Investments can serve many purposes, from preserving your wealth to creating alternative sources of income. One of the most important reasons to invest is to unlock financial freedom.
When deploying your money towards investments, you can choose investments that reward you in different ways. One type of investment may be valuable to you, but less so to others.
In any case, the aim of your financial investments is to move you forward financially. However you achieve that is up to you.
Welcome to the Investing Series – my thoughts on how building a carefully crafted portfolio of investments allows you to change your relationship with work.
Financial freedom doesn’t come easily – especially not if you want your investments to cover all of your expenses. But I believe that waiting until your investments cover all of your expenses before changing your life is the wrong goal to strive for.
The Door to Financial Freedom
Many people – especially those in the Financial Independence Retire Early community – see financial freedom as the ultimate goal to work towards. Having all expenses covered passively allows one to fully devote themselves to whatever pursuits they desire.
The goal of financial independence appeals to those across all income levels. FI advocates earning a lower income will have less options with either how they pursue it, or whether they succeed. For those people, the pursuit of FI is essentially an escape from a life of modern slavery.
They’re not wrong, but I think this approach is misguided for a few reasons.
To me, financial freedom lies on the other side of a locked door. But your problems aren’t magically solved by walking through it. Rather, it gives you the space to be able to resolve the problems in your life.
Financial freedom isn’t the panacea by which your life will be fixed, and I fear that making it the goal leads to bigger problems in life. A life devoted to work you hate doesn’t suddenly get better when the work disappears.
In addition, it takes concerted effort to be able to open the door. You can’t just walk up and expect it to open to you. It’ll likely take you multiple decades of steadfast dedication to saving and investing before you can expect to reach full financial freedom.
I don’t write this to talk you out of pursuing financial freedom. In fact, it’s the opposite – I write this to help you ensure you have your best interests at heart.
What Are You Running From?
A warning about blindly pursuing “Full Financial Independence”:
Financial freedom is a noble goal to pursue. Being able to meet your needs independently without trading your time for money is an incredible advantage to have in life. But consider why you’re on this path, and the level of intensity you choose for it.
Are you pursuing financial freedom because it allows you to put off larger decisions until after you reach your “number”? Are you living in alignment with your Highest Self in this moment, right now? Do you risk burnout and entropy of your mind, body and soul in the pursuit of Financial Independence?
Remember to live a good life while on the journey to your “number”. Reaching the summit of this mountain is wonderful, unless you still have other mountains you should have climbed prior.
Live a good life today, and give your wealth time to grow. There are alternatives to the traditional FI approach.
The Keys
To unlock the door leading to financial freedom, you need the keys. The keys come in the form of the rewards you received for investing.
Throughout the Investing Series, I’ve mentioned the various ways that investments can reward you. Each of them benefits you in different ways, which can be used to unlock freedom sooner than you may think.
Compounding
Compounding refers to interest on interest, and explains the exponential growth in your portfolio value over the long term. This comes in two forms: reinvesting income and capital gains.
Compounding’s benefits usually come from holding an investment for a long time horizon. Generally speaking, the longer you hold an investment, the more valuable it becomes over time.1
Your portfolio is like a snowball rolling down a hit. At first you’ll need to grow it and push it along, but as it picks up more and more snow it’ll take on a life of its own.
Investing your money is betting on humanity’s future. If you think that we, as a species, are going to succeed, then invest money towards the future.
Using Compounding for Financial Freedom
Compounding allows you to bank on the value of your portfolio rising over time.
This can help inform strategies around how much you contribute to your investments, or how much you expect them to grow over time.
While nothing is certain and historical records can only be relied on so much, compounding is an essential component of how you benefit from investments.
Dividends & Rent
Many types of investments will reward you with income for being invested in them. Dividends are paid from stocks or shares, and are usually a distribution of company profits. Rent is usually paid from real estate investments, with tenants providing a consistent income to the landlord.
Dividends are inconsistent – no business can guarantee a certain amount of profits each year. But perhaps with a diverse enough portfolio, one could create a dividend income stream that provides a semi-stable income.
Rent is more consistent, however it’s often tied to property. Investing in property usually requires leverage, or borrowing money. That means that a portion of your rent will need to go towards paying off a mortgage, in addition to other ownership costs.
Before reaching Financial Independence, you can reinvest this income back into the investment to continue compounding the investment more quickly. This makes sense if your strategy is to retain your full salary while on the path to financial freedom.
Using Investment Income for Financial Freedom
Both dividends and rent can be used to create income streams that help you achieve financial freedom. This method is popular as it doesn’t rely on selling investments to fund a work-optional lifestyle.
Once your portfolio reaches a large enough size, the income from that portfolio may be enough to meet all of your needs. If you reach this level, you can retain the full value of your portfolio and continue to derive income from it in the future.
It’s worth considering that income paid out of investments isn’t used by that investment. That is, a dividend paid by the company could be used by the company to improve the business, which may lead to further profits. Dividends are therefore a “forced cash-out” of your investment. On the surface this isn’t an issue, but there is an alternative.
Capital Gains
I use capital gains to refer to the act of selling an investment for higher than you paid for it. Generally when you do this, you’ll pay capital gains tax on a portion of the difference between the selling and buying price.
Utilising capital gains as part of your investment strategy can be useful and is sometimes necessary. Certain asset classes, such as precious metals, art, or certain stocks, will never provide you an income. Due to this, the only way you are rewarded for these investments is by selling them.
The nature of this type of investment is that you will meet your needs by selling off a portion of your portfolio over time.
Using Capital Gains for Financial Freedom
If your strategy involves using capital gains for financial freedom, you’ll want to find investments that have a high degree of compounding – a high rate of return. Many of these types of investments can be high risk, however given a long enough time horizon you may still be able to compound enough.
A benefit of companies that don’t pay dividends is that they often use the profits they earn to make themselves better. They use careful and pragmatic business practices to create even more shareholder value compared to simply paying it out. If it’s paid out, an investor is taxed on it and needs to invest it themselves. This disrupts their ability to compound their own investment.
Utilising these types of assets can be helpful when considering financial freedom – even if it ultimately means reducing the total number of assets in your portfolio. Ideally, the value of your remaining assets will rise to make up for it.2
What Does Financial Freedom Look Like?
We’ve reviewed the ways in which your investments reward you for being invested, and how you can use those rewards to achieve financial freedom. But what does financial freedom look like, and what options are out there?
There are endless options to this question. If you have the investments and are being rewarded enough, you can choose how to utilise your current rewards – even if you haven’t achieved full Financial Independence.
Retiring Early
Retiring early is the most obvious option that people think about in terms of financial freedom. After all, it’s part of the FIRE acronym (Financial Independence Retire Early). Retiring early involves quitting your paid employment and letting your investment income provide for you instead.
Those never looking to work again are aiming for this level of financial freedom. Due to the difficulty in attaining this level of wealth (often somewhere between 25-35x your annual expenses3), it’s a difficult task for many.
I also think it’s paradoxical in nature. Those who are able to save and invest their way to retiring early often have traits that lend themselves to work: discipline, focus, strategy. I don’t see these types kicking back and relaxing for the rest of their lives. They will commit themselves to some type of work, some duty or service – regardless of how much it pays.4
Therefore in my eyes, the need to build a passive income stream that covers all of your expenses is effort wasted in avoiding building your ideal life now.
So what do you do if you’re planning to quit working, but don’t want to wait until you can quit and never look back?
Reduce Your Work Hours
While working towards full financial freedom, you can work less hours and extend the length of your accumulation phase. This serves two purposes:
- You can be intentional about creating your ideal life now; and
- You can learn to leverage your partial progress towards financial freedom to support that lifestyle.
This isn’t coping about not being able to reach the number. It’s a serious method to give yourself time to understand what it is you actually want to do with your free time.
By using your financial freedom to free up your time, you learn what it is you truly want to do. As your financial independence grows, you become able to do those things more and more.
Reducing your work hours allows you to see what things you want to do, right now, and work towards making it a reality. This blog wouldn’t have been possible if I hadn’t done that and taken a break from my career.
Seasonal Work/ Contracts
Instead of working less hours in a week, you can simply work less months in the year.
This approach will work better for certain professions. Tax accounting, project-based roles, and consulting come to mind. Jobs with high hourly rates directly allow you to make each hour more valuable to you. This in turn allows you to use that free time towards other pursuits.
These types of roles are ideal: you have a higher degree of control over both your rate of pay and your hours of work. I intend to avoid jobs where I cannot control my rate of pay5 or hours of work.
My Strategy
My current strategy is to only trade a small amount of my time for money. I can do this by taking advantage of several aspects of my career, investments and good fortune:
- Keeping expenses as low as possible
- Work project roles in my niche field for a high hourly rate
- Avoid sacrificing health due to overwork
- Weather slow work periods with investment income
- Build income-producing projects outside of my work
- Continue to save & invest to meet my goals of being fully FI by 40
My investments don’t cover all my expenses; far from it. But when combined with saving and investing my project income, they allow me to go without an income for extended periods.
Now, I can spend months working on smaller projects, focusing on exercise, learning new things, or spending time with my family. I earn enough, I invest enough to meet my goals, and I continue to learn new things that may increase my income even further.
But most importantly, I’m happy.
Closing
Financial freedom isn’t just about attaining it, it’s how you use it to build your ideal life. And you can do that much sooner than you think.
Even if you’re working towards 100% Financial Independence, you can still use your investments to create freedom in your life now.
I used the principles of Saving, Investing, and Choosing Work I Love to create a lifestyle that works for me. A lifestyle with enough financial freedom to allow me to work towards my Highest Self.
I believe that this is possible for anyone already on the path to Financial Independence. You just need to decide what matters to you right now.
Thank you for reading.
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- There are many exceptions; invest wisely. ↩︎
- Yes, this is a gambit – much like hoping the stocks you own pay nice dividends. ↩︎
- Deliberately vague. Check out the Trinity study for more information. ↩︎
- It could pay nothing. The point is that you have power to choose how you work. ↩︎
- Unions are great for collective bargaining but less good at allowing for upwards mobility of pay rate. Generally you’ll reach the highest band of the highest skill level and need to break out of this in order to increase your wage further. Getting stuck here is a trap if that maximum isn’t “good enough” to achieve your goals. ↩︎