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Tuesday 4 October 2016

10 Steps To Financial Freedom

There are only 10 types of people in this
world - those that understand binary, and
those that don't. 
Even though this is a 10 step plan, Early Retirement and Financial Freedom can be as easy as 1,2,3.

You see steps 1 to 3 are actually by far the most important. But, having said that, they are also the toughest and will definitely take some sacrifice. If you can get past step 3 then you are more than half way there, because by then all the good stealthy habits needed to retire early and become financially free are already ingrained on you, and the rest will just follow naturally...

The regular readers of this blog will know I have a 15 year Early Retirement plan with a goal of being Financially Free by 2030. After I made the decision that I wanted to retire at age 45, I needed to figure out how exactly I was going to do it. So I sat down (because it's kinda difficult to operate a computer standing up), put down some numbers, worked through a number of spreadsheets and went about getting all my ducks in a row1. Recently I looked back at this process, my thinking, and what was left for me to do before I could reach my goal. The result is this blog post detailing the steps I took and those which I am going to follow to get to where I want to be.

It is quite a coincidence that there are exactly 10 steps - but after I realised this, round number syndrome got the better of me and unfortunately I was forced to give the post a suitable click bait-ey, listicle type title (because no one wants to read about a 17 step plan!) And hence "10 Steps to Financial Freedom" was born! Since you are reading this I take it that my choice of title was a resounding success :)

Personally I am currently moving between the steps 7, 8 and 92 - these need to be cycled through as I go along, because nothing ever stands still, and information and outcomes are continually changing.

So here it is, my 10 steps to Financial Freedom:

1 - Determine Your Current Expenses

Any financial plan starts with a budget, and a plan for early retirement and financial independence is no different. It is important to know where your money is going in order to gain control of it. A budget is a way to gather all your expenses and take stock of what is eating your hard earned cash. I did a post on how to draw up a budget which also has a template for you to download to get you started.

2 - Reduce Your Expenses

Once your budget is sorted you will have a good idea of where your hard earned cash monies are running away to. It's time to bring the lost souls home. Start eliminating unnecessary expenses, and reducing necessary expenses - even if that means moving providers and cutting out some of your "nice to haves". You will surprised how much you can save by doing a little pruning. 

I won't lie, this takes some sacrifice, may not be easy and can take some getting used to. But decide what is important to you and focus on the bigger picture and the long term goal. It is quite amazing how adaptable human beings can be3.

3 - Attack Debt

Now that you have packed your budget shears away and managed to free up some cash, it is time to start throwing all that extra money at debt. Attack your debt like a demon possessed. You see something fantastic happens after you have paid off all your nasty debt - firstly you no longer have the financial drag of instant gratification interest, but the money used to pay off the debt each month is now available. And the best part about this extra cash is that you were getting by without it - and this means it can be used to invest without you even missing it!

If you can get to this point, then there is some brilliant news - you have just completed the hardest part of the Early Retirement journey! The rest will follow quite easily since you are now debt free and running a tight ship. Your debt days are behind you and you can now look forward, instead of back!

4 - Determine Your Retirement Cost Of Living

At this point all bad debt has been eliminated and your monthly expenses have been significantly reduced. From your new super awesome budget you can now get an idea of what your cost of living in retirement will be. Most of your current expenses will still be relevant, but some won't - for example your shitty work commute will no longer be applicable. However being retired and financially free also comes with some additional expenses which you will need to add - for example maybe you want to do some more holidaying, or take up a hobby - crochet anyone?

Once you have removed the irrelevant expenses, and added in the additional expenses, tally everything up to get your Early Retirement Cost of Living. For those of you who are interested, I calculated mine in this post.

5 - Calculate Your Retirement Number

Numbers....numbers everywhere!
This may seem like a tricky calculation filled with a host of financial jargon and mathematical complexities - but it really isn't. From your retirement cost of living, it is actually very easy to work out how much you need to retire. The number you are looking for can be calculated using The 4% Rule. Basically you will need 25 times your annual expenses, or 300 times your monthly expenses - this is your magic retirement number. 

So if you worked out you can live off R25k a month, then you will need 300 x R25k = R7.5million to retire and be financially independent. For R40k a month you need R12million. This is why it is important to get your Cost of Living down - maybe it is worth revisiting Step 2?

Your retirement number may seem scary at first, but you will be surprised how the power of compounding can get you there a lot faster than you think!

6 - Determine How Much You Can Invest Each Month

Once you know your retirement number, it is time to hunt it down. How quickly or slowly you are able to get there all depends on how much you are able to invest each month. This is why step 2 is again so important - the more you can reduce your expenses, the more you will have available to invest, and the faster you will be able to hit your retirement number.

The real secret to achieving financial independence is to get your expenses down and your savings up.

7 - Draw up your plan

Okay awesome - you now have all the variables you need to put together your Early Retirement Plan. Time to get out a pen and paper an Excel spreadsheet. Start with what you currently have invested/saved, add in what you can afford to invest each month (remember all the cash you have freed up in Step 3?), throw in some reasonable assumptions about inflation rates and investment returns and then check how long it takes you to get to your magic retirement number.

Also remember you will be chasing a moving target as your cost of living will increase by inflation each year, which means your retirement number will need to be adjusted annually. But you should also be able to increase the amount you invest each year - if you have ass-creeped impressed your boss enough to earn an inflationary increase, or even better a promotion!

I will do a post with my calculations in the near future which you can maybe use as a starting point to run your own numbers.

8 - Execute your plan 

Executing your plan....terrible pun!
Armed with your Early Retirement Plan and your superior will power and Stealthyness, it is now time to go out and make Financial Independence your bitch!

When you know what it takes to get to Financial Independence, set up the necessary investment account(s), debit orders and recurring payments. And remember Tax Free Savings Accounts are your friends! 

Getting these set up is not as difficult as you may think - I plan on doing a getting started guide in the future for anyone who is at this step and needs some help.

You will also need a good dose of discipline, patience and perseverance as you run your Investment Marathon towards Early Retirement. Remember this is not a get rich quick scheme and the only way to generate wealth requires time. Be ready to ride all the ups and downs that reducing expenses and investing will bring, and enjoy the journey as the excitement builds with each passing month as you get closer and closer to a life of leisure.

9 - Adjust and Adapt

The only certainty about the future is change - and especially over longer time frames. While you execute your plan the Tax Laws can change in ways you cannot imagine which will affect the plan in ways you cannot predict. Assumed investment returns and inflation rates may be slightly off, or even way off.

There is no way of knowing what the future holds. But knowing that we don't know is important - because it means that we are aware that as this journey unfolds we will have to adjust and adapt. If the market is not performing as well as we expected, maybe we need to cut some more costs and invest more? If the market exceeds our expectations maybe we can shave a year off our early retirement date?  If interest rates spike, maybe we need to focus more on attacking our bond? If the Government increases the TFSA limits we can try throw more money at our TFSA's. If x happens then we will need to do y. If you can solve for x and y please send me the answer :)

It is important to be flexible and willing to cut costs, reallocate money or adjust the plan.

It is also important to check progress against the plan and make sure everything is on track. Do an annual review and see if you are more or less on track. Check your current savings against your target. Are you in the ballpark? What can you do better?

10 - Retire Early!

Ladies and Gentlemen, you have arrived at your destination. If you look out the left window you will see a life filled with only the activities you want to do. To the right you may notice a tonne of family time, no more work commuting and a lot of awesomeness!

Of course there is still some ongoing work to be done. You will need to stay on top of your expenses and make sure you don't let anything unnecessary creep in. You also need to be disciplined in the application of the 4% rule and avoid temptation to draw down extra when market returns are good.

An annual review will always be a good idea. It will also be wise to keep up to date with current investment offerings and products - if a cheaper alternative exists, it may be worth considering and switching.

Till next time, Stay Stealthy!
 - ~ - ~

1 I have a kinda weird obsession - whenever I come across an idiom and I am not sure where it comes from, I like to look it up. So for the ducks in a row one, it seems the most popular theory of it's origin is that it came from the early days of ten pin bowling. Apparently the early bowling pins were shorter and thicker than the ones in use today. These shorter thicker pins got the nickname ducks. Before those awesome machines which clean up and reset the pins were invented, people would have to manually put the "ducks" into place before the next ball could be bowled. And so the metaphor of having all your ducks in a row before sending the next ball down was born. Of course when Graeme Smith was out of form, he too would have all his ducks in a row!

2 Why was 9 scared of 7? Because 7 8 9. Doh! I'm sorry.

3 When my wife (then girlfriend) moved out of her fathers place and into a Granny cottage, we both went from DSTV to some of the worst programming imaginable SABC. I won't lie, at first we missed the DSTV. But after a while you get used to it, and even forget you ever had it as you find other stuff to occupy your time with. And the nice thing is that most of this "other stuff" is far more beneficial than sitting on a couch for 2 hours every evening. We found ourselves cooking better meals, exercising more and having a lot more meaningful discussions. So contrary to popular belief there are people who got rid of DSTV and still live to tell the tale.