July 4th, Financial Independence Day

On July 4, 1776, a small band of colonial leaders declared independence from the Kingdom of Great Britain.  The American Revolution changed the course of world history forever and launched a nation that no other has since rivaled.

In the spirit of the heroes of the American Revolution, would you be willing to consider declaring your own revolution…your Declaration of Financial Independence?

5 Stages of Wealth

To get where you want to go you need to know two things.  You need to know where you are and you need to know where you want to end up.  Let’s set the context by describing what I call, the five stages of wealth.

Wealth Stage 1.  Your cash flow (including your paycheck) is sufficient to pay all of your bills (on time!) plus consistently invest 10% of your gross income. This puts you on the pathway to financial independence.

Wealth Stage 2.  Cash flow from your investments is equal to your earnings contributions (10% of gross pay).  I call this ‘one to one’…where for each dollar you are contributing to your long-term investment program, the pot of money you’ve created is also projected to contribute (earn) a dollar.  For example, you’re investing $10,000 per year and your investment portfolio of $120,000 is expected to have total average earnings of $10,000 per year (over the long term).

Wealth Stage 3.  Expected cash flow from investments is equal to your paycheck.  Congratulations!  You are financially independent!  At this point, you would expect to be able to tap your investments each month for an amount that would cover your expenses (including inflation) indefinitely.  For example, if it takes $4,000 per month to pay your bills and you had a portfolio of stocks and bonds worth $1,200,000; using a 4% annual withdrawal rate you should be able to meet your current and future lifestyle expenses.

Wealth Stage 4.  Cash flow from your investments is equal to two-times the income needed to pay your bills.  We define this as ‘Wealthy’.  You now have enough cash flow from investments to pay all your bills with a substantial margin which allows you to raise your lifestyle, make charitable and family gifts, etc.

Wealth Stage 5.  Cash flow from your investments is five-times or more what is needed to pay your bills.  We define this as ‘Rich’.

Which wealth stage best represents your situation?  When I was describing the 5 Stages of Wealth to a small group, someone said, “I’m not at stage one yet.  How would you describe that stage?”  “Financial stress,” was my reply.  If you’re having trouble paying your bills or are not saving and investing at least 10% of your gross income for the long term you’re either in la-la land or feeling stressed out.

If you are not where you should be at this point in time, here are a few tips to get you started:

  1. Automate your investment program- Ten percent of gross income is the minimum needed to put you on the path to financial independence so just do it!  Start with your company’s 401k program, particularly if they match contributions.
  2. Attack bad debt- Bad debt is anything you borrow money to buy that is expected to go down in value.  First commit to avoid creating any new bad debt, then put in place a plan to automatically pay off your debt as fast as you can.
  3. Adjust your lifestyle- Adjust your spending patterns to compensate for items number one and two above.
  4. Hire a coach- Accelerate your success by hiring a coach, someone who has the experience to take you further, faster.  If you wanted to transform your fitness and physical appearance, hiring a nutritionist and personal trainer would be a good place to start.  In the financial world consider hiring a Certified Financial Planner™ practitioner.

At the time, the idea of a small group of colonialists taking on the world’s mightiest country would have seemed impossible.  They proved anything is possible to those with vision and an unwavering commitment to never give up until they achieved success.

If you decide what you want, set in motion a plan to achieve it, and never give up until the deed is done, you, too, can create the life of your dreams!  Happy Fourth of July!