There is a very small but growing group in the financial independence (FI) movement. Being financially independent does not mean you have to be retired. It can simply mean you have enough money to vastly expand your choices in life.
Some people do pursue FI for the goal of early retirement (or maybe just retirement), but I personally don’t recommend early retirement. If you have a job that you hate or just aren’t passionate about, it is fine to set goals to leave that job. However, even for those who have a lot of money, I still recommend that people act in a productive way, as you will likely get more fulfillment out of life. It doesn’t have to be your typical cube job though. It can mean pursuing something you are passionate about.
There are typically three aspects involved in becoming financially independent:
- how much you spend (or conversely, how much you save)
- how much you make
- how you invest
I find that any subject that comes up is some variation of these three when dealing with accumulating wealth.
It is obviously far easier to reach financial independence if you make a high income, and I find that some people don’t focus enough on the income side of the equation.
However, it is impossible to reach financial independence, or save any money for that matter, if you always spend every dollar coming in. Therefore, the spending side (which is also the savings side) is an important part of the equation.
I actually think the investment side is typically the least important, but I do cringe when I hear people say they are investing all of their money in a stock market index fund. Personally, I recommend a permanent portfolio for safety and stability.
On the spending topic, the two biggest expenses that you can control are typically cars and houses. Taxes are probably your biggest expense whether you know it or not, but most of that is out of your control except to the degree of taxes you pay in accordance with how you make and spend your money.
When it comes to buying a car or a house, the debate is often whether to buy or rent. In the case of a car, we would say buy or lease. There is obviously the issue of price, and most people pursuing financial independence, and those with some degree of frugality, are going to agree not to go overboard. You don’t buy as much house as what you qualify for in a mortgage. You don’t buy a $40,000 car either just because you can afford it.
I think one important element that perhaps doesn’t get discussed enough is how long you keep the items you buy, especially when it comes to these two categories. It certainly does get discussed in FI circles, but I think it is important to point out that it is really one of the main keys to financial independence.
If you are buying a house, it isn’t just a question of how much house to buy. A big question is: How long are you going to live there? In my opinion, if you aren’t planning to live in the same house for at least 5 years, then I don’t think you should buy. You should just rent. There are major transaction costs in buying and selling a house aside from the actual process of moving. When you add in all of the closing costs and agent fees, you may be talking $20,000 or more for the average house.
You may get lucky and see the value of your house go up in the time period that you live there, but that is leaving it to chance. If there is approximately no change in price from when you buy and sell, then you will lose money if you live there for 5 years or less, and maybe far more. You aren’t going to be paying down the principal balance on your mortgage enough to cover the closing costs.
The one exception to my rule is if you are planning to buy another house in a similar area in 5 years and then rent out the house you had been living in. But in this case, you are not planning to sell in 5 years. You are just planning to move.
In the case of a car, most FI people will say to buy instead of lease. I think this is usually correct, but even here there are exceptions.
Then you get into a debate about whether to buy new or buy used. I have found that used car prices are so high that it is often just better to buy new in some cases, especially as compared to buying something just a few years old.
I have seen used cars that are 3 years old that are selling for around $4,000 less than a brand new car would cost. Personally, I think it makes more sense just to buy the new car with the full warranty, the new tires, the new battery, and new everything else in this situation.
The key here though is that you keep the car for a long time. It is people who have a high turnover rate with their cars who are typically making poor financial choices. If you buy a new car and drive it for 15 years, then you have done well. Even if you took out a five-year car loan, you were able to drive the car for 10 more years without a payment.
If you are frequently buying a new (meaning different) car, then you are going to lose financially. You are paying the transaction costs on both ends. I find that most people who operate this way just accept the fact that they always have some kind of a car payment.
In conclusion, if you are looking to become financially independent, or to retire one day, or even to just save some money for a rainy day, then you should buy things you need and hold on to them for a long time. This is a way to be able to save more and spend less. It makes for a more likely path to financial independence.