As with most things in life, there are only a few key elements to the process of financial independence.
These are the three rings and they are the foundation wealth accumulation.
- First, you must find a way to earn money
- Second, you must save a significant portion of the money you earn
- Third, you must wisely invest the money you save
In fitness, if you want to build your body you must be disciplined and consistent over a long period of time to generate results. It is the same with building wealth. Recognize from the start that it is a long journey that typically takes decades and there are many ups and downs along the way.
1st Ring – The Ring of Income
The first ring involves earning money in some way. To maximize this ring, you must learn and develop skills that are valuable to others and will allow you to earn a premium. If you fail to do this, you will be unable to demand a higher rate for your work which will make saving more difficult. The skills you acquire could be anything from university degrees to technical skills or starting your own business, etc. It is important that you are able to translate the skills you acquire into an ability to increase your income and you should do this continually throughout your career or you will plateau. As with each of the rings, it is not a single step but an ongoing, perpetual process which is why it is represented by a circle or a ring.
2st Ring – The Ring of Savings
The second ring involves saving a significant portion of the money you have earned. To maximize this ring, you must be able to restrict your lifestyle and spending to a level that will allow you to save money every week and avoid any debt. Many people struggle with this as they are enticed by a desire to live in a bigger house, wear the latest clothing, and buy a fancy car. All of this is fine in moderation but, in order to build your wealth, your influx of money must be significantly greater than your outflux of money. I would suggest to target a savings rate of 30-50% of your income. Essentially, this money you are saving is being used to purchase your time and your time is your freedom.
3rd Ring – The Ring of Investment
The third ring involves the investment of your savings so that your money will work for you as if each coin were an employee. If you invest wisely, each coin will work tirelessly for you and earn more coins and so on and so forth. This is the power of compound interest. As Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” Essentially, there are those who spend beyond their means and take out loans to which they must pay interest. They dig themselves deeper and deeper in debt. On the opposite side, others save and invest their money which earns them interest and appreciation. This is not to say you should never take a loan but, if you do, you should ensure that taking out the loan will allow you to earn more than the interest you will need to pay or will reduce costs that you would pay anyway as in the case of rent or buy.
Investing wisely means avoiding the myriad of financial scams and get rich quick schemes. If it sounds too good to be true, it is. If you do not fully understand the investment, then do not engage in it. Do not ignore investment fees of even 1-3% and certainly not if they are higher. It is critically important that fees be minimized. Do not entrust your savings to an investment manager or guru and allow these “helpers” to manage your money for you. Even though many of them may be very smart and convincing, they do not help without taking their fees so the result for you is not advantageous. Consider the famous $1M bet by Warren Buffett in 2008 where he bet the hedge fund industry that a simple S&P500 index fund would beat the hedge funds over the following decade after fees. In 2017, Buffett summarized the results of the bet in his letter to shareholders. The S&P500 index returned 125% gains over the decade and the hedge funds only achieved 2.8% at the low end and 87.7% gains at the high end. It was not even close. Educate yourself about investing as if your life depended on it because your financial freedom does depend on it. Track and monitor your investments and read abundantly. Historically, the tried-and-true investment vehicles have been diversified portfolios of stocks and bonds and/or investment in real estate. However, any investment requires research and due diligence and crashes and crises are inevitable. Be prepared for those crashes and try to position yourself to capitalize on opportunities when they present themselves. Often, this will involve doing the opposite of the masses and thinking for yourself.
Each of the three rings is critical to amassing wealth and each ring builds on those before it. Eventually, the Ring of Investment will generate enough income to sustain you if you are persistent in your efforts. At this point, you will have achieved financial freedom since you will no longer be dependent on your work for financial support. However, I would suggest that even at this point to make your investment income slightly exceed your expenditures so that your wealth continues to build and each ring continues to flow into the others.
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