Achieving financial freedom means having enough investment income so that you don’t have to work for a living. When your investment income exceeds your living expenses (including taxes), you no longer need a job to pay your bills. Of course, you don’t have to quit your job once you achieve financial freedom, but you have instead the choice of whether or not you continue to work.
You will also want a margin of safety. If your living expenses are $5,000 a month and you make $5,000 of investment income a month, for example, you have little financial wiggle room if your living expenses spike or your investment income takes a hit. It’s better in such instances to have perhaps $10,000 or more of monthly investment income before submitting your resignation letter.
To achieve your Financial Freedom Day, you need to reduce your living expenses and increase your investment income until your investment income exceeds your living expenses by your desired margin of safety.
Reducing Your Living Expenses
The best way to reduce your living expenses and keep them low is to live well below your means. There are many good suggestions in the Personal Finance Education section of this blog. The idea is to maintain your quality of life while living it in a more frugal manner.
Borrowing money for consumption is considered “bad debt” because it costs you money. Bad debt takes money out of your checking account every month when you make the payments. To get rid of bad debt more quickly, consider a Prosper debt consolidation loan. By refinancing your debt at a lower interest rate, you will save interest expense. These savings can be used to help buy the income-producing assets you need to increase your investment income.
Increasing Your Investment Income
You investment income must come from a portfolio of income-producing assets. If you need $5,000 of investment income per month (or $60,000 a year), for example, you should work towards building a portfolio worth $1.5 million in order to be able to draw income at a 4% safe withdrawal rate.
If your investment management costs are 1% of your portfolio’s value and inflation is 3% a year, your portfolio needs to earn at least 8% (4% + 1% +3%) a year on average in order to be able to generate the same purchasing power of income on an inflation-adjusted basis.
Diversifying with non-correlated asset classes is important. Although the stock market averages 10% a year over the very long term, its returns also swing wildly on a year-to-year basis. Prosper loans, on the other hand, are correlated with the job market rather than the stock market. Hence, making loans to your fellow Americans is a way to help diversify your portfolio of income-producing assets. But since unsecured loans to people are also risky, it’s important to keep your Prosper portfolio to a small percentage (e.g., less than 5%) of your overall investment portfolio.
The only constant is change. Investment returns change. The inflation rate changes. The economy changes. You need to monitor the financial environment and make adjustments to your investment choices and living conditions as the world changes. This is an area where you need to take full responsibility for the results you get. No one else is going to do it for you.
Borrowing money to buy income-producing assets is considered “good debt” because doing so puts money into your checking account on a regular basis (so long as your investment return is greater than the interest rate on your debt). When you find the right opportunities, consider taking out a business loan on Prosper to be able to take advantage of them. With your good credit and your excellent track record of on-time Prosper loan payments, lenders will want to loan you money and you will find Prosper to be an ongoing source of inexpensive money to fund your wealth-building programs.
Making It Happen
The first decision you need to make is to decide you want to achieve financial freedom. Then commit to making it happen, whether it takes you years or decades to achieve your dream. With your decision and commitment, you will start looking for ways to increase your income, live below your means, and invest the difference. Set up a capital account and add to it the money you save by consolidating your debts with a Prosper loan (along with the many other ways you will discover to save money).
When you are tempted to buy a non-essential luxury item you just have to have, decide what you want more — the luxury item or financial freedom. Buying the luxury item will push your Financial Freedom Day further out in time; avoiding the purchase of the luxury item and putting the money into your capital account instead will pull your Financial Freedom Day in closer to the present. There is no right or wrong answer here. Rather, it’s what you decide to do with your money and your financial future.
The conceptual framework provided in this blog post will get you started on the road to financial freedom. All you have to do is reduce your living expenses and increase your investment income in a steady fashion until your investment income exceeds your living expenses by your desired margin of safety. Prosper is here to help when you need it. Enjoy your journey and may it be a profitable one.
Roger Steciak achieved early semi-retirement in 2006 and became a Prosper lender to diversify further his portfolio of income-producing assets. His book Happy About People-to-People Lending With Prosper.com, How to Lend Money to Friends You’ve Never Met was published in 2007.