We all know the formula to Financial Independence is to have your passive income greater than your expenses. How do we go about doing that?
I like to break this down into 3 parts.
Where is your money going?
The first step to becoming financial independence is to reduce your expenses. In order to do that, you have to map out your expenses. Simply put, where is your money going? There is no easy way round this. You have to make an effort to track this.
- Necessity Bills – internet, phone, electric and water bills, rent etc
- Loans – home, car, student loans etc
- Allowance – for your parents, wife, kids
- Subscriptions – netflix, cable tv, spotify, cloud storage, software etc
Everyday dollar has a great article on how to track your expenses. Once you know where your money is going, then you can start trimming the fat.
Reduce expenses with conscious spending
Conscious spending just means that you know where you are spending your money. You can choose on what you want to splurge on. It can be $5,000 handbag, a $5000 vacation or a $5,000 macbook. But it cannot be all three. You have to choose where you want to spend your money.
To do that, you have to decide on what brings you joy. Then look at your spending and reduce on things that doesn’t bring you that much happiness. This is how I reduce expenses with conscious spending.
For example, I can’t do without coffee, and I need my daily dose of entertainment, and an occasional overseas holiday. So I don’t mind splurging on freshly roasted coffee, and some good old Netflix and Spotify subscriptions. I tend to plan for one overseas trip, so I don’t mind paying more for comfort and convenience. Buying new clothes or gadgets, on the other hand, doesn’t excite me. So I din’t spend a lot on those categories.
Setting a budget
Even though I mentioned that you can reduce expenses with conscious spending, you still need a budget in order to save. You can’t save if you are spending all your income.
With your expenses mapped out, you should have an idea of how much you are spending on each category. This is when you can set a budget against each category and allocate more on categories bring you joy and less on areas that don’t excite you.
For most of us, salary makes up the bulk of our income. If you want to increase income fast, you should find ways to increase your salary. This includes job hopping, working towards a promotion or asking for a pay raise.
Alternatively, you start building our sources of income. This can be from your side hustles such as giving tutions, or collecting rentals if you have extra room to rent out. Or the most common collecting dividends from stocks. For me, dividend forms my 2nd source of lincome.
Once you have managed to do the above, then you can decide what to do with the excess money that you have saved. Before you start investing, make sure to have an emergency fund of at least 6 months of your expenses.
You earn less than 1% of interest by saving money in your bank. That is why in order to build wealth, you need to start investing. There are tons of option out there these days, from regular saving plans (monthly investing plan), to robo advisors. The difference being with robo advisor, they will do portfolio rebalancing automatically. If you have lump sum of money, you can also do your own stock picking. However, you have to take time to learn about the companies you are investing in. I do a mixture of both.
These are the steps I’m currently taking to become financial independence. I like to think of these 3 parts as 3 pieces of jigsaw puzzle where you cannot complete without all 3 pieces.