There are pillars of financial freedom on the path to freedom. Along the way the same concepts apply, but in different magnitudes at different times.
Whether you are sitting here reading this with a couple of dingy nickels you scraped out of the bottom of your buddy’s couch to your name or are using 100 dollar bills as paper towels, these four pillars of financial freedom are the keys to increasing your assets.
Each pillar, while all equally important, is going to provide a different level of impact and overall magnitude to your results along the way to financial freedom.The great thing about the internet is that you can quickly find thousands of opinions, insights and knowledge on any topic you can imagine, especially personal finance.
While it is important to be aware of all the different considerations and aspects of your finances, the biggest positive impact you can have is the ability to recognize where you are in your path to being a financial badass and apply the majority of your time and energy into conquering what that is at that time. Otherwise you may fall victim to being a jack of all trades and a master of none.
Budget Like A Pro
Warren Buffet probably isn’t too concerned about his monthly cable bill siphoning off up to a couple of hundred bucks each month so that he can stay up to date on his favorite telenovelas.
However, someone who is suffering from the crushing pressure and stress of consumer debt could benefit greatly if they can peel off that couple hundred bucks in their tight budget to apply to a high interest rate debt.
Mint is one of the easiest ways to set up and stick to a budget. You can set up alerts to notify you when you are getting close to over spending in a category. You will receive a weekly over view of your spending so you can see where the leaks are coming from.
Living below your means is one of the most important aspects of personal finance and a budget is the best way to make sure you’re doing so.
If you are in debt, than budgeting is the first critical step in destroying that debt. Your debt is an emergency.
You can’t save for a home, a vacation, or a child’s education if you are drowning in debt. Particularly if it’s credit card debt because the interest rate is higher than any returns you are going to get in the market.
If your debt is mortgage or in some cases, student loan based, it’s a different story. A home is an investment (although it should never be your only investment) and many student loans have an interest rate lower than what you can get in the market.
If you have consumer debt, the only things you should be doing other than throwing every extra cent at it are saving for an emergency fund of a couple of month’s expenses and putting money into your 401K IF your employer matches. That is free money which should never be turned down.
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Invest Your Money
For someone just starting out with investing, there are a million mistakes and pitfalls that can come up; misinterpreting macro-economic trends, haphazardly ignoring concentration risk in your portfolio, human emotion and pride to name a few.
It’s important to remember that the very best portfolio managers, those who are paid millions of dollars with the singular goal of maximizing returns for their clients while managing the risks associated, are considered legends if they can eek out the slightest returns above their related benchmark.
In fact, according to the 2014 S&P Dow Jones Indices survey, 86% of active large-cap fund managers failed to beat their benchmark. These are some of the most knowledgeable, experienced and well trained investors!
I know what you are thinking, “Yeah, yeah whatever, I don’t need a complicated strategy, I am going to invest my money in X. It’s up 30% in the last 12 months and 15% over the last 3 years”. That strategy works great. Until it doesn’t.
Anyone that tells you with any degree of certainty that they can accurately predict when the tide will turn, and it will, is lying to you. Now that’s not to say that selecting individual stocks is something that is shameful or not allowed, just understand that you are taking a very concentrated risk when doing so. Therefore I wouldn’t recommend having a great deal of your total portfolio concentrated in a certain stock or market sector; diversification is your friend!
If the very best, most highly skilled investors only exceed the market benchmarks 14% of the time, why spend your time and effort trying to do it? The hours and hours of researching individual stocks, pouring over K1s, SEC filings, and annual shareholder reports are more likely to result in headaches than significantly better investment returns.
There comes a point on the road to wealth building where increasing your income or reducing your expenses has less of an effect then being able to eek out better market returns, but for many of us, that is a ways down the road. And a good problem to have!
Grow Your Income
You could alternatively spend that time developing new skills or learning something that can help you command a higher salary or start a side business to increase your income.
Here’s a quick example to illustrate this point:
Say you are a recent college grad who is just entering the workforce and looking to start on the path to being a financial badass. Congrats! You just started an entry-level job in a big company and are looking to climb that corporate ladder.
You are a LMM reader so you know the importance of starting investing early and the magic of compounding so you not only put money into your employer sponsored 401k, but you start a Vanguard ROTH IRA because you know you are going to be the CEO here one day so your taxes now are much less than they will be in the future.
You are able to put $1000 into the ROTH that first year and spend a couple of hours per week reading the latest news on the market and making educated investment decisions to pick and choose your spots.
At the end of the year, your portfolio gained 10% (Almost double!) against the broader market’s return of 6%. You develop callouses on your hands from patting yourself on the back for your investing genius.
$1000 at 10% for one year leaves you with $1100 (Basic math, ignoring daily compounding for simplicity).
Now consider this alternative. Same situation, recent college grad, new entry level job, blah blah blah. Instead of becoming a master investor, you focus those extra hours each week on networking both inside and outside your new company.
You take on some extra responsibilities that, while not resulting in immediate increases in income, get your name out there to higher ups and you prove that you can handle more responsibility. You still know the importance of investing early and drop $1000 into the Roth. But you just ride alongside Mr. Market, earning the 6%.
Additionally, at the end of the year someone you worked with on one of those extra projects drops your name as someone to talk to about a recent job opening within a different department. You of course kill the interview, have a great reputation in the company and earn the promotion, with a $4000 salary bump to go along with it,
At the end of the year your $1000 in your Roth is only worth $1060, but you now have an additional $4000 that you can drop in the Roth next year!
Just for the example’s sake, say we have the same investment results and now compare our two options at the end of year two:
Example one has $2310.
Example two has $5364!
On the flip side, having absolutely no investment strategy or acumen can be damaging. Say you threw that $1000 into Blockbuster, Radio Shack or pets.com; you’d be better off not investing at all. There is a certainly a balance of all four pillars.
Mind The Pillars
The biggest takeaway is to understand what stage in life you are in along your financial freedom journey and to effectively choose the pillar to devote the majority of your energy toward.
Understand that all four intertwine throughout your life so do not just ignore one because it isn’t the most important at the time. Become a jack of all trades, master of THE IMPORTANT ONES!
Featured Image Photo Credit: “Jack of Spades” by Poker Photos on Flickr