This was one of the first blog posts I wrote when I started this site back in 2007. It is also one of the most popular. I describes what I did in the period from 2001–2006. Maybe some day I’ll write a summary of the period 2007–2011, but for now you’ll have to dig into the blog to see what has changed and what has remained the same. When I set out on this journey in 2001, I didn’t have anyone to follow or look to for ideas. Blogs didn’t really exist and I didn’t have access to a good library, so I had to figure out most things myself. In retrospect and with more guidance I would have done it differently, much more efficiently, and with less personal hassle. So don’t think you have to follow the details of what I did to reach a similar goal. In fact, you can follow the journals of some of my readers to see how it’s done better than I did. With that in mind, here’s my story …
I posit that most people can attain financial independence in less than 10 years and in less than 5 if they are truly determined. I also submit that many people are not willing to make the necessary changes.
My journey towards financial independence was not always with financial independence in mind per se. Had that been my sole goal all a long I would have done things differently and probably faster e.g. 3-4 years instead of 5. If I had a six figure income, which I never had, I would be able to do it in 2 or 3 years. However, that’s the thing. As we gain in knowledge and wisdom our priorities change as that which was once important becomes less important as things are put in a different and hopefully bigger perspective.
First of all I have to confess that I have never been dumb with money. I believe I once made an accidental overdraft because I forgot about an automatic payment, but otherwise I have never been in the red zone. I also suspect I was born with certain miserly qualities so that I did not need to change my basic personality too much. Spending money on “spontaneous fun” e.g. perishables like candy, ice cream, parties, beer, going out… have never meant much to me. Instead I was more interested in gadgets and electronics. Basically I would discover some new hobby. Then I would save until I had the money, and then I would go out and buy a new computer, then a SLR camera, then a HiFi rack, then another computer, then a telescope, etc. Since I enjoyed gadgets a lot more than sugar, alcohol, cab fares and other things that seems to make everybody else happy, I was already ready to save for big items and thus it was not so hard for me to aim for something bigger.
The first thing I realized was therefore that my expensive hobbies had to go and be replaced with “free” hobbies, which meant no more buying toys. Instead I become interested in system administration, linux, and geopolitics, in particular resource depletion and overpopulation – which of course makes for great ice breakers at any cocktail party. I did not immediately make the connection to think of hobbies that make me money. At the time when I started saving money to keep it rather than spend it on the next big piece of electronics, I was a grad student living in a dorm room. There were 18 other people on the floor and we all shared the kitchen, 3 showers and 3 toilets. Most grad students I have known all had their own apartment, their own car, etc. and thus leave school with a degree and a ton of student debt. I did, however, not live there to save money but to meet other people more easily. In addition it was only a 10 minutes walk (or a 5 minute run) from my office and 5 minutes from the closest supermarket. Thus I did not need a car nor a bike.
The two personal finance books that have influenced and inspired me the most and which I caught hold of at that time was Rich Dad Poor Dad and Your money or your life. If I could have only two personal finance books those would be it!
Your money or your life can easily be summarized. There are two main ideas. The first idea is to calculate your real wage by subtracting taxes, transport, business clothes, cost of living (for instantly, suppose your job requires you to live in New York City), and dividing by time spent on the job, time spent on commuting, and time spent unofficially preparing yourself for your job. If you do this calculation you might find some particularly scary numbers. For instance, the hourly real wage of a commuting grad student (e.g. a highly skilled and competent person who would fetch $40-60k in the private sector) is certainly below the minimum wage. The second idea is to use the real wage to calculate the cost of something in hours. Suppose a Wii is $400 and your real wage comes to around $8/hr. Then you would have to work for 50 hours to get it. Since we only live once and never get this time back, those 50 hours have to be weighed against the game system. 50 hours seems fair to me, however, there was no way I was going to add 10 more hours on top of that by buying it on credit. In particular, I did not want to pay for my house 3 times over by getting a mortgage. Thus my initial motivation was to save for a house to avoid the mortgage interest.
Apparently the personal finance blogging community doesn’t like Rich Dad Poor Dad because it does not contain enough “actionable” items and/or because the author gave some questionable real estate advice in some of his subsequent seminars. For me, though, that book was like striking gold. It completely changed my attitude towards money from being something one spends to buy stuff to being something one invests to make more money. Leave it to me to figure out the details, I am a smart guy, but it takes a genius to create a paradigm shift and I am not a genius.
By Rich Dad Poor Dad standards I was still thinking like a poor person, saving and paying in cash and I was probably on my way to thinking like a middle class person who buys everything on credit. Instead I started thinking like a wealthy person and having my money work for me while cutting down on my liabilities and avoiding having me work for money. My guess is that it is probably easier to go from poor to wealthy than from middle class to wealthy. The middle class is weighed down by a large set of liabilities in the form of house payments, car payments, credit payments, educational payments, … Once you have those liabilities, they are very hard to give up to replace with assets.
Initially I was just putting my money in savings accounts and watching it grow. In retrospect pure savings accounts turned out to be a good idea, since that was the period of 2001-2004 which was mostly a bear market. But an important point is that I did not invest for the first 3 years out of the 5 years it took me to gain financial independence. For extreme savers, financial independence is not achieved through investing. There is simply not enough time for compounding to make much of a difference. Instead compounding becomes somewhat irrelevant as the eventual portfolio becomes more focused on preserving principal, generating income, and not suffering too much in terms of inflation and taxes.
to be continued … Read part II here.
(Much thanks to Moneymonk for asking this very pertinent question. Questions are always very welcome).