Modern life has spoiled us when it comes to having things done for us. Its been about 15 or so years since I used an actual map to find my destination. I’m not sure I could go back to it with much success after becoming hopelessly reliant on GPS. Unfortunately such a device has yet to be invented for real time turn by turn directions to financial freedom (at least not for us starting at the bottom). Still, there are countless resources out there to provide us with ideas to help point us in the right direction.
So I thought to myself, “self, why don’t you write down a simple model that others can use as a jumping off point?” Then I thought “stop talking to yourself like a psychopath”. Nevertheless, here is my simple look at what a game-plan for financial freedom may look like for the average person to.
Pinning down the average income was a very difficult challenge. The household median salary for 2019 was $61k, but the median individual was $31k. The thing is, median does not mean average, its just the middle. So this that doesn’t necessarily paint the best picture. Average doesn’t necessarily do justice either because some outliers really skew the numbers. For example, if it were between Jeff Bezos who’s annual earnings are estimated at $78.5 billion and 100 individuals making $15,000 per year annual income then the average income would be estimated at $777 million per year.
So I picked a nice round number that seemed reasonable based on the available data which was $40,000. Factoring in 401k contributions, taxes and insurance that should leave roughly $28,000 per year that you actually receive in your bank account. OUCH!
The best practice for finding a home is to spend no more than 25% of your monthly gross income on your house or rent payment. That means for someone making $40k per year the maximum housing cost they should take on is $833 per month ($40k/12 = $3,333.33 x .25 = $833.33). The average utility bill in the US is $112 per month, food spend is $500 for an individual, the average vehicle expense is $710 per month and the average entertainment spend is $200.
Now Lets take Stock of Things
If you have an annual income of $40k, then the actual take home pay is roughly $28,000. That gives you monthly cash flow of $2,333. So what does that look like based on the averages?
The disposable income is unfortunately negative based on this. That helps to explain the massive credit card debt we see in America But lets modify a little, my suggestion is that your monthly spend on your vehicle be no greater than about 20% of your net income (fuel included). It may sting a bit now to forego driving around in the car that’s keeping up with your nemesis Steve at work.
But in the long run Steve will be sobbing when he’s working well into his 60s and you’ve been sipping mojitos on the beach getting fat for years. So, back to the here and now, what does that tweak look like?
Much better. Not perfect, but there is disposable income now. So how do we make this work for you? You’ve got food, shelter, electricity and a little entertainment/cloths spend $218 of extra in your budget.
For the sake of making things simpler lets contribute the $18 to a savings account and work with an even $200 going forward. So lets take stock, since we’re dealing with a cash flow of $2,333 with a disposable income of $200 then the immediate cash flow requirement is $2,138 per month.
I’m sure you don’t want to lose a single cent of that $200 per month that you’re working hard for. That being said, a diversified portfolio is probably the best way to approach this. My preference is to have no less than 3 truly passive sources of income.
Making your first pick a stock means gaining equity and maintaining liquidity so you can take it out if you ever need to.
My second pick is Peer-to-Peer Lending because can offer a fairly high return while allowing you to reinvest and start compounding quickly. This is a little higher risk, but in my opinion worth it as my annual return has been about 24%.
The third is a relatively new investing platform called Driverloans. This offers a 15% annual return, but requires you to commit your cash for at least 3 months (the longer term the greater the return with 15% being a 1 year commitment).
Stock and Dividend Investing
The medium I use for stock investing is Robinhood, much like every other millennial. (If you haven’t gotten started you can earn a free stock by signing up from my link). The strategy I take is investing for dividend income and growth. I prefer stocks and REITS to be at least 50% of my total portfolio because it is historically a safe bet given you have a good mix of investments. My top 5 picks are SPLV, Coke, AT&T, Home Depot, and McDonalds. I invest in more, but these are good core stocks in my opinion.
The reasoning is that SPLV is a conglomerate of dividend stocks. Its is generally one of the most steady and dependable stock choices I’m aware of. Its dividend payout is 2.57% per year.
Coca-cola (3.51%), Home Depot (2.216%) and McDonalds (2.642%) are all dividend aristocrats. That means that they have historically raised their dividends year over year and are very likely to continue.
AT&T is a strong, stable company with an extremely impressive dividend of 6.837% and has generally experienced stable earnings.
To me these give a reasonably good mix of the economy as a whole. You can try spreading out your investments among these just adds another layer of security for me.
My choice here is is LendingClub fore no real reason other than this is what I tried first. The average return using lending club is advertised between about 6 and 8 percent, but there’s a little more to it than that. The way loans work an 8% interest rate on a 3 year loan of $1,000 (LendingClub offers 3 and 5 year loans) actually provides a total return of $128 or 12.8%. You can actually take this a step farther and leverage your money a bit more.
LendingClub only requires a $25 investment for a single loan. So assuming an initial investment of $1,000 at 3 years per loan you would receive about $25 per month of your principle back. If you reinvest your principle each month then by the end of the first 3 year cycle your actual return on principle would be closer to about 20% (more if you reinvested the interest as well).
This is more or less a straightforward 15% interest with not much leveraging you can do. It has limited liquidity, but not a great deal of risk involved either. The initial requirement is $50 so the expected return for 1 year should be about $7.50 on $50. Once your initial investment is in you can add in increments as low as$5.
Let put this all together now. Understandably, with only $200 per month to invest the results won’t seem groundbreaking at first. Thankfully, each month you invest your disposable income will grow. This is through your passive income streams which accelerate any further growth. Assuming a mix of about 50% in stock 25% in P2P lending and 25% in Driverloans, your money growth may look something like this.
Your income would be growing at about $1.12 per month. In other words, if your disposable income this month is $200, next month it will be $201.12 and the following would be about $202.25 (the rate of growth should increase month over month as well).
The Long Game for Financial Freedom
We established earlier that the income need we are looking at is about $2,138 per month. So at first glance it looks like it would take 1,909 months or 159 moths to get there. That’s horrible. Thankfully, the power of compounding interest really helps a lot. If you reinvest then that 159 years can become a bit more reasonable pretty quickly.
In fact, assuming you reinvest every penny generated by your investments, then in only 22 years the investments should provide an income equal to the needs. If you did this then your portfolio would likely look something like this:
Meaning you would have a total equity of about $239,000 and a yearly passive income of $25,778 or a monthly income of $2,147.
Reality of Your Financial Freedom Journey
I get it, you don’t want to wait 22 years for all that. What’s worse is that by then $2,147 per month will be worth less than it is right now. Dang inflation. We’ll here’s the thing, the calculations I just mentioned didn’t factor in the dividend aristocrats. Or rather, it doesn’t factor raising their dividend rates. It also doesn’t take into account your personal raises or promotions ( I recommend putting back about half of the take home from any raise you get).
More than that though, any chance you get to make a side income will take months off of your time to freedom. For example, $20 today in the stock market in SPLV should equal about $36 ten years from now. It should also offer a dividend payout of about $0.91 per year. That doesn’t sound like much, but money today is worth more tomorrow when its invested.
In all honesty, this may be a lot of shallow information. Nevertheless I hope it gives you some ideas of how to break out of a 9–5 job. Research before investing, and begin taking steps to generate some passive income and create some financial freedom for yourself. The more you cut expenses and are able to invest the quicker you can become self reliant.
Compound interest is a powerful force that can catapult you toward your financial goals Unfortunately it loses its potency with every passing day because its dependent on time. Waiting to get started is costing future income and equity. There have never been as many opportunities for passive income and “side hustles” as there are today. Now is the time to take control of your finances and make some big moves.