Financial independence day: 5 ways to get there

July 4, 2011

No fireworks will explode if you can pull off financial independence, but it sure beats working for the man. How do you do it? Do you have to live like a monk? Give up chocolate? Move to a tent? Stop watching the Cartoon Network?

While it helps if you were an investment banker, CEO, professional athlete, movie star or inherited a ton of money, there are other ways to get there. Here are some favorite, little-heralded ways.

Debt is the Devil
The biggest impediment to financial independence is unbridled debt. If you spend more than you make and get into debt, you’re working for the banks. That’s pretty standard advice, although most folks don’t know how to systematically avoid this trap. Like a demon, debt needs to be exorcised. First, get to the point where a bank is paying you to use credit. Use reward cards (they give you cash awards, airline miles or other dividends) and pay them off by their due date. Don’t carry over any balances. If you can’t pay for something when the bill comes due, don’t buy it. Don’t take out home-equity or installment loans. They are not worth it. I have nothing against carrying a mortgage balance — it’s always been called “good” debt. But the sooner you can pay it off, the better. The benefit of getting a tax deduction is overblown. A long-term debt impairs your freedom as much as a short-term one.

What can you live without?
Unfortunately, most consumer societies are predicated on having it all now thanks to readily available credit. Save up to pay cash for the things you really want. Get rid of the things that provide marginal pleasure. Can you live without cable or satellite TV? Dump it and save the difference. How about that health-club membership? Did you know you could exercise at home for nothing (remember calisthenics)? Most libraries allow you to check out movies, music and books for free. Go without that morning cup of coffee or that daily lunch. Bank the savings. Make it your motto to “save first, spend later.” Fill up your short-term money market account with savings that can take care of emergencies and rainy days. Check your health, home or auto insurance. Make sure you have enough money to cover out-of-pocket expenses. As for life insurance, unless you have dependents who would be financially hurt if you pass, don’t buy it. Disability insurance is a good idea. You have a greater chance of being disabled than dying during your working career.

Save like a demon
You’ve probably seen suggestions that saving 10 percent to 15 percent of your annual income will lead to a comfortable retirement. Forget it. On most retirement withdrawals — including annuity income — you’ll need more to pay Uncle Sam and then cover higher medical expenses in coming years. Start with a goal of saving one-third of your income. Open up a Roth IRA or 401(k). You pay taxes on the contributions, but not on the withdrawals. Use every opportunity you can to save with tax-deferred accounts. No amount is too small.  Don’t forget to save enough to cover taxes.

Small fees take big hits
I’m a raging evangelist on this issue. Being nickel and dimed by brokerage fees, commissions and middlemen expenses eats up your wealth in a big way. Some 70 percent of employees don’t even know that their employer or 401(k) fund provider is charging them fees to invest in their retirement funds, according to an AARP survey. What looks like a small amount on your statements can eat up your kitty over time. And forget about brand names, advertising and the supposed prowess of fund managers. All that matters is cost and diversification. Let’s say you have the American Funds Growth Fund of America, a popular stock fund for retirement. Then compare it to the ultra-diversified, passive Vanguard Total Stock Market Index . While I can’t predict what future returns will be in either fund, if you invested $10,000 in each fund, earned a modest five-percent annual return, you’d have saved $1,152.97 in fees and sales charges (on the “A” shares in the American fund) in the Vanguard fund after a decade. This is not a patent endorsement of Vanguard, although I have most of my retirement funds invested with them. It’s basic math. Costs matter. The less you have to pay — whether it’s in fund fees, banking charges, commissions or interest — the better. Avoid any broker-sold product. Buy direct. Run your own numbers to compare funds with the FINRA Mutual Fund Cost Analyzer, which is what I used in the above example.  You can’t beat Wall Street. They beat you with the small stuff every day.

It’s not about numbers, it’s about your life
I’m sick of self-serving surveys of how poorly people are saving for retirement. They are usually published by the same companies who want to gouge you to invest in their “retirement” products. Find out how much it would take for you to live comfortably and put away enough money to get there. Develop a dynamic lifetime financial plan that changes with each phase of life. Get a ballpark estimate to see if you’re on track. Financial independence is possible if you can live below your means. Although that sounds unpatriotic in a consumer economy, what you save is what you keep. You’ll have plenty of reasons to celebrate if you can reach that goal.


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Posted by Financial independence day: 5 ways to get there | Report as abusive

I did the CFP thing for a while, and still do it for a very few clients that I have personal relationships with. I actually did it after retirement from a career in IT, so it was more about personal interest than about income.

Probably one of the most dangerous things you can do is talk to a financial adviser. I talked with soooo many people who’s inheritance had been plundered. It would be good if you would do a candid discussion of the differences between commission based, fee based, fee only, and maybe kick in a few references to some of the ongoing FINRA complaints and legal actions that go on daily with some of the bigger named outfits.

But, it’s FUTILE John. If they won’t read any of the mountain of books, and won’t read the info on the websites like Vanguard’s they are not going to read you. Don’t know why, but know it’s so. Good luck on your crusade, river flows are dropping here, almost time to start snagging flies in trees.

Posted by ARJTurgot2 | Report as abusive

Your rules have been the way I have lived for the past 25 years (goodness it sounds long but went fast) and I have achieved “financial serenity”. They work. But I agree with ARJTurgot2, you are probably preaching to the choir.

Posted by Tom_M_1 | Report as abusive

the author wrote “Open up a Roth IRA or 401(k). You pay taxes on the contributions, but not on the withdrawals.”

Not exactly accurate. Roth IRAs are funded with post-tax dollars and withdrawals are not taxed. With 401(k)s, they are funded with pre-tax dollars and the tax is applied upon withdrawal.

Posted by TomB22 | Report as abusive

One could easily stop having a life and save a bunch and continue not having a life and live off of the savings of 50 years or so and finally die not having lived a life.

It seems this article is unbalanced – why would you want any money to continuing not living a life or living a life that is completely disinteresting to you?

Part of the balance that must be brought into any financial planning is the life/living planning that makes having all that money worthwhile – and very few of us actually understand how to do that – much fewer than know how to save money for retirement.

What would make your life worth prolonging – that’s key to a financial retirement plan that makes sense – otherwise you are just taking up space and spending money.

Posted by mikeinSacto | Report as abusive

Actually, Tom B22, there is such a thing as a Roth 401K. It became known in 2006 when congress allowed many employers to offer it to their employees. It can be a great investment vehicle if your circumstances and tax situation permits it.

Posted by rjd757 | Report as abusive

Another one-sided financial advice column that completely misses the point.

Financial advice columnists always speak as though the individual has total control over their financial lives, and if we, the readers, fail to build a massive nest egg by retirement, then that’s our own fault for buying too much coffee at Starbucks.

This overly simplistic perspective completely ignores the simple fact that minimum wage in this country is grossly less than the base cost of living. Contributing to a Roth IRA is not possible when a family’s rent, utilities, and grocery bills combine to exceed the household’s monthly revenue. When balancing a budget, cutting down on costs is not enough; you’ve got to raise revenues too.

Posted by 1progressive | Report as abusive

I’m always in search of a higher salary alongside saving. In Canada, we have a tax free savings account where you can save $5000 per year tax free. I think people should also consider having a 9-5 job in addition to their own company on the side.

Posted by seppl | Report as abusive

“Develop a dynamic lifetime financial plan that changes with each phase of life.” ok! check this out Gs

Posted by darkangel | Report as abusive

Few people stop and think that for every 3 years a person is employed at $20,000 per year (or $10 per hour fulltime), it only takes 1 year another person to earn that same about if they are making 3x as much (at $60,000 per year).

Put another way, imagine a job where every 3 years, you get a 2 year vacation. In a fast food job at 10 bucks per hour ($20,000 per year), it would take you 30 years to earn what a guy making 30 bucks per hour ($60,000 per year) would only take 10 years to earn!

Example: A manager approaches two people at MacDonalds as they sweat over flipping burgers. Each are making $10 per hour fulltime and both have worked there for 10 years — let’s call them Steve and Barbara. The manager says, “Barbara, you’ve done much better than Steve over the past 10 years. I’ll tell you what. You take a 20 year PAID VACATION starting (looks at watch) right now.”

When you get a mere $60,000 per year (many are earning much more) you effectively do just what Barbara did, because people that are earning less than you are working many years longer than you for the same amount of pay!

A burger flipper earns $600,000 over a career spanning 30 years if he/she is making 10 dollars per hour fulltime.

An office worker over that same 30 years earns $1,800,000 if he/she is making 30 dollars per hour. It’s not difficult to realize that those who don’t progress in their careers, over a lifetime, are pinching pennies while throwing away over a million dollars! That makes no sense to me!

Posted by DisgustedReader | Report as abusive

win the lotto folks it’s the easiest way to financial independence.

putting money into your 401k pension plan is just a way to let the Wall Street bankers steal it.

Posted by JEYF | Report as abusive

if u save too much u run into more risk to make a bad investment, or to keep too much cash doing nothing for u and just being inheritance for your survivors.

Also is important to use credit/mortgage to buy a nice house where u live. If u buy a bad one later on u will be stuck. We r alive today, invest in yourself first.

Posted by robb1 | Report as abusive

“What would make your life worth prolonging – that’s key to a financial retirement plan that makes sense – otherwise you are just taking up space and spending money.”

It’s not about enjoyment, but survival. Sure, rampant saving doesn’t sound like living now. Being foreclosed upon for failure to pay property taxes in those advancing years certainly isn’t much of a life.

We can talk about quality of life until sunset, but that is a very 1980’s kind of mentality. This is about saving now just to get by later, period.

Posted by DwDunphy | Report as abusive

[…] don’t usually do this, but Reuters Wealth hit it out the PARK with this […]

Posted by Had to repost this post : Ryans Ramblings | Report as abusive

when will we do without money at all?
Its time. Technology will replace menial jobs. Eventually all jobs will be done better by machines and they will build and maintain themselves. How will an ever growing population earn a living then? Cant we think of something a little more advanced than what even the most primitive tribes had? (a monetary system) The whole notion of profit (and planned obsolescence) need to be removed form society, otherwise our destruction is assured.

Posted by winston2015 | Report as abusive

I’m always heartened to find new acolytes. I suspect that I’m not preaching to the choir. And I’m aware of the challenges to saving — they’re huge. One theme prevails: If you’re able to reduce consumption and debt, boost your savings. Put that money away tax-deferred and you’ll do even better.

Posted by johnwasik | Report as abusive

The income part of the equation is more important than the debt part. If you’re lucky enough to hold onto your corporate job, you can work on controlling your debts. If you’ve been thrown under the bus like I was at age 51, you need to borrow just to stay alive.

We’re living through a depression right now. Access to capital is limited. Most people reading this article are going to work well into their 70’s anyway, so who cares about debt. In the long run, we’re all dead.

Posted by Viaphacops | Report as abusive

A penny Saved is a Penny Earned Twice.Good article and very candid observation.

Posted by Ismailtaimur | Report as abusive

I get really frustrated when people automatically equate low-wage work with flipping burgers. I am an office worker in a management position, making a whopping $11 per hour. I do not know any office workers who make $30 per hour but I know they exist at certain companies in my city. However, it is an ignorant stereotype to say that the only people who make low wages are unskilled labor. I have a college degree, I am even in demand in my area…but no one offers me wages much higher than $13 per hour. I have no credit card debt, no car payment, no mortgage, do not have cable.. but I do have college loans that I cant even make a dent in. My job is enjoyable and challenging, and I would not have this kind of work without my degree.. yet I have no clue how to pay it off. At 36 years old it is starting to seem like I may never retire. These kinds of articles are sort of interesting but they do not apply to me , nor anyone that I know.

Posted by brokeofficewrkr | Report as abusive

I don’t understand: supposedly sophisticated investors falling for Vanguard’s line about low fees. The only thing that matters with a mutual fund is the profit YOU make from it. Vanguard funds mostly don’t do as well as the market while some high fee funds consistently beat the market yeilding much better returns to the investor. And yes, I too have some Vanguard funds; I just find their advertising very disingenuous.

Posted by TexasOkie | Report as abusive