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SAFE STRATEGIES for FINANCIAL FREEDOM
By Van K. Tharp, Jr. D.R. BARTON, STEVE SJUGGERUD
The McGraw-Hill Companies, Inc.Copyright © 2004Hezekiah, Inc., and Lake Lucerne, LP
All rights reserved.
WHAT IT TAKES FOR YOU TO NEVER HAVE TO WORK AGAIN!
"There is a strong correlation between investment planning and wealth accumulation."
—Thomas Stanley and William Danko
Imagine that you never have to work again in your life. If you do choose to work, all the extra money that comes in is used to improve your lifestyle and help those you care about. You take two month-long vacations each year. You even have a list of places you want to visit — exotic places around the world that most people will never get to see.
You are now free to spend most of your time doing the things you love to do. You spend at least 30 hours per week on your hobbies. In fact, you have a new interest—finding deals and investigating investment opportunities. The amazing part is that your new hobby will bring you much more money than you ever made while you were working 50 hours per week at a job.
You also have plenty of time to exercise, to eat right, and to be happy. Now that you are financially free, that's just what you do. All it took for this to happen was a small shift in the way you thought about money. It took you about 18 months to achieve this financial freedom and it started with a simple step—determining your financial freedom number.
Discovering Your Personal Financial Freedom Number
People have been brainwashed to think that they need millions of dollars to be financially free. This is not true. Financial freedom is not just a goal for the rich, and you don't have to be a genius to achieve it. All you need to do is look at how much money you require to live comfortably every month. Then find ways to bring in that money each month from investments that work for you rather than from you working for money. When you have this passive income every month, you are financially free.
Let's start with the first step—determining your financial freedom number. Your financial freedom number represents the difference between your passive income and your expenses. If your passive income is greater than your expenses each month, then you are financially free. It's that simple.
Let's go through the exercise of determining your financial freedom number right now. It will only take you about 15 minutes. And isn't it worth a few minutes of your time to figure out what it takes to get rid of your boss, your job, and your money worries?
Step 1: Calculate Your Monthly Expenses
If you currently keep track of your personal and household expenses, this step will be simple. If you don't have such records handy, don't despair. We'll first make a rough estimate of all your expenses. If you can easily look up a helpful piece of information, go ahead and do it. However, it's very important that you take no more than one minute on any expense category. The reason for this time limitation is simple. When starting a distasteful task, one of our coping mechanisms is to procrastinate. It would be easy to convince yourself that you'll do this exercise as soon as you get all your records together. If you allow yourself to wait, it may take a day, a week, or a year to compile those records. You can't wait that long to get moving on an important task. And chances are good that your best estimates will be very close to actual numbers. So get started! Keep in mind that your figures should be based on what you actually spend. Use the worksheet provided in Figure 1.1.
Divide any annual expenses by 12.
Start with your monthly income and write that down here. Monthly income is __________. If you are a U.S. taxpayer, you can take the informations from line 22 of your 1040 tax return. If you take this number from your tax return, remember to divide it by 12 to get your monthly income. (If you are not from the United States, take the total income figure from the tax return that you do file.)
For example, determine how much you spend per month in category one, charitable expenses. If you give $300 to charity each month, enter that amount. You might then determine that you spend $670 on taxes, which is the second expense category. Fill in all of the expense items in each category. If you discover that you spend more than you make (i.e., your expenses seem to be more than your combined income), then determine what's wrong. Either you made an error in your computations or you are spending too much (meaning that you're using your savings or borrowing money each month to pay expenses). But don't worry; you will learn how to fix the problem later.
When you finish, do a reality check to make sure that your number makes sense. For example, if you make $4,000 per month and typically run out of money by the end of the month, then total monthly expenses of $3,500 before savings do not make sense. If you run out of money by the end of the month, how can you have only $3,500 in expenses? You've obviously missed some expenses, and you need to find them. If your numbers suggest that you are saving $500 each month, be certain that $500 is what you are actually putting away. Be honest with yourself and determine where your money is going.
This exercise was intended to give you a good estimate of your expenses. If you do only what was asked and the numbers add up, you will probably get 90% of the intended results. If you want to dig deeper for more accuracy, take whatever time you need to gather the records to verify or correct your original estimates.
Now you know what it currently costs you to maintain your standard of living. This is your base number and, for many of you, it is also your financial freedom number.
Step 2: Determine Your Passive Income
To find out how close you are to being financially free, you'll also need to determine how much passive income you make on average each month. For most people, the list of passive income sources is much shorter than their list of expenses. Passive income represents the cash flow produced when money (or an asset purchased with money) works for you. This cash flow may come from an investment in real estate, in a business, in stocks, in bonds, or in other financial instruments. Although the cash flows from a passive source, it is generated by having an asset work for you rather than by directly trading your time for money. With that said, passive income still requires management and oversight. And in the start-up phases it may require even more time and energy than traditional jobs. But the end result is an asset that produces cash flow (or passive income) without directly trading an hour of work for an hour of pay.
A valid example of passive income would be the cash amount that you receive from a rental property after all expenses (i.e., principal, interest, taxes, advertising, maintenance, property management, vacancy, insurance, etc.) have been paid each month. If the property costs you money after you have deducted all expenses, then it is a negative cash flow property and needs to be recorded as such until the rent increases or the costs go down and the property is making money.
If the rental property is providing you with cash every month after the expenses have all been paid, then it is a positive cash flow property. Sure, you may have to put some time into maintaining the property and collecting the payments, but you are not directly trading an hour of work time for an hour of income. Your property (asset) is generating cash flow for you. And this cash flow is what we are calling passive income.
Note that the value (or appreciation) of the property is not included in this calculation. Values go up and down and cannot truly be determined until you actually sell the property. In
Excerpted from SAFE STRATEGIES for FINANCIAL FREEDOM by Van K. Tharp. Copyright © 2004 by Hezekiah, Inc., and Lake Lucerne, LP. Excerpted by permission of The McGraw-Hill Companies, Inc..
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