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There are four, overall stages along the path of financial independence. Each stage builds upon the other much like algebra. As you move further along the path, your financial picture becomes a stronger foundation.
Defense and Security
This stage provides for food, clothing and shelter and really, nowadays, you should include health insurance here as well. If you lost your job at this point, your passive income will allow you to survive, the necessities will be covered. The benchmark at this stage is having enough passive cash flow to cover your monthly expenses. If, for example, you have $3,000 a month in expenses and $3,000 in passive cash flow from covered calls, dividends and rental property, then you have arrived at stage one. Technically at this point, you are financially free but in order to have greater riches that will allow you to give more money away, buy more toys and have control over your time, you need twice the amount of monthly expenses in passive cash flow which brings us to stage two.
Having a Chair When the Music Stops
Stage two is about two things:
1.) Having twice the amount of monthly expenses in passive cash flow. (for example: with expenses of $3,000 you will need passive cash flow of $6,000 a month to fulfill stage two.)
2.) Ensuring that you have a nice chair to sit in once the music stops.
As I stated previously, “having a nice chair” means the ability to buy luxuries over and above the essentials and allows you to indulge in a passion that you truly enjoy instead of a job, unless of course you love your job. Stage two is all about building a nice place to sit once the music stops and making sure you enjoy sitting there. In many ways, the fulfillment of the nice chair analogy ensures that if you left your job today, you wouldn’t be bored and would have the means to indulge in passionate work. Again, if you enjoy your job then by all means keep it.
Also, it is perfectly plausible for one to become completely financially independent say through property managed, passive cash flowing rental property, which would allow you to sit around and fart in a bathtub all day. Some would enjoy this. Many would not. The real questions are: would you go back to work? Would you keep your job? Would you turn a hobby into a small business? Would you to devote more time to family and charitable work? Is the financial independence structure working, e.g. is the cash still flowing in? This is the main focus of taking the last steps to financial independence and the focus of the second part of this book which will help you evaluate these questions.
Attaining Control, Ultimate Freedom and Riches
As I stated in the introduction, stage three is the ultimate goal of the financial independence path. Once the necessities have been taken care of, (food, clothing, shelter and health insurance) and a nice chair to sit in once the music stops has been built, (twice your monthly expenses) it is time to increase your wealth even more, give more away, spend more time with family, indulge in other hobbies, turn your hobby into a business, buy more toys, volunteer. Stage three is the point at which you have at least $10,000 a month in passive income flowing in from assets, if your expenses are $3,000 a month. What follows are the common size definitions for the progressive financial independence stages.
Stage 1: Monthly Passive Income = Monthly Expenses
Stage 2: Monthly Passive Income = 2X Monthly Expenses
Stage 3: Monthly Passive Income = 3.33X Monthly Expenses
Stage 4: $100,000 in Monthly Passive Income
Examples:
Stage 1: An individual has $1,000 a month in expenses and $1,000 in monthly passive income from dividend paying stocks.
Stage 2: An individual has $3,000 a month in expenses and $6,000 monthly income from a combination of rental property, dividend paying stocks and covered call options
Stage 3: An individual has monthly expenses of $3,000 a month and passive cash flow of $10,000 a month from a combination of assets; rental property, dividend stocks, covered call options, a small business writing and publishing books.
Stage 4: In addition to the assets mentioned in stage three, an individual generates $100,000 in monthly passive income by adding book royalties, IP licensing income, and a big business to the cash flow pot.
As you can see, there is a stage four of $100,000 a month in passive income which truly is the land of ultimate riches. This is a far-reaching goal that should be kept on the radar screen but is outside the scope of this book. As you can see, the first three stages are tightly grouped cash flow-wise and are thus the within the focus of Taking the Last Steps to Financial Independence.
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