How to win your financial independence


Amidst the sparklers and smores, the Fourth of July is a time to remember those who fought to win our nation's independence as well as those who have fought to defend its freedom.

Fortunately, when it comes to winning our financial independence, we're hardly called on to risk our lives. Figuratively speaking, however, it's still a battle. Here's a simple way to win it and a new way to measure your financial freedom.

First, although I said it was simple, I didn't say easy. You must fight for this freedom. If only attending a few seminars like Rich Dad Education actually allowed you to make millions of dollars working a few hours a week from a yacht in the Bahamas. Would that be easy? Definitely. Is that likely to work? Definitely not.

The simple way to win the battle is to live below your means and invest your savings well. It's not exactly rocket science.

How much money you earn is important, but how much you spend is far more important. And the reason for that is you earn money only until you quit working, but you spend money for a much longer period of time.

Spenders like immediate gratification, while savers are good at deferring it. Curiously, I've found that spenders who have saved very little are far more optimistic about their retirement than the savers are. This is likely due to the delusional optimism of spenders who believe things will work themselves out and the worst-case-scenario pessimism of savers who fear running out of money and living under a bridge.

Many of us are stuck on the hedonic treadmill of keeping up with our neighbors and friends. They get a shiny new Lexus, so we must also get one. I've previously calculated that driving a Ford or Chevy vs. the fancy luxury car can equate to $1.9 million of financial freedom over 30 years. Research also shows that spending more buys only short-term happiness and can lead to longer-term misery if your friends are enjoying their retirement while you're a Walmart greeter.

Along with saving, you need to simultaneously execute a second strategy: investing those savings well. Investing well is simply "minimizing expenses and emotions and maximizing diversification and discipline."

If you're paying 1 percent in fees, that will set back your independence. New Morningstar data show that investors pay a larger price in emotions in what it calls the investor gap. This gap demonstrates that investors underperformed mutual fund returns by 2.49 percent annually over the decade ending 2013 because we get in and out of funds at the wrong time.

If you're pretty sure this isn't you, you may want to look at how you behaved during the real estate bubble.

My research shows that our financial freedom will be set back an average of four years for each 1 percent paid in expenses and emotions. Cutting that expense ratio and eliminating that investor gap can save you about 3.4 percent, which translates to moving financial independence up by as much as 13 years.

Here's a real life story of financial freedom, which has little to do with luck.

Fighting a battle has metrics, and so does fighting for your financial independence. I measure wealth in terms of the number of years of financial freedom one has. That's simply:

Wealth in years = net worth / annual expenditures

For instance, someone who is worth $5 million but needs $2 million a year to live is poor, while another person worth $250,000 who needs only $10,000 a year beyond Social Security is wealthy. The former has 2.5 years of wealth versus the latter's 25 years of independence. The implication is that cutting spending has a far greater impact than making more money.

So, Independence Day is a perfect time to assess where you are in achieving your own financial independence and gaining the freedom to pursue whatever gives your life meaning.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.