Financial Independence

Most people find personal finance dull as ditchwater. Think of it as helping you work less and using the fruits of your labour more effectively if that helps.

There are two ways you can fund the costs of what you want to do as an adult. The first way is the one everyone tells us all about.

paying your way through income from working

You go to work and earn money, and from that money you pay for your lifestyle after paying taxes and other necessary costs.

It works well – the trouble is, of course that you have to keep working otherwise your lifestyle takes a hit. It’s also worth making sure your lifestyle matches your income – Charles Dickens’ Wilkins Micawber 1 put it as well as anyone since.

Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery

It is in the interest of many organisations to get you to spend money their goods and services, and they have become very good at persuading people to part with their hard-earned cash – that is what consumerism is all about. There’s nothing inherently wrong in it, if it gives you the quality of life that you want. If it doesn’t, then you might want to consider living more frugally and spending less, because that gives you options.

Raptitudes’ An Interview with The man and Your Lifestyle has Already Been designed are informative alternative  takes on how the Western consumer lifestyle works.

There is another way – our economic system isn’t called capitalism for nothing

Earning your lifestyle costs is not the only way. Labour is one of the means of production, capital is another. You can inherit capital, you can marry it, and you can steal it. Or you can live below your means and save, accumulating capital, that can be put to work by investing it 2. The way many people in Britain can understand it is buying a house and renting it to someone – you get a steady income from the rent, but you had to find the saved money (capital) to buy the house, or at least borrow the capital.

You can then sit back on your deckchair in the sand and drink beer while your capital goes to work and earns you your living costs. Although buy to let 3 is one form of investment, stocks and shares are another, and building your own business is yet another.

When you can support your lifestyle whether you work or not then you are financially independent. It doesn’t mean you have to stop working, merely that you can. It is as much about the cost of your lifestyle as how much capital you have.

There isn’t a strong financial independence/early retirement scene in the UK for some reason, though there is in the States. But we have some – the go-to site I’d recommend for learning about investment is the excellent Monevator site. You will need to invest your capital rather than saving it unless you can save a huge amount or live off virtually nothing.

Lunchtime at Canary Wharf in the heart of London's financial centre

Lunchtime at Canary Wharf in the heart of London’s financial centre

there’s a catch about living off capital

You need a lot of it – about 20 times the amount of capital 4 as you want to draw from it annually. That means it’ll take you a few years of living below your means to get to purely living off capital, there’s a good reason why most of us have to work for 30-40 years before we can retire – which is a form of living off capital. To do something different you have to live different.

I have chosen to eschew some of the trappings of consumerism – my ex-colleagues have bigger houses and jet off to multiple city breaks each year. I’ve chosen to save on that and become a bit more self-reliant and live more simply in order to own my time a bit earlier. Britain is a rich country; I don’t need to live a monastic life to be free after working for three decades.

spending less is your friend

There is a compelling logic about saving more/spending less. Conventional retirement is based around saving about 8% of your gross income, and it takes you 40 years to be able to retire. Save a higher percentage of your pay, and not only do you actually save more, but but the fact you save more makes you drive down your costs further, so you need to save less in total.

This is an issue of straight maths, and is described by Mr Money Mustache here. Although his style is very American, the maths will cross national borders without a passport.

It’s not easy

Few things that are worthwhile are easy. Is it worthwhile? Well, it depends how much you value your time, which is something each and every one of us is running out of, 24 hours every day. It’s an individual and personal decision, but it is surprising how many of us fail to realise that working can be an elective decision after mid-life, if our younger selves served us well, and we had some luck.

Notes:

  1. From the novel Great Expectations
  2. Investing typically means lending it in some form to other people so they can get to work adding value. This usually goes along with some risk of loss because those people may be unlucky, incompetent or charlatans. Our money system slowly depreciates the value of money, so you can’t just save it and expect to come back to find the same value ten years later.
  3. BTL is a particularly complex and non-transparent form of investment with exceptionally high transaction and carrying costs. I have no way of qualifying it and don’t touch it. For all that it’s one most people believe they understand because the underlying asset is tangible and everyone uses the product.
  4. 20 times because the real return on a diversified investment portfolio average a over decades is about 5% p.a. Some people say you need more. For a high-level piece like this it’s in the general ballpark.