The term financial independence is defined as the status of having enough income to pay for your living expenses for the rest of your life without having to be employed or dependent on others. Income earned without having to work a job is commonly referred to as passive income. Personally, my goals of financial independence do not necessarily fit into the rigidity of this definition… and yours don’t need to either.
Everyone is on a different financial journey with too many different variables for a one size fits all approach to financial planning. Not just because people have vastly different incomes, backgrounds, relationship status, family situations & money beliefs. But because some people don’t necessarily want to stop work at 35 to retire, even if they did have the means. However, If we are being honest, most people would probably not mind having full-time work be optional.
When you are creating a plan for how to achieve your own financial independence you need to think about the following things:
- Know how much money you need/want to live on per year for your lifestyle
How can you formulate S.M.A.R.T goals relating to your finances if you don’t actually know how much you are spending annually to live a lifestyle you are happy with? For some single people they might be happy living very frugally with annual expenses of less than 25K per year. For couples and families they might need a lot more, say around 60K per year to live the lifestyle that they currently enjoy. Knowing the figure you require to live happily is the first step in formulating your goals and your time line to financial independence. This is also known as calculating your FI number.
2. Approximate time lines & clear financial goals. I say approximate because inevitably life happens. Large unexpected illnesses, fertility treatment costs, a new car, all can alter the timeline, however it is good to have a rough idea to help formulate a proper plan. You also need to think about what the milestones are that you wish to acheive in order to reach your goals. For example they might include the following:
a) Fully Paid of PPOR (Primary Place of Residence). Eliminating your mortgage payment or rent payment allows for a certain level of financial security. Of course we all know that there are ongoing costs of owning property however having a debt free residence is a huge financial advantage for most people. In the early stages of the financial journey it is likely that your housing payment, be it rent or mortgage, is a huge chunk of your yearly expenses. If you can eliminate this as part of the overarching plan, it will greatly reduce the stress on your annual budget.
b) Passive Income stream/s. This might be generated through an investment property or a share portfolio. The investment property pays you rent which you use to pay down that mortgage. Over the course of however long depending on how much you borrowed eventually you will have no mortgage left on the investment property. Now the rent is purely an income stream for you with limited expenses. (Aside from realestate fees and maintence costs of course)
A share portfolio is also a popular method to incorporate into your financial independence plan. Some ETF’s focus more on capital growth and some focus more on dividends, both are good. A younger person in the accumulation phase of their financial journey might be more focussed initially on shares/ETF’s that tend to have better capital growth. This is because capital growth is not taxed until the investment is sold. For example I buy $500 worth of shares in apple. In six months those shares are worth $1000, I have had capital growth of 50% but I won’t pay any tax on that unless I was to sell my shares in apple and lock in the capital gain.
On the other hand, dividend payments are taxable. Every time you get paid a dividend from shares or ETF’s that you own, you will pay tax on them. These payments will be included in your tax return at tax time as part of your income. So for a young person working full time in a higher tax bracket focussing on dividends over capital growth will inevitably mean paying more tax. Now paying a bit of tax on money that your investment paid to you is not really a bad thing, but these are all things to consider when working out your financial plan & timeline. As we all want to reduce the tax we pay.
3. What life stage you are currently at?
Following on from above, your age and life stage will have an impact on how you formulate you financial plan. Someone in their 50’s approaching retirement is going to have a very different set of milestones and timeline to someone in their 20’s just starting out. These two hypothetical people have different risk tolerances and this needs to be taken into consideration.
In our retirement system in Australia, access to superannuation is also an important aspect of this conversation. For example a woman in her mid 50’s formulating a financial plan to retire comfortably by 65 can take into consideration that she will have access to her superannuation by this point in her life. She can utlise this aspect of her life stage to help her formulate the best financial plan & goals for her. This might include salary sacrificing more into superannuation with the knowledge that it will be accessible to her in 15 years and that she will hopefully have gotten some good compounding in that time.
On the other hand, for a young woman in her 20’s, there is a much longer time period for super to be accessible. In this scenario making smart investments outside of super might be a better plan. Especially if the goal is to semi retire prior to the age of 65 when super becomes accessible.
4. Once you have a plan, make sure you are actually sticking to it
Understanding how much income you have coming in and where it is going out is integral to any sort of financial success. At the stage, where you are thinking about financial independence and planning you should already have a clear understanding of your income and expenses. It is a prerequisite for creating a successful financial plan.
For example, if 25-year-old Sally knows she can save 30K per year then she can clearly break down where she is going to direct those funds. If she has a 15-year plan and she hopes to in that time pay off the mortgage on her apartment (let’s face it with house prices the way they currently are, Sally doesn’t have a house) & also to build up a share portfolio she can aim to funnel 10K per year into extra mortgage repayments & 20K per year into her share portfolio.
Not too bad for Sally at the age of 40. Keep in mind that lifestyle changes can dramatically affect things. Some years Sally might have no excess money to invest or maybe she gets a partner and now they can save/invest double the amount. No one will ever be able to account for all the potential changes in life but by following the above steps and having some sort of rough guide you can really set yourself up for success in a relatively short period of time.
5. Invest in yourself in order to increase your income (especially in your 20’s & 30’s)
Everything in life is getting more expensive. Despite thoughts and prayers from first home buyers, the reality is that without a pretty severe change the house prices are not getting any cheaper. For women interested in finance, the main focus in 2022 has to be around increasing income in conjunction with saving money. You can only save so much if you are only earning 55K per year. The early stages of your working life are often when you are best primed to switch jobs to chase those salary increases. Not to mention having the energy (and freedom if you are lucky) to take more work on. Whether that is part-time work, starting a business, or some other form of side hustle in order to increase your salary.
Overall, every woman in Australia should have a financial plan no matter what the financial situation is. These goals will not happen overnight, however, with small steps it can really make a big impact. At the end of the day, it does not matter if it takes you 5 years or 35 years to achieve the end result of financial independence as long as you have some sort of financial security along the journey.
