3 Major Milestones to Financial Independence

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3 Major Milestones to Financial Independence

The journey to financial independence is a long and difficult road for regular people like you and me. After 25+ years of saving and investing, we achieved financial independence. Our passive income exceeds our expenses, but it is precarious. The last few years have been tough on our passive income. Our dividends income decreased because some companies cut dividends. Our rental income also got hit due to Covid. Fortunately, our real estate crowdfunding investments helped fill in the gap nicely. We also reduced our expenses so that helped as well. Now, I want more margin in case the economy goes south again.

So how did we achieve financial independence? We never had any big windfall so our wealth was built solely on our income. We had to build our passive income from the ground up. Also, we reduced our spending quite a bit over the last few years. The average US household annual expenditure was $61,334 in 2020 according to the Bureau of Labor statistics. That year, we spent $40,030. That’s 33% less than average. Our big 3 expenses (housing, transportation, and food) are much lower than average by design. You can read about how we minimized our big 3 expenses here.

Anyway, many of you are slowly working toward financial independence. There is a beginning, middle, and end to this journey. Let’s take a look at these 3 major milestones to financial independence.

*Written in 2015. Updated in 2022.

1. Spend Less Than You Make

Spending less than you make is the first step on your journey toward financial independence. It sounds simple, but it’s difficult for many people. Let’s look at our son for example. He is 11 years old and won’t be making any meaningful income until he graduates from college. Hopefully, he won’t have a lot of student loan debt, but that’s unusual these days. Many young college grads have to make loan payments and it’s tough.

It can be difficult to spend less than you make even when you have a high income. A lot of people fall into the consumerism trap and spend more than they can afford. Luckily, we always lived within our means and rarely spend more than we make. Hopefully, we’ll be able to impart this important step of the journey to our son by the time he is a young adult.

Here are the important steps in this first milestone.

Find a way to make a decent income. The easiest way is to get an education in a well-paying field and work hard to get ahead. Starting a business and side hustling are also great ways to make money and gain experience. Although, a college diploma is no guarantee these days. Life is tougher for the kids!
Live frugally when you’re starting out. Most of us lived through the starving student phase. We rarely spent money on entertainment and luxuries when we were students and we still had a lot of fun. You need to keep that habit for a while after you landed a well-paying job. Don’t spend all your income like many young people do.
Pay off all consumer debt. Those high-interest consumer debts are a huge drag on your wealth-building progress. It’s like trying to run with those training parachutes. You can do short sprints, but it’s impossible to run a marathon with debts hanging over your head.
Start investing as early as possible. It’s not enough to save, you need to invest, too. Most young people won’t be able to invest much, but they will gain invaluable experience as the stock market goes through the boom and bust cycles. It takes a long time to formulate an investment strategy that you will be comfortable with. The earlier you start, the better off you’ll be.

2. Invest more than you spend

Spending less than you make is just the first step to financial independence. If you want to get there quicker, you will need to invest a sizeable portion of your income. Most financial advisors advocate saving between 10 to 20% of your income. But that isn’t enough. It will take you 40+ years to reach financial independence.

Instead, I encourage you to invest more than you spend. This is a tall order for most people because the gap between income and expense is usually very small. Most people spend almost all of their income, that’s why the US personal saving rate hovers around just 5%.

We have been investing more than we spend for many years now. I had a good income when I was an engineer and we lived a modest lifestyle. It was easy to save more than we spent. We continue to save and invest more than we spend even after I quit my engineering career in 2012. Mrs. RB40 is still working and we continue at a slower pace. If you invest more than you spend, you will reach financial independence in a reasonable timeframe. This is one reason why it’s important to track your income and expense. You can use your annual expense as a baseline for your financial independence calculation.

Here are some pointers on how to surge pass this milestone.

Increase your income. It’s much easier to invest more than you spend if you make a decent income. If you can barely pay your monthly bills, then you should concentrate on increasing your income first.
Take advantage of the tax-advantaged accounts. We have been maxing out our 401k and Roth IRA for years. This helps defer tax and the compound interest will add up over the years.
Minimize lifestyle inflation. It’s easy to spend more when you get a raise, but you should take the long view and invest most of that instead of spending it.
Buy income-generating assets. Your home isn’t an investment, it’s a liability. You’re spending a lot of money every month to live there. Almost everything you own is depreciating.
The stock market and rental properties are proven investments. The income they generate should increase over time and beat inflation. These two investments are great ways to generate wealth.
Reinvestment counts. We reinvest most of our investment income. That’s the basic concept of compound interest. As your investment income increases, it becomes easier to invest more than you spend.

3. Passive income exceeds expenses

This is the last step to financial independence. Once your passive income exceeds your expense, then you’ve made it! Unfortunately, most people never reach this point. They either spend too much or didn’t invest enough to generate enough passive income. Of course, there are other sources of passive income such as Social Security benefits and pensions. Those are great, but our generation can’t really count on them anymore.

In 2020, our passive income exceeded our expenses by 20%. That was great! It took us years to get here.

Here are some things to keep in mind while working toward this goal.

Keep at it. The journey to financial independence is a marathon. It will take most of us 15 to 20 years to get there even if you’re dedicated. Keep at it and eventually, you will get there.
The cost of living can make a huge difference. We kept our spending pretty low while increasing our passive income. If you can do this, it will make this milestone much easier to achieve.

3 Major Milestones to Financial Independence

So those are my 3 major milestones on the journey to financial independence. They might seem difficult, but we have to remember the journey can take many years. Even reaching the starting point (spend less than you make) already will take up a major portion of our lives. I didn’t get there until I was 22. If we are diligent, the 2nd and 3rd legs of the journey will be much shorter than that.

Of course, you’re not quite done even when you reach the 3^rd milestone. You need to be vigilant so you can make adjustments as needed.

What do you think of these 3 milestones? Where are you on the journey to financial independence?

Passive income is the key to early retirement. These days, I’m investing in commercial apartments with CrowdStreet. They have many projects across the United States. Go check them out!

Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.