Woohoo! It’s Independence Day, my favorite holiday of the year. Life is good and it’s easy to take freedom for granted sometimes. I am very grateful that we live in a country where we’re free to do almost anything we want (within reason). The US has its share of problems, but they are relatively minor compared to many places in the world. Most of us have a very good standard of living and we should be thankful for that. This year, we’re going to relax at home, BBQ some ribs, go swimming, and enjoy the Blues Festival. The fireworks should be a ton of fun as well.
July 4th is also the perfect day to declare your Financial Independence Day. Financial independence is about having the freedom to work the way you want. We live in a free country, but most Americans are completely dependent on their employers. If you leave your job, would you be able to maintain the same standard of living? Once you’ve achieve financial independence, the income from your investment will generate enough money to cover your expense. Life will be full of possibilities then. Imagine what you would do if money isn’t an issue. Would you keep working in the same job or try something else? You can follow your dream and dictate your own agenda. You’ll be the one to fire your boss when you decide to retire instead of the other way around. Now, that’s freedom.
Financial independence (FI) is a concept many aspire to, but only a few achieve. FI is difficult because it can only be achieve with deliberation and perseverance. It is a simple concept, but the execution can take a lifetime. Here are the 3 essential steps to financial independence (more in-depth article through this link.)
- Track your finance– Most people have no idea what they spend their paychecks on. Money flows through their hands like water. The first step toward financial independence is to figure out how to cut back on unnecessary expenses. This can be done by tracking your expenses carefully and getting rid of the expenses that don’t add real value to your life. The goal is to spend less than you make. As long as you can achieve this consistently, your finances will keep improving.
- Save and Invest as much as you can– The next step is to save and invest as much as you can. This will determine how fast you can reach FI. If you save 10% of your income, it may take 50 years to achieve FI, i.e., a lifetime. However, if you can save 70% of your income, you will most likely reach FI in less than 10 years.
- Passive income exceeds expenses– It’s simple, once your passive income exceeds your expenses, you will be financially independent. There are other ways to define financial independence, but this is the safest way. You will never run out of money if your passive income covers your cost of living. It’s best to build in a little margin, of course. The expenses will inevitably increase over time.
Financial Independence Day
Our FI goal is to generate enough passive income to exceed our expenses by 2020. Mrs. RB40 plans to retire by 2020 and it would be ideal if our passive income can cover our expenses by then. Right now, we could support our lifestyle with the combination of passive income and my online income. However, the online income is volatile and we never know how long it will last. We’ll keep on ramping up our passive income and shoot for completion by 2020.
Coincidentally, July 4th is the half way mark of the calendar year. It’s a great time to take stock and see if we’re on track. I do this by checking our FI ratio. In previous years, I only checked it twice per year. Now I do it every month in our monthly passive income report.
FI ratio = passive income / expense
Once our FI ratio consistently tops 100%, we’d be set financially for the rest of our lives. Here is how we generate our passive income.
- Dividend Portfolio– The dividend stocks in our taxable brokerage account.
- Rental properties– We have a rental duplex and own half of a one bedroom condo.
- Real Estate Crowdfunding – This is our first year at RealtyShares. It is looking good so far and I’m looking to add more investments here.
- P2P Lending– Unsecure personal loans through Prosper.com.
- Interest– This is the interest from our saving account.
- Joe’s Retirement Accounts– My 401k, rollover IRA, and Roth IRA. These are pretax accounts.
- Mrs. RB40’s Retirement Accounts – Mrs. RB40’s tax-advantaged accounts.
Some of these are tax-advantaged accounts and we don’t plan to access them yet. We’ll focus on reaching 100% FI ratio first. We’ll deal with the taxes and how to access the pre-tax accounts later. The best way to minimize tax is to build a Roth IRA ladder. Assuming the law doesn’t change too much, we should be able to access our retirement funds without paying the 10% penalty.
Passive Income 2017
For this post, I’ll only look at passive income and ignore gains and losses.
2017 is looking really awesome so far. Our passive income streams are doing much better than the previous year. Let’s go through them one by one. We should be around 50% mark because we are half way into 2017.
- Dividend Portfolio– We’re doing quite well with our dividend portfolio. I’m pretty sure we’ll break $12,000 by the end of the year because I recently transferred some money into this account.
- Rental Properties– We are way ahead in 2017 with our rentals. We haven’t had any big repairs this year so the income had a chance to accumulate. This might be our best year with the rentals yet.
- P2P Lending– I’m slowly pulling money out of P2P lending and investing in real estate crowdfunding instead. The return seems to be on par and real estate is much more tangible than unsecured lending. Unsecured loans will be the first thing borrowers default on when the economy turns south.
- Real Estate Crowdfunding – I opened an account at RealtyShares in January and invested $8,000 in a commercial property in Arizona. The ROI for this project is estimated to be in the high teens after 3 years. That’s amazing and I’m anxious to see if they can deliver.
- KickFurther – Kickfurther is similar to P2P lending, but investors lend to small businesses instead of individual borrowers. I’m slowly pulling out of KickFurther as well. It’s been fun, but small businesses have too many problems.
- Interest–This is the interest from our banking accounts.
- Retirement Accounts– Our retirement accounts are all invested in low cost Vanguard index funds. We are a bit behind here because most of the dividend will be paid out in Q4. I think we will be okay here.
You can sign up with Realty Shares through this link if you’re interested in real estate crowdfunding. I will write about my experience investing with RealtyShares at some point. Currently, only accredited investors can invest at RealtyShares. Accredited means your annual income exceeds $200,000 or your net worth is at least one million dollars. You can still browse the investment listing even if you’re not accredited.
What about the FI ratio? How are we doing so far?
FI ratio = passive income / expense
Our FI ratio = $22,503 / $23,856 = 94%
Wow, we’re doing very well with our FI ratio this year. At this rate, Mrs. RB40 might be able to retire before 2020! The big difference this year is the rental income. We haven’t had any expensive repairs so the YTD rental income looks great. Our expense is also a bit lower than in 2016. Our kid started kindergarten at the local public school so we didn’t have to pay for preschool anymore. RB40Jr has more activities and lessons, but they are still cheaper than preschool.
There is still a little gap between our passive income and our expenses – $1,353. My online income can easily cover this gap so I feel pretty good about that. A big part of my early retirement strategy is to work part time. This way we could put off withdrawal from our retirement accounts until we’re about 55. A little active income goes a long way in retirement.
Unfortunately, I’m pretty sure we won’t be able to maintain 94% FI ratio for the rest of 2017. Our expense will increase in the 2nd half of 2017. We’re paying for summer camps (childcare) in the summer and we have a few vacations coming up. The 2nd half of the year is usually more expensive for us. We’ll see how it goes.
To reach 100% FI ratio by 2020, we need to increase our FI ratio every year. Here is the progress we need to make.
- 2015: 54% ($28,415/$53,037)
- 2016: 71% ($38,222/$54,000)
- 2017: 78% (We doing great so far this year at 94%.)
- 2018: 85%
- 2019: 92%
- 2020: 100%
All in all, I’m very happy with our progress through the first half of 2017. The 2nd half will be tougher, but we should be able to exceed 78%, my goal for 2017. Anyway, it’s a great idea to keep track of your personal FI ratio. It will let you know how much progress you are making toward financial independence. It is also a good early warning system. If your FI ratio decreases, then you know you need to fix something.
Do you keep track of your passive income vs expense? The ratio should improve every year if you hope to reach Financial Independence.
If you plan to track your passive income, you should consider signing up for Personal Capital to help manage your investment accounts. They are very useful and I can get all my passive income data from one site.
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.