Postpone Your Investing Plan !

Do you know your monthly expense ?

In other words, do you have budget? Maybe you ask, “Why do I need to know this?” Well, this is something to do with the very fundamental of investing. Investing is basically to make your spare money making more mpney. The keyword is spare.

For example: if you earn regular salary of $50,000 per year. You need to know how much exactly you take the money home after tax. Say if your income tax is 30%, then your “take home pay” is only $35.000 per year or $2916 per month. How much you need for mortgage? How much for grocery shopping? How much for credit card repayment? Electricity or Gas bill? Phone Bill? Car Insurance? School Fee?, etc.. The bottom line is,  you need to know exactly whether or not the “take home pay” that your have will be enough to cover everything. Only then you will know how much the “leftover” for your “investing” account.

If your pay is not enough, then you need to do some actions to reduce your expense or increase your pay. Budgeting will definitely can help you in this matter. If you have never make a budget, you might be surprise that it doesn’t have to be fancy – just like this will do.

Investing Carry Some Risk

Emergency Fund Before Invest

Then, as you probably know already, investing has some risk. Some risk higher than the other, some can be mitigated or even eliminated, but small or big there is risk involve.

For example: if you “invest” your next month homeloan/mortgage money to buy some stocks in stockmarket and “hoping” that it will produce extra profit, then this is not investing. This is more “gambling” than anything else. What if the stockmarket crash? — happened several times already and make you cannot pay your mortgage? Will it be a start of a disaster? You betcha….

So, as hard rule, any money that you are willing to use for investing, you need to be able to (of course, you don’t want and should not) lose it all without affecting your life. If the result of your “investing” activity is very crucial for your day to day life, then it’s very risky activity – definitely not investing as it is.

Emergency Fund /Money – A Must Without Question: The Financial Protection

One more aspect of investing , sooner or later, everyone of us will experience something bad happen in our life. When it comes to financial matter, having an emergency fund can be very important to overcome the problem without ruining your long-term life. For example: what happen if suddenly the economy collapses and you got no job anymore. How do you survive ?

Therefore as rule of thumb, before doing any investing, you need to save money first to get this “emergency fund”. How much ? It should be at least 6 months worth of your living cost. If your living cost is $2500 per month, you need to have at least 6 months x $2500 = $15,000 in your hand. Cold hard cash of $15,000 should be in your pocket or your saving account all the time to weather any problem. Of course, the assumption is , if something abd happened, you should be able to recover or improve the situation within 6 months.

This financial protection is actually the first level of what so called “financial freedom” – read more here.

What You Will Do

So, what you will need to do is:

1. Have a budget to know exactly your living cost and potential saving
2. Collect dollar by dollar until you have 6 months worth of living cost in the bank! This is your emergency fund – once you get it do not touch this – only for emergency.
3. Collect dollar by dollar until you have good capital to start your investing (maybe at least $10,000)
4. Start doing your investing strategy
5. Review budget and add more emergency funds once you start earn more money from investing
6. Build your investing portfolio to earn more passive income

Investing Become More Enjoyable

Once you do the above, investing will become more enjoyable. The money from your salary will keep supporting your living cost. But you have other “investing money” that worst case , if the investment tanks, it will not disrupt your life. And more importantly, your “investing” is no longer “gambling” where you force the result to be always good. Remember in investing, sometimes you win sometimes you loss, but you need to make sure you win more than lose.

So, postpone your investing desire as yet ! Do the above !

For example: if someone asks how much money need to have before considered financially independent? Person A say: “a lot of money”, Person B say: “$1 miilion per year passive income”. Which one is easier to visualize, an abstract definition from Person A or Person B?  Of course from person B.

Freedom with No Burden !

This step is absolutely crucial to start your financial freedom journey. Why? By having this milestone, your goal is no longer MOVING TARGET. It’s fixed and written black on white. You can put it on your file, paste it on your wall, etc and become your tangible goal. You are no longer shooting in the dark, you have real figure number as your target.

5 Levels Toward Financial Freedom

Toward Financial Freedom

There are 5 milestones that help you achieve financial freedom. You need to get to Level 1 before go to level 2 and vice versa. The levels are:

1. Level 1 – Financial Protection
2. Level 2 – Financial Security
3. Level 3 – Financial Independence
4. Level 4 – Financial Freedom
5. Level 5 – Absolute Financial Freedom

Level 1 – Financial Protection

Financial Protection is achieved one you have 6 months worth of cash to meet all basic needs to survive without anybody need to go to work. So, if something bad happened, you have full 6 months to back to your feet again but continue your life as it is. So, what you need to define your level is your monthly cost or overhead.

This include all basic living cost: food, clothes, transport, all bills, insurance, home maintenance, credit card repayment, mortgage, basic entertainment, etc. But no holiday, no saving or other major purchase included. Only everything that needed to continue ‘normal life’

Example: John and Jane requires in average $3000 per month to meet all basic living cost. Hence their level 1 – financial protection is 6 x $3000 = $18.000. So, once they have $18,000 in the bank, they can survive for 6 months without having to work but can still be able to live as normal.

Level 1 – Financial Protection for John and Jane is $18,000.

Do not put this money in term deposit or the like. Put it on your daily saving account or any account that accessible from your ATM card. You might consider have stack of cash from this money. This is pure for emergency only.

Level 2 – Financial Security

Financial Security is achieved once your investment can produce 12 months worth of all basic living cost. This is not your income from work, but only from your investment such as: profit from share market, profit from your investment business, interest from your term deposit, your rent income from your positive cash flow property, etc. This is a passive income that provide you with financial security

Example: With $3000 mothly cost, then John and Jane’s investment need to produce $3000 x 12 = $36,000 profit per year before they can get Level 2 – Financial Security status.

Level 2 – Financial Security for John and Jane is $36,000 per year passive income

What sort of investment can produce this kind of passive income ?

• Cash interest. With 5% interest from your term deposit, $100,000 deposit can produce $5k per year, hence to produce $36k per year, they need to have $720,000 in a bank.
• Share market strategy. With typical 15% return from share market strategy, $100,000 portfolio will produce $15,000 per year. Hence $36k can be achieved if they have $240,000 as their portfolio.
• If you own profitable business that can produce 20% of return, then $36k can be produced if you have invested $180,000.

Of course you can do combination from all of them. The higher the return, the less capital needed to achieve the goal.

Level 3 – Financial Independence

Financial Independence is achieve if the investment can produce profit equal to your combined annual salary / current earning. So, at this stage your total income is basically doubled. In other word, income from your investment have produce the same amount of money that you can get from salary or work.

Example: John and Jane have total combine annual salary of $90,000 per year. Then their investment income need to produce $90,000 as well before they can hold Level 3 – Financial Independence status.

Level 3 – Financial Independence for John and Jane is $90,000 per year passive income

Level 4 – Financial Freedom

To achieve Financial Freedom (Level 4), the investment / passive income need to produce not only whatever you get from Financial Independence, but also 12 months worth of all the cost needed to cover the living cost plus all lifestyle and luxury item. All from your investment income. So, at this stage you can cover all the living cost plus lifestyle cost just from passive income derived from your investment. You still have additional earning from your salary / work. But obviously you no longer have to work again.

This additional lifestyle/luxury item can be calculated using the interest payment as if we get a loan to get hold of that item. (i.e: controlling vs owning, see the article)

Example: John and Jane have 3 lifestyle items that they really want to have once they have financial freedom:

1. $200,000 boat. With 8% interest, the monthly repayment will be: 8% x $200k * 1/12 = $1334 per month
2. Charity $1000 per month
3. New house of $1.5 million. Monthly repayment: $10,000 per month assuming 8% interest
4. Total these 3 items above is $12,334 per month/$148008 per year plus $90,000 = $238,008

Level 4 – Financial Freedom for John and Jane is $12,334 per month passive income

Level 5 – Absolute Financial Freedom

Your investment income have absolutely covered all your expendentiure beyond your imagination. Absolutely everything that you can buy with money in the world. For quantitive sake, let say at least you have 3 times the amount from Level 4. Hence :

Level 5 – Absolute Financial Freedom for John and Jane is $37,002 per month passive income

The Capital

The capital needed is really depended to the return expected from the investment. Say if the return of investment of cash is 5%, share market is 15% and business investment is 20% and John and Jane decide to invest 20% of their money as cash, 50% as sharemarket investment and the rest is business investment, then the capital neede for each level is as follows:

To reach your ‘critical mass’ of capital the soonest, you need to use the power of compounding interest. That means you always invest back all the profit from one period to the next periode. i.e: $10k investment with 10% return will have $1k profit. All of this profit and capital (total $11k) is invested to the next period that yield $1.1k profit, and vice versa.

What’s Next

Now that you have understood the meaning of the 5 level above, it’s time for you to calculate your own number. Remember you just need 3 data: monthly cost, annual income and monthly cost for lifestyle/luxury item. Then just use “Toward Financial Freedom” to calculate and print your pledge.

Then you have taken your first step toward Financial Freedom. Congratulation !

Recommended Readings:
[1] “7 Habits of Highly Effective People” by Steven Covey
[2] “What I Didn’t Learn AT School But Wish I Had” by Jamie McIntyre. The digital version of this book can be obtain legally and free of charge by clicking here. Some minor modification to enhance the definition has been applied on this article but did not change the big picture of the understanding.