedom
Have you ever wondered why some people always go on cruises, travel to places, and spend quality family time and do not seem to have to work to earn an income?
How do they financially support their lifestyle and living expenses?
The magic may be passive income.
All of us have 24 hours a day. If you are in employment to earn an employment income, so-called active income, your earning capacity will be limited by the time you have. You are at the same footing as everyone else.
If you are capable of earning passive income, which is income earned in a manner that does not require too much on-going effort, you are in a superior position compared to everyone else.
If you have multiple passive income streams substantial enough to fully support your lifestyle, you are said to achieve “financial freedom”.
If you earn only active income or if you do not have adequate passive income streams to support your lifestyle and living expenses, you have no freedom to choose not to engage in employment or another form of income-generating work.
Having an adequate passive income to support your lifestyle and living expenses will give you the most important benefit – the freedom to choose.
When you have financial freedom, you have the freedom to choose how you want to live your life without the worry of finances.
It is horrible to have to worry about finances when we are in our retirement years, when we may not have the energy or good health to engage in employment or another form of income-generating work.
Can we rely on pensions provided by governments?
Well, many developed countries have already cut back on welfare budgets. Future pensions provided by governments can only get less.
In any case, the governments’ role is to provide a basic social safety net.
We must be personally responsible for our destiny and our finances if we want to achieve financial freedom, or retire in comfort and with dignity.
In summary, you must build up passive income streams in your pursuit of financial freedom or a good, comfortable, and dignified retirement.
Financial Freedom – a Lifelong Project
The role of passive income is always overlooked by many people until it is too late.
The earlier you start to work on financial freedom, the more time you have to achieve financial freedom.
Make time to be your advantage.
Think of financial freedom as a lifelong project.
A lifelong project of optimising your resources.
What are your resources?
Your time, your money, your assets, your job skills, your qualification and experience, your potentials, and your ability to learn new skills or upskill.
The magic of passive income is that you let money works for you rather than you work for money.
If you recognise this, you will use your resources to build up passive income streams in this lifelong project of yours to achieve financial freedom.
Passive Income Streams
Building up passive income streams is hard work.
Most sources of passive income involve substantial initial time, money, skills, or all three.
Broadly, you build up passive income streams by:
- Acquiring income-generating assets;
- Creating income-generating assets; and
- Generating income out of assets you already own
1. Acquiring income-generating assets
Acquiring dividend-generating shares requires an adequate understanding of economic fundamentals and performance, and prospects of industries and companies for the dividend yield and capital growth.
Acquiring rent-generating real estate requires adequate knowledge and prospects of the real estate markets you are buying for the rental yield and capital growth.
What to invest in? Fixed-income assets? Managed funds? Australian shares or global shares? Australian real estate or global real estate?
What about buying low input businesses such as laundromat or vending machines or pinball machines? What about becoming a capital-contributing passive owner or partner in a small business?
You need to build investment knowledge to determine what income-generating assets suit your investment strategy, your risk profile, your personal preference, etc.
What works for others may not work for you.
Acquiring passive income assets requires your time, your money, and your skills and knowledge about the assets and their potential rates of return.
The Australian Securities & Investment Commission (ASIC) has useful information about investing tools, tips, and guidelines at their money smart website.
2. Creating income-generating assets
Developing an online training course or guide, ebook, professional photographs as stock images, software, and App on the Apple store or Google Play store will require a substantial initial investment of time and highly specialised skills.
What about developing a blogging website with good content and readership and receive monetised income? What about developing a YouTube channel? What about writing and making music and songs for online streaming?
All of these require a substantial initial investment of time and highly specialised skills.
3. Generating income out of assets you already own
Do you have a spare bedroom, spare parking lot, or spare storeroom for rent, or spare space that can be rented as an office? What about renting out your holiday home? What about renting out your under-utilised car? What about your boat?
Good Money-Management Skills & Financial Discipline
For most people with job skills, staying employed, and use the surplus active income after living expenses to acquire income-generating assets is the most common pathway to achieve financial freedom.
Over time, a person must acquire new skills or upskill to increase active income earning capacity, which in turn will create more surplus to invest in more passive income-generating assets to have multiple passive income streams.
This leads to the other side of the equation, that is the living expenses.
The current average living expenses in Australia is $2,835 per month for one person, $4,118 per month for a couple, and $5,378 per month for a family of four.
Obviously, lifestyle determines living expenses.
You have to determine your living expenses based on your lifestyle.
You must also plan for major financial commitments such as buying your family car, buying your first home, completing your home renovation, having your first child, having your second child, etc.
Planned major expenses are expenses you have information about in terms of the amount and the timeframe. Some examples are the purchase of your first home, your marriage, or the purchase of your family car.
Because you know the amount and timeframe, you should include in your saving and on-going budget without impacting your financial freedom fund.
Unplanned major expenses are expenses you do not expect. Some examples are your decision to help a closed relative in financial hardship, an unexpected renovation to your rundown kitchen, or a major rectification to part of your house.
Because you do not know the expense in advance you may decide to use part of your financial freedom fund to pay for it.
You will need to make a major adjustment to your subsequent budgets to restore the financial freedom fund.
The financial discipline to maintain the financial freedom fund is very important if you want to achieve financial freedom. Any shortfall in the fund will defer your financial freedom journey.
Your income, your living expense, and your “planned” major commitments determine your budget.
You must have the discipline to commit to your budget and set aside a separate “financial freedom fund” and consistently and continuously contribute to it to build up multiple passive income streams, just like what you do to your superannuation fund. The difference is you do it because you want to build up multiple passive income streams.
Optimising your resources must include maximising your earning capacity while minimising your living expenses without compromising your lifestyle.
How?
You reduce waste. You make sound financial decisions to avoid overpaying, to reduce unnecessary expense, and to minimise unnecessary potential loss.
The 6 Stages of Financial Freedom Journey
Financial freedom is a lifelong project, a long journey.
We need to have visibility of where we are on this journey and make adjustments where necessary to ensure to reach our destination.
There are 6 stages of the financial freedom journey:
Financial Dependence – When you have no regular income, whether active or passive income. When you rely totally on others such as the government or your parent or your family members for your living expenses. You may be temporarily out of a regular job or you are studying to learn new skills.
- Living Paycheck-to-Paycheck – When you have some form of regular active and passive income but the total income is not adequate to support your lifestyle and living expenses. You may have substantial consumer debt or credit card debt that you are paying down. When you overspend your total income every month, you have no savings or worst still, you have net negative saving.
- Financial Freedom Starter – When you have regular total active and passive income more than your living expenses and you start to build up passive income streams. You use surplus after living expenses to acquire or create new passive income streams, although your total passive income is small relative to your living expenses.
- Financial Freedom Midterm – When you have regular total active and passive income substantially more than your living expenses and you have substantial multiple passive income streams. Your passive income streams provide approximately half of your living expenses.
- Financial Freedom Homerun – When you have regular total active and passive income substantially more than your living expenses and you have substantial multiple passive income streams. Your passive income streams have substantial passive income that can fully support your living expenses.
- Financial Freedom with Resilience – When you have substantial passive income to support at least 125% of your living expenses. Maintaining multiple passive income streams make you resilient to temporary earning dip in some assets. 25% is the additional safety margin to weather significant financial downturn or economic shocks that may cause a significant decrease in passive income from your multiple passive income streams. The safety margin enables you to maintain your lifestyles and support your living expenses without having to divest your assets during a financial downturn or economic shocks.
The Basic Principles Stay the Same
The COVID-19 pandemic has reshaped the economy substantially.
Ecommerce gains popularity. Digital transformation gains speed. Digital skills are in high demand. Dramatic reduction in immigration in Australia will cause skill shortages in healthcare, engineering, construction, and manufacturing.
This is the critical time to review what and how you can upskill or learn new skills to improve your future earning capacity.
The basic principles to build up passive income streams stay the same.
Some of the basic principles are:
Maximise the Power of Compounding
Make time works for you rather than against you.
Start early in your pursuit of financial freedom.
To gain the maximum from compounding by reinvesting your passive income earning and staying engaged with your investment through the economic cycles.
When we invest in the long-term, timing the market becomes less important. This is especially true when we continuously invest in the market. The short-term volatility will have less impact on long term investment. The right time to invest is no longer determined by the market situation or economic cycle, but by your need and by the long-term fundamentals and potentials of the investment.
In this case, your need is to achieve financial security and freedom.
Develop and Practice Good Money Habits
Living within your mean is necessary but not sufficient in your financial freedom journey.
You need good money habits and money-management skills to manage your financial affairs. They are the necessary skills to build wealth and financial security.
Improve Earning Capacity
We make our own luck.
The harder we work, the luckier we get.
Your time, your money, your assets, your job skills, your qualification and experience, your potentials, and your ability to learn new skills or upskill are your resources unique to you.
Take stock of your resources and deploy them to optimise returns in the financial freedom journey.
Develop Multiple Passive Income Streams
Doing nothing to develop multiple passive income streams is the greatest risk to financial security.
Multiple passive income streams give you resilience.
Learn from books, seminars, online resources, and by talking to other investors will help build up your knowledge and skills that will help you make sound investment decisions.
Continue to learn is key.
Reduce Waste
You can reduce waste and minimise unnecessary costs without compromising your lifestyle.
It is unrealistic and unsustainable to give up or compromise your lifestyle for financial freedom. It will not work in the long-term.
However, you can reduce waste without compromising your lifestyle.
Manage Major Planned and Unplanned Capital Expenses
There will always be planned and unplanned major expenses in life. They do not happen frequently but they will happen.
It is important to deal with them properly with the discipline to avoid a significant impact on your financial freedom journey.
Plan the “planned capital expense” in your budget.
Plan to recover the “unplanned capital expense” if the “unplanned capital expense” has impacted your financial freedom fund.
Make Sound Major Expense Decisions
There are tools to help you make sound major expense decisions.
Learn them to make the best decision you can make.
Why?
Because a wrong decision will set you back on your financial freedom journey.
Review Your Finances Regularly
Obviously you must have visibility of where you stand in the financial freedom journey. Are you at midterm or homerun?
The best time to review is when you file your annual tax return. This is the time you gather information on all your income sources.
You should also review your financial freedom fund standing when there is a major capital expense event that may impact your financial freedom fund.
One of the review tasks is to check how your passive income streams perform financially against established asset class benchmarks. If the rental yield of your investment residential property is well below the average rental yield of similar investment residential property, you will need to know the reasons, and take feasible actions to rectify or learn to avoid a similar situation.
Everyone is a learner on the financial freedom journey.
Learning makes all of us smarter.
Learning improves our chances of achieving financial freedom.
Want to read more about financial freedom? Check out the financial freedom blogs.