This is a guest post by blog reader and finance expert Brian Davis.
“Retirement” is becoming a fuzzier word.
In the past it meant ceasing to work, at the end of a long career. Nowadays, you have 35-year-olds quitting their full-time jobs and working in the gig economy when it suits them and their family. Are they “retired”?
I believe that financial independence is a better term – and a better goal for most fathers. Financial independence means no longer being dependent on a full-time job to pay your bills.
How would your life be better if you were untethered from your job, able to prioritize your family, and work only when it suited you? It’s the ultimate work-life balance. But what does it take to get there?
Replacing Active Income with Passive Income
The strategy to reach financial independence is simple: you replace your active income with passive income. Active income is money that you have to work for, trading hours for dollars. Passive income is money that arrives in your bank account without you having to labor for it.
For fathers who want to unchain themselves from their full-time jobs, to spend more unstructured time with their family, a new car or house won’t help them. Replacing their active income with passive income will. Passive income requires investments though, and investments require savings. So where do you begin?
The “B Word”
No one likes the word “budget.” It conjures up all kinds of unpleasant associations like “sacrifice” and “discipline.” The less income you spend, the more you can invest, of course. But the other benefit is that you’ll need less to reach financial independence.
Retirement advisors talk about the “4% Rule,” or its corollary, the 25X Rule. In short, it’s a rule of thumb that retirees need a nest egg at least 25 times their annual spending. If you want to spend $40,000/year, you’d need $1,000,000 in investable assets.
That’s a lot of savings. Fortunately, there are ways to cut that down (for example rental properties can lower your retirement numbers significantly), but right now I want to illustrate a simpler point.
Every dollar you spend needs $25 in savings to replace it. For every $100/month you spend on lattes or cable TV, that’s another $30,000 that you need to save. No, really: $100 x 12 = $1,200/year in spending, and $1,200 x 25 = $30,000. That’s why it’s so important to slim your spending, if you want to untether yourself from your job sooner.
Budgeting in Practice
The average American family spends 70% of their income on just three things: housing, transportation, and food. That makes these a prime place to start trimming.
Start by cutting out most meals prepared by someone else. Make your own lunch. Cook every dinner. Instead of going out to a restaurant with friends, invite them over (you’ll save on babysitting costs, as a bonus). Instead of drinks at the bar, have a beer fire.
Do you need as many cars as you have? Cars come with a slew of hidden costs; maintenance and repairs, insurance, gasoline, parking, often interest to a bank. In fact, NerdWallet estimates that owning a car costs over $10,000/year on average. Could your family share a car, by biking more, or carpooling more with friends and neighbors? What about taking advantage of public transportation? That doesn’t have to mean riding a bus; it could mean taking Ubers, or trains, or other local options.
Then there’s housing. The most obvious strategy is to move into a less expensive home, but it’s far from the only option. Have you considered house hacking? In short, it means creatively having someone else pay your mortgage. Could you rent part of your property on Airbnb? How about putting up an exchange student for a stipend? Or setting up the basement for a college student to rent it?
As a final tip, set your savings rate target first, and work backward from there to figure out how to pay for it. Set up automatic transfers for your savings, to take place on the same day you get paid, to make sure it’s the first “bill” paid from your paycheck.
Investing for Passive Income
After slimming your spending and starting to build a reservoir of savings, how do you actually start earning passive income? There are dozens of options for passive income, but the three most common are dividend-paying stocks (or mutual funds), bonds, and rental properties.
Admittedly, I’m biased about rentals, since passive income from rentals is what I teach. But two huge advantages to rentals include your ability to predict their returns (through cash flow calculation) and to control those returns (through proactive property management, such as rent deduction from the tenant’s paycheck). Contrast that with, say, a stock pick – you can’t predict or control whether that company will grow or go bankrupt, you can only buy and hope for the best.
If you could afford to live on half the income you currently earn, how much more work-life balance could you create?
The more active income you can replace with passive income, the less you’ll rely on your job, and the more flexibility you’ll have to prioritize your family.
About the Author
Brian is a real estate and personal finance writer, who offers a free mini-course for working parents on creating passive income from rentals. You can contact him, take his course, or read more about passive income and rental investing at SparkRental.com.
Thank you, Brian, for the great advice! While we are all in different financial situations, I firmly believe that managing one’s finances gives you more options on how to best use your most valuable resource- time. There are lots of great guides (including chapter 2 of The Working Dad’s Survival Guide) that can help.
What do you think about passive income? The financial implications of work-family balance? Let’s discuss in the comments.
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