How to Become Financially Independent
[caption id="attachment_29462" align="alignright" width="220" caption="Following the "right predictions" is not a winning investment strategy. Successful investors become financially independent by following the right principles."][/caption]
When I speak at financial seminars and conferences around the country, I feel a tension - a palpable fear - that didn't exist in the past.
Investors aren't just nervous or uncertain. They're scared. And who can blame them?
The economy is sputtering. The Eurozone threatens to come apart at the seams. And the stock market is gyrating wildly.
In response to all this, some stock market pundits are pounding the table, insisting that this is an historic buying opportunity. Others, however, are infected with anxiety themselves. And a few are actively fear mongering.
Who should you believe, the raging bulls or the rampaging bears?
CNBC won't make you financially independent.
The answer is neither.
As historian David McCullough often reminds his audiences, there's no such thing as the foreseeable future. None of these gurus has a crystal ball.
And that's okay. Because financial independence is not about following the right predictions.
It's about following the right principles.
Fortunately, the principles of successful investing are well understood.
Why don't most people follow them? One reason is ignorance. There's no shame in this. It's a big, complicated world out there and we're all ignorant of different things.
However, it's unfortunate that most kids graduate from high school without a modicum of financial literacy. It's tough to get a quick start in this world if you don't understand compound interest, 401(k)s, adjustable-rate mortgages, or why we have a stock market.
Great principles will make you financially independent.
So what are the great principles of investing?
It's tough to cover them all in a short column like this. (Although I cover the bases in my first book, The Gone Fishin' Portfolio.)
But here are the nuts and bolts everyone should know:
For starters, few people get rich by founding a computer company in their garage, recording a platinum record, or playing third base for the Yankees. Most people with a net worth of a million dollars or more became financially independent the old fashioned way. They maximize their income, minimize their outgo, and religiously save and invest the difference.
As my friend Rick Rule likes to say, when your outgo exceeds your income, your upkeep becomes your downfall.
Six ways to make your money work for you...
Ok, let's assume you've done what many people are either unable or too undisciplined to do: You've saved some money. Now what?
The next step is to understand that there are six factors that will determine what your investment portfolio is worth in the future:
- The amount of money you save.
- The length of time you let it compound. (Hands off.)
- Your asset allocation. (This refers to how you diversify your portfolio among uncorrelated investments like stocks, bonds, cash and precious metals.)
- Your security selection. (i.e. the individual investments you own.)
- The amount you pay in commissions, fees and other expenses.
- And the amount you fork over in taxes.
Note that there's nothing here about forecasting the economy, timing the stock market, or figuring out how the European debt crisis will end. You cannot know the answer to those questions.
And that's okay, too, because they will have little bearing on what your investment portfolio is worth five, 10, or 15 years from now.
If you're investing to become financially independent, think long-term and forget about the day-to-day trivia that dominates the headlines and pays the salaries of so-called experts.
Focus instead on following proven investment principles. In other words:
- Save as much as you can.
- Start as soon as you can.
- Leave it alone as long as you can.
- Follow a sensible asset allocation.
- Diversify among high-quality securities.
- Minimize your investment costs.
- And tax-manage your portfolio.
The principles are not complicated. Spend less money than you earn. Save.
Put your savings into a diverse portfolio of uncorrelated assets. Diversify to prevent big losses. Live below your means, and let compound interest do the heavy lifting.
Want to learn more about becoming financially independent?
Our free white paper, How to Build Wealth, covers asset allocation, position sizing, tax management, and other sound investment principles in detail.
Did I mention that it's free?
Until next time, heed the advice of Thomas Jefferson:
“In matters of style, swim with current; in matters of principle, stand like a rock.”