For most people, making money means working hard every day and consistently squirreling away a few nuts for retirement. But to become financially independent, you need to do more than exchange your hours of labor for dollars. You need your dollars to make money for you, even when you are not working hard.
Making money through your own efforts is limited by how many hours you can work. Financially independent people don’t have to work at all to pay for expenses because their money works for them, even when they are sleeping.
But how do you build more income from the yield you receive by investing your savings than from your hard work?
1: Make Rational Decisions About Your Wealth
If I made you an offer to accept $100 now or $150 in a year, which would you choose?
Research shows that most people would choose $100 now than wait for $150 a year from now.
If we humans were rational, we would choose $150 next year over $100 immediately because most people cannot generate a reliable 50% return annually.
So, the likelihood is by accepting $100 today, you will have less money a year from now than if you selected the $150 choice today.
Rationally, it makes no sense to virtually guarantee that you will have less money in the future yet most people still make that choice.
When you hear about saving a few bucks on a coffee each day, the decision to not make the purchase is much less about the few dollars on any given day as it is about consciously deciding to focus on building wealth over time.
You need to make the rational decision to be more wealthy in the future even though it may feel better short term to choose otherwise.
It feels better in the moment to choose the one hundred dollar bill or grab the coffee, but over time the sum of all the small decisions that give you short-term satisfaction will cost you a much larger nest-egg.
2: Create Financial Goals You Believe You Can Achieve
How did mixed-martial artist fighter Conor McGregor go from collecting welfare checks to fighting one of the most successful boxers of all time, Floyd Mayweather, in a fight billed as the first billion dollar fight?
He shared the secret in a press conference when he was asked about how he manifests his visualizations into reality:
“I see it in my head, I speak it out loud, I believe it, then it will happen”
When you look to the future, what do you visualize? Are you on a yacht in the Mediterranean? Are you living in the house of your dreams?
Do you have the confidence to say to your family and friends that you will be on that boat or living in that home within a certain time period?
Conor McGregor has the braggadocio to tell the world his goals, do you?
A Fortune 500 CEO needs to publicly state each quarter how the company he/she leads will hit financial targets in the next quarter and year.
The CEO is accountable to shareholders. And when you speak your goals out loud to your friends or family, you too become accountable.
It takes courage to share your goals because, if you are like most people, you don’t want to be seen to fail publicly.
And that’s why it is crucial to believe in your financial goals before you share them.
If you set a goal to buy a mansion in the Hollywood Hills but you don’t truly believe it can manifest into reality, then set a goal you realistically believe you can achieve.
Once you have set a financial goal you truly believe in, select a time period in which you can achieve your goal that is also feasible.
Be very specific with your financial goals. Break them down so they are achievable in small time increments.
If you want to own the mansion in the hills, how much will you need? How much will you need to save each month? How much will you need to earn?
When you specify your goals, you will have greater clarity about how to achieve your financial dreams.
Then summon the courage to share your goals publicly so you are accountable to them.
Each month, keep track of where you are compared to your targets. If you fall short one month, don’t dwell on it. Keep in mind the journey is long. Don’t let any single month throw you off track.
Stay focused and committed to your savings and earnings goals. This is your financial future after all. Nobody will care about it as much as you, not even your financial advisor.
>> Related: Retirement Planning For Dummies
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3: Make Yourself Rich, Not Your Financial Advisor
When athletes compete at the highest level, they say the same thing as Paris fashion designers: success comes from paying attention to details.
To become financially independent, you need to pay attention to the little details too.
Perhaps the most important “small detail” is fees. What do you pay your financial advisor, how much do you pay in expense ratios, and what transaction costs do you pay each year?
Fees are easily ignored because the magic of compounding is hidden from view.
Take an investor with a million dollar portfolio who meets a financial advisor charging 1.5% in annual fees.
The advisor shows the investor a historical chart of market performance over time. It seems like a compelling pitch because a 7-8% annual return outpaces the “paltry” 1.5% paid in fees.
The investor signs a contract to let the financial advisor manage their money. Naturally, the investor’s mind drifts to the happy place making $70,000 → $80,000 in possible future annual gains and neglects to pay as much attention to the $15,000 in guaranteed costs.
But stop a minute and think about that 1.5%. It seems like such a small percentage and yet it translates to $15,000 a year.
That’s almost enough to buy a new car.
How easily would you hand over $15,000 in any other walk of life? If any other sale were being made, you would probably spend a lot more time figuring out what value you were receiving from the vendor.
But it’s easy to sign over the management of your nest egg to a financial advisor without calculating the long-term fee costs.
And what’s more, management fees aren’t the only costs that can bite you later on.
When your financial advisor invests your money, it will most likely be in mutual funds that charge ongoing expense ratios to operate the fund.
If you pay 0.5% in fees to the mutual fund company plus 1.5% to your financial advisor, your total annual fees will amount to 2.0% annually.
And that’s not counting commissions costs or any other hidden fees that may surprise you.
In fact, an investor with $100,000 who earns on average 8% over a 30 year period paying 2% in fees each year will amass a portfolio worth just over $550,000 whereas an investor paying just 0.50% in fees annually will see portfolio growth of $866,000+.
| Expense Ratio | |||||
| Year | Annual Gain (8%) | 0.50% | 1.00% | 1.50% | 2.00% |
| 0 | $100,000 | $100,000 | $100,000 | $100,000 | $100,000 |
| 1 | $108,000 | $107,500 | $107,000 | $106,500 | $106,000 |
| 2 | $116,640 | $115,560 | $114,485 | $113,415 | $112,350 |
| 3 | $125,971 | $124,222 | $122,488 | $120,771 | $119,070 |
| 4 | $136,049 | $133,529 | $131,045 | $128,595 | $126,180 |
| 5 | $146,933 | $143,532 | $140,193 | $136,917 | $133,702 |
| 6 | $158,687 | $154,279 | $149,974 | $145,768 | $141,660 |
| 7 | $171,382 | $165,828 | $160,429 | $155,180 | $150,078 |
| 8 | $185,093 | $178,238 | $171,605 | $165,187 | $158,980 |
| 9 | $199,900 | $191,571 | $183,551 | $175,828 | $168,395 |
| 10 | $215,892 | $205,897 | $196,319 | $187,141 | $178,350 |
| 11 | $233,164 | $221,290 | $209,965 | $199,168 | $188,875 |
| 12 | $251,817 | $237,827 | $224,550 | $211,952 | $200,002 |
| 13 | $271,962 | $255,594 | $240,136 | $225,540 | $211,763 |
| 14 | $293,719 | $274,682 | $256,790 | $239,981 | $224,193 |
| 15 | $317,217 | $295,188 | $274,587 | $255,328 | $237,329 |
| 16 | $342,594 | $317,217 | $293,602 | $271,635 | $251,209 |
| 17 | $370,002 | $340,881 | $313,918 | $288,962 | $265,873 |
| 18 | $399,602 | $366,302 | $335,622 | $307,370 | $281,363 |
| 19 | $431,570 | $393,608 | $358,809 | $326,925 | $297,725 |
| 20 | $466,096 | $422,939 | $383,578 | $347,697 | $315,004 |
| 21 | $503,383 | $454,443 | $410,035 | $369,759 | $333,251 |
| 22 | $543,654 | $488,282 | $438,293 | $393,189 | $352,516 |
| 23 | $587,146 | $524,626 | $468,474 | $418,070 | $372,853 |
| 24 | $634,118 | $563,661 | $500,705 | $444,489 | $394,320 |
| 25 | $684,848 | $605,583 | $535,125 | $472,537 | $416,976 |
| 26 | $739,635 | $650,605 | $571,879 | $502,313 | $440,883 |
| 27 | $798,806 | $698,955 | $611,124 | $533,920 | $466,108 |
| 28 | $862,711 | $750,878 | $653,024 | $567,467 | $492,718 |
| 29 | $931,727 | $806,634 | $697,757 | $603,069 | $520,786 |
| 30 | $1,006,266 | $866,507 | $745,511 | $640,848 | $550,388 |
So, small fee differences make a big difference over time to your net worth.
The bottom line is pay very close attention to the fees you pay financial advisors and in mutual fund expense ratios.
>> Related: Which Robo Advisors Have Low Fees?
➤ Free Guide: 5 Ways To Automate Your Retirement
4: Buy-And-Hold Vs. Buy-And-Sell?
Philosophers such as Friedrich Wilhelm Nietzsche have written volumes about how humans are their own worst enemies at times.
One way we can sabotage ourselves is when we succumb to action bias as we try to become financially independent.
Life teaches us that taking action generally leads to progress:
- Study hard and graduate from school
- Work hard and get promoted
- Hit the gym and get in shape
In most areas of life, action equals progress, and progress leads to success. But when it comes to building wealth for the long-term, action can stifle growth and limit wealth.
Take for example a buy-and-hold investor earning 15% annually. Admittedly, this is a high figure, so let’s pretend it’s a billionaire, like Warren Buffett, generating those returns.
Why does Warren Buffett advocate holding for the long-term?
The reason is obvious when you look at the table below comparing the portfolio growth of a buy-and-hold investor with the wealth accumulated by an investor who locks in gains each year and pays short-term taxes of 30%.
| Year | Buy-and-hold | Tax Liability | Buy-and-sell | Tax Liability |
| 1 | 100 | 0 | 100 | |
| 10 | 352 | 0 | 272 | 8.4 |
| 20 | 1,423 | 0 | 804 | 24.8 |
| 30 | 5,758 | 0 | 2,380 | 73.4 |
| 40 | 23,292 | 0 | 7,038 | 217.0 |
| 50 | 94,231 | 0 | 20,818 | 641.9 |
| 60 | 381,217 | 0 | 61,576 | 1,898.5 |
The buy-and-hold investor who we’ll assume pays 20% in long-term capital gains taxes overall at the end of a 60 year period, amasses over 6x more than the “buy-and-sell” investor who pays taxes along the way.
Even though both investors enjoy the same portfolio growth annually, the result of taking action to lock in gains every step of the way is to severely hurt a portfolio long-term.
By choosing not to succumb to an action bias that makes you feel better short term (because it locks in gains), you have a better shot at becoming financially independent.
But sometimes this is easier said than done. So, how do you commit to the long-term, take less action, and transact less in order to pay fewer taxes, commissions and fees, and build greater wealth?
Simple. Trade less frequently. Or, find a broker with low commissions costs so you don’t churn your account.
For example, TastyWorks permits options traders to close positions without paying any commissions costs.
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These days you can find brokers who charge no commissions for stock trading too, such as Robinhood.
>> Related: What Are The Best Options Trading Platforms?
>> Related: Trade Options? Here Are Some Options Tips
5: Become Financially Independent Automatically
If you do not have the time or inclination to learn how to research stocks, or manage your portfolio by diversifying in stocks and bonds through low-fee index funds, then a hands-off approach might be a better fit.
One avenue is to select a robo advisor, who manages your wealth automatically on your behalf.
To get started, answer questions pertaining to your risk profile, time horizon and financial goals, and the robo advisor will allocate your money to a portfolio that aligns with your preferences.
The best robo advisors, such as Betterment and Wealthfront, can harvest tax losses for you too.
Tax loss harvesting can be so powerful over time that it even has the potential to cover the management fees you pay to a robo advisor.
And by relying on an automated investment management solution, you get to enjoy a hands-off approach to becoming financially independent that eliminates the temptation to succumb to an action bias.
Some robo advisors, such as Personal Capital, offer excellent mobile apps that let you track your spending and net worth by linking to your bank and brokerage accounts, as well as your credit cards.
Others, including Betterment, offer retirement calculators and financial calculators to help you figure out how fast you can grow your money and how much you need to retire comfortably and live the same lifestyle as you do during your working years.
What tips have you learned to become financially independent? Share your stories with us below. We would love to hear from you.
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