Understand Wealth and Become Financially Independent

There is no set definition of "financial independence." Some might consider it having enough income-generating investments to no longer have to work. Others ... TheBalance Budgeting HowtoBecomeFinanciallyIndependent •••  HeroImage /GettyImages TableofContents Expand TableofContents IncomeIsNotWealth Long-TermThinking AssessingYourBalanceSheet ReachingaGoal CreateSurplusFundstoInvest RememberThatTaxesMatter—aLot TakeControlofYourTime GradesDoNotCorrelateWithWealth FindaComplementarySpouse InvestinNicheMarkets SupportYourProductiveRelatives FinancialIndependenceFAQs By JoshuaKennon FullBio Twitter JoshuaKennonisanexpertoninvesting,assetsandmarkets,andretirementplanning.Heisthemanagingdirectorandco-founderofKennon-Green&Co.,anassetmanagementfirm. Learnaboutour editorialpolicies UpdatedNovember04,2021 Reviewedby ChipStapleton Reviewedby ChipStapleton FullBio LinkedIn ChipStapletonisaSeries7andSeries66licenseholder,passedtheCFALevel1exam,andisaCFALevel2candidate.He,andholdsalife,accident,andhealthinsurancelicenseinIndiana.Hehaseightsyears'experienceinfinance,fromfinancialplanningandwealthmanagementtocorporatefinanceandFP&A. Learnaboutour FinancialReviewBoard Thereareseveralmythsandmisconceptionswhenitcomestofinancialplanning,andindividualscantakeinalotofadvicefrommanygoodandnot-so-goodsources.Mistakescanrangefromconfusinghighincomeswithwealth,tonotknowingtheimportanceoftax assetplacement whenchoosingyourinvestments.Reviewthesekeyinsightsthatcanleadtoamorefinanciallyindependentlife. UnderstandThatIncomeIsNotWealth Mostpeoplebelievethatthekeytohavingwealthisahigh-payingjob.Yes,it'seasiertoamassassetsifyouhavemoremonthlyincome,butonekeytoincreasingyournetworthistospendlessthanyoumake.Ultimately,spendinghabitsarethereasonaprofessionalathletemaking$20millionayearcanquicklygobankrupt,whileabusdrivercanretireamulti-millionaire. Youneedtounderstandthedifferencebetweenincomeandlong-termwealthinordertoescapethespendingtrap.Incomeisanobviouscomponentofwealth,butit'snottheonlyfactor.Manypeopleseewealthastheirtotalnetworthatanygiventime.Inotherwords,wealthcanbethoughtofastheequityonyourbalancesheet—your​assetsminus liabilities. Long-TermThinking Thinkinglong-termisanimportantcharacteristicofaccumulatingwealthandachievingfinancialindependence,regardlessofyourincomelevel.Thereareseveralconsiderationsforlong-termwealth,andthey'lldifferforeveryone. Youhavetoputinlonghoursafteryearsofeducationandspecialtytrainingtogetapaycheckifyou'readoctororlawyer,butthatpaycheckdoesn'tnecessarilytranslatetowealth.Helpingtoensureyourjob’ssecurity,takinginitiativetoachieveapromotion,ortakingstepsthatwillresultinhighercommissionscanallbefactorsforwealthandwaystomovetowardfinancialindependencewithlong-termthinking. Sidegigs,privateinvestments,andahostofothervariablescanalsobewaystothinklong-termandaccumulatewealth.Theymightincludeaportfolioofprivatebusinesses,stocks,bonds,mutualfunds,realestate,patents,ortrademarks.Someofthesecashgeneratorscanbereliedonforlong-termincomeinadditiontoyourjob,orjustascashgeneratorsthatcanpullinmoneywhileyoutakelongvacations. AssessingYourBalanceSheet Takealookatyourpersonalfinancialstatement.Youmightalreadyhaveorganicinvestmentsthatyoucanrelyoninyourquestforfinancialindependence.Oftentimes,thisiswealththatgenerates capitalgains,income,anddividendswithoutlabor.Themoreoftheseinvestmentsyoucanafford,thesooneryoucanfullyachievefinancialindependence. ReachingaGoal Therealvalueofyourincomeispartiallydeterminedbytheamountyoucaninvesttoachieveafinancialindependencegoal.Settingthisgoalcanbeimportantforkeepingyourperspectiveonincomeincheck.Atyourgoal,youcansuccessfullymaintainthelifestyleyouwantwithoutworking. Workingwithafinancialadvisercanhelpyoutosetagoalforwealthaccumulationthatallowsyoutomaintainyourstandardoflivingwithoutanadditionalpaycheckandachievefinancialindependence.Thisgoalcanbelofty, however,becausemostpeople’sannualspendingincludesalonglistofbudgetitems,suchasmortgage,carpayments,clothing,collegetuition,entertainmentexpenses,andmore. CreateSurplusFundstoInvest Theonlywaytotakeadvantageofinvestmentopportunitiesistohavethemoneytoinvest.Thereisacertainpointinsuccessfulinvestingwhereyoureachcriticalmass,andthereturnsgeneratedonyourassetscanchangeyourlife. Earninga10%returnon$10,000willonlynetyou$1,000beforetaxes—hardlyearth-shattering.Butthesamereturnona$1,000,000portfoliois$100,000,whichhasfarmoreutilitydespiterequiringthesameeffortandresearch. Amassingwealthandbecomingfinanciallyindependentisaslowprocessthattakestime.Youdosmallthingseveryday—cutyourexpenses,generateextraincome,andputthemoneyintobrokerageandtax-deferredretirementaccounts.Itbeginstoamounttosomethingwithtime. Youcanreactonalargerscalethanyourpreviousinvestmentsaseachnewopportunityappears.That'scalled "compounding."Theinterest,dividends,andcapitalgainsyourmoneyhasearnedbegintogeneratetheirowninterest,dividends,andcapitalgains,andaprofitablecyclecontinues.It'show$10,000cangrowto$331,000over50yearsata7%annualreturn. RememberThatTaxesMatter—aLot Notallincomeisequal.Whereandhowyouholdyourassetscanmeanthedifferencebetweenbeingsomewhatwell-offandexceptionallyrich. Thosewithlittleornowealthgeneratealotoftaxableincome,whilethosewhoendupfinanciallyindependentgeneratelargeunrealizedgainsintheformofrealestateappreciation,unrealizedcapitalgains,andprofitsmadethroughtax-advantagedortax-freeaccounts,suchasanIRA or 401(k). Aphysicianearning$250,000peryearwillbetaxedheavily,probablypaying$95,000intaxesforanetincomeof$155,000.Yet,hewouldn'tpayasinglepennyintaxesifhehadearnedthesameamountfromwithinapensionplanorIRA,atleastnotinthatyear.Thatmoneythatisn'ttaxedcancompoundandgrowwithintheretirementaccountuntilitiswithdrawninretirement. Moneyinatax-deferredretirementaccountwillbetaxedeventually—thetaxesaredeferreduntilretirementwhenyoumayfallintoalowertaxbracket.However,thelargeryourretirementaccount,themoresubstantialyourretirementincome,andwealthyretireescouldfindthattheystillhavesubstantialtaxbills. TakeControlofYourTime Gainingcompletecontroloveryourtimeisoftenonefactorinachievingfinancialindependence.Youmaynothavetotallyreachedtheinvestinggoalthatallowsyoutomaintainyourlifestylewithoutanadditionalpaycheck,butifyouhavethefreedomtospendyourtimeasyoulike,thatmightbethemostpowerfuldefinitionofwealthforyou. Ifitfeelsasthoughyou'reunwrappingagifteachmorningwhenyoushowuptotheoffice,jobsite,practicefield,orstudio,you'reontrackforachievingfinancialindependence. Youhaveahugeadvantageoveryourcompetitionifyoufindtheprofessionthatgivesyoupleasure,andyou'redisciplinedinmanagingthebusinesssideofitbycontrollingcosts.Youmightcontinuetoworkeight,ten,ortwelvehoursaday,fortwo,four,ortenyearslonger,becauseyoulovetheprocessandproductitself,notbecauseyouneedto. KnowThatGradesDoNotCorrelateWithWealth AccordingtodecadesofextensiveresearchbyThomasJ.Stanley,Ph.D.,authorof TheMillionaireNextDoor,thegradesoneearnsinschoolhavenocorrelationwitheconomicwealthandsuccessoutsidethemedicalandlegalprofessions. That'snottosayeducationisn'timportant—88%ofAmericanmillionairesdid,infact,graduatewithanundergraduatedegree—butacademicperformanceisnotallit'scrackeduptobe. Whydoparents,teachers,andcounselorscontinuetotellchildrenthattheywon'tbesuccessfuliftheyhaveaC-GPA?Statisticallyspeaking,it'sbecauseoftenthesepeoplearethemselvesnotfinanciallysuccessful,accordingtoStanley.Theythereforehavenoideawhatittakestoachievefinancialindependenceandthusbuyintothemyththatgoodstudentsgofurtherinlife. Theseparentsandteachersmeasureanalyticalintelligenceonly,notthecreativeintelligencethat'sresponsibleforsparkinginnovations,societaladvancements,andcraftingsolutionsinnichemarkets. Theyfailtorealizethatmostmillionaireswearbluejeans,overalls,orworkshirts,notasuitandtie.TheyeatatMcDonald'sandBurgerKing.Theyliveinordinary,well-establishedneighborhoods.Mostowntheirownbusinesses. Statistically,you'dbemorelikelytopredictafuturemillionaireifyouweretochooseaself-sufficientstudentinshopclasswhopaysfortheirowncar,getsdecent(butnotspectacular)grades,hasajob,andenjoyswhattheydo,ratherthanselectingsomeonefromthehonorroll. FindaComplementarySpouse Youreffortstowardabetter,financiallyindependentlifearegoingtofeellikestrugglinginquicksand,nomatterhowsuccessfulyouare,unlessyourspouseisequallydisciplined,frugal,andinvestment-oriented.Theemotional,financial,andsocialtollthatmarryingthewrongpersoncantakeonyourlifewilloverwhelmalmostanyprogressyoucanmakeinyourcareerorpocketbook. Atremendousamountofsuccessisbasedonpropertemperamentandpsychology.Howcanyoufocusonyourworkandcreatingthelifeyoualwaysdreamedofifyou'reworriedaboutthesituationathome?Youneedthekindofsupportthatallowsyoutotakerisks,becauseyouknow,nomatterwhathappens,thattherewillalwaysbesomeonewaitingforyouathomewholovesyouandsharesyouroverarchingfinancialgoals. Investin(NotSoGlamorous)NicheMarkets Billionaireinvestor CharlieMunger hasremarkedthatentrepreneurscanthriveiftheyspecializeinanoverlookedeconomicniche,muchlikeanimalsinnature.Often,thesenichesareextremelylucrativebutnotlikelytowinyoufriendsatcocktailparties. Conjureupimagesofamulti-millionaire.Whatdoyousee?High-tech20-somethingsonayacht?Molecularbiologists?Althoughthereareafew,mostofthebigmoneyisinindustriessuchaswastemanagement,pizza,clothingstores,trailerparks,andshipping. Considerthecaseof SamWalton.HebuiltatinydimestoreinacornerofArkansasintothebiggestretailerintheworld,amassingafamilyfortuneofmorethan$191billion. There'snothingparticularlyexcitingaboutselling50-centflip-flopsandbottlesofcheapcologneinsmalltowns,butWaltonwasonamissiontobringaffordablegoodstoeverydayAmericans.Hewasamanpossessedwithvision.Hebuilthiscompanyonestoreatatime—onemightevensayonecheckoutatatime—withnofanfareorredcarpetwalks. Businessownersrepresentadisproportionatelylargesegmentofthemillionairepopulation.There'sagoodchancethatthebiggesthardwarestoreownerorplumberinyourtownhasanetworthmanytimesthatofthehighest-paiddoctor.Partofthereasonisaconceptwe'vediscussedcalled"capitalizedearnings."AnotherreasonisonethatDr.Stanleymentionedinhisbook. Doctors(butnotplumbers)arepressuredtobuystatussymbolstoconvincetheirpatientsthatthey'resuccessful.Overdecades,theresultismillionsinadditionalwealthfortheguywhouncloggedtoiletsinsteadofarteries.That'snotsomethingyoulearnaboutinschool. SupportYourProductiveRelatives Itisalmostalwaysamistaketoprovidegiftsofcashandsupporttothoserelativeswhoareunabletogeneratehighincomesontheirown,orwhoareconstantlyinfinancialtrouble. Considertheincentivesystemyousetup.Onesonbecomesaphysician,andonedaughteranattorney,andyousaytheydon't"need"yourmoney.Atthesametime,youprovidefreerent,board,andbailoutsfortheirsibling,whositsathomeincreditcarddebtbutrefusestolookforwork.You'vemanagedtoeffectivelyturnthatchildintoafinancialandcreditjunkie.It’sunlikelythey'llevergetovertheiraddiction. Thechildmighttellyouthattheyonlyneedonemoreloan,butthefundamental,underlyingproblemistheir inabilitytomanagemoney.Thesupportyougivetoyourrelativesshouldhelpthembecomefinanciallyindependentthemselves,notcreateadependenceonyou,whichisonewaytoensurethatyou'llneverhavefinancialfreedom. WhatIsFinancialIndependence? Thereisnosetdefinitionof"financialindependence."Somemightconsiderithavingenoughincome-generatinginvestmentstonolongerhavetowork.Othersmightconsideritnolongerhavingtodependonotherstomeettheirfinancialneeds.Itcouldalsobelivingwithoutdebtandhavinganincomethatcaneasilycoverexpenses. WhatIsanIRA? Anindividualretirementaccount(IRA)isatax-advantagedaccountforretirementsavings.TraditionalIRAscontributionscanbedeductedfromyourincometaxesifyoumeettherequirements.RothIRAsallowyoutocontributeafter-taxfundsifyoumeetcertainincomerequirements,whichmeansyoucanwithdrawfundstax-freeinretirement. WhatIsa401(k)? A401(k)isaretirementsavingsplanofferedbymanyemployers.Youcontributeapercentageofyourincomepre-tax,andtheemployermaymatchsomeofthefunds.Youdecidehowyouwantyourcontributionstobeinvestedfromoptionsprovidedbytheplanadministrator. ArticleSources ThomasJ.Stanley."TheMillionaireNextDoor:TheSurprisingSecretsofAmerica'sWealthy."TaylorTradePublishing,1998. RamseySolutions"TheNationalStudyofMillionaires."AccessedJune11,2021. GuruFocus."ValueTalk:Buffett’sPartner,CharlieMunger."AccessedJune11,2021. Bloomberg."TheWorld’sWealthiestFamilyGets$4MillionRicherEveryHour."AccessedJune11,2021. Share Tweet Share Email RothIRAvs.BrokerageAccount:What’stheDifference? HowtoSet(andKeep)RealisticInvestingGoals WhatIsaMillionaire? WhatIsaPortfolio? BestFinancePodcastsof2022 LearnHowtoBecomeRichandFindYourPathtoFinancialFreedom HowtoMinimizeTaxesWhenYouHaveaHighNetWorth 5FinancialGoalstoHelpYouMaketheMostoftheNextYear 4WaysToMakeYourMoneyWorkforYou WhenShouldIBecomeFinanciallyIndependent? TheseTopTipsWillHelpYouGainFinancialSuccess TransferringWealthWithLifeInsurance HowToSetFinancialGoalsYouCan(Actually)Achieve WhatIsFinancialFreedom? KeepYourInvestingFocusedbyWritinganInvestmentPolicyStatement WhatIsaDecamillionaire?