What is Financial Freedom?

As you know this blog has been inspired by financial freedom. While there are differing opinions about what financial freedom, this article will present financial freedom from my personal perspective.

What is financial freedom to me?

Financial freedom to me is having enough money to live without ever really having to work again. Now this does not mean you never have to work again. Instead it means that you work on your own terms.

You never have to worry about the stress of losing your job. You don’t have to worry about whether you have clients or not. When you are financially free, work no longer becomes a requirement in life but rather a choice.

How would you get there?

There are a number of ways to achieve financial freedom. The most effective way is by building passive income streams. This is done in a few ways shown below.

Have Your Money Make You Money

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Build up enough cash so that it will generate money-almost like planting your very own money tree.

The first way to build a passive income stream is to build up enough cash so that it will generate money. Use your cash to purchase dividend paying stocks or bonds which pay you interest. You could also purchase annuities which would pay you over the life time of the annuity.

For example, if you have $5 million in cash right now you could invest in bonds which pay out 5% a year. Just by having those bonds alone, you will generate $250,000 a year in interest income!

Imagine, $250,000 in your pocket and you don’t have to do anything at all! You can accomplish this with dividend paying stocks as well.

Stocks pay a wide range of dividends, and are not quite as reliable as bonds for paying you out every month.

But stocks do have the advantage of appreciating in value over time, so that when you sell the stock you have a chance to make more money.

I don’t have $5 million to put away, what should I do?

Fair enough. Most of us do not have $5 million in liquid cash at our disposal at any time. So what should you do instead?

Create a Business which Produces Cash with Minimal Effort

While I was writing that subheading, it sounded a tad bit scammy. Just like one of those spam emails which tell you how some guy makes $5,000 a day just by clicking a few buttons.

There are people out there with legitimate businesses that do not require much effort on their part.

They do this by doing one of two things

1)      They automate their business so they don’t have to do most of the work or,

2)      The create a product which they can sell to the masses

In order to accomplish number one listed above you would do a few things. First you would have to build a business up from scratch (if you can’t buy one initially).

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Automating your business by hiring employees is one method you can use to become financially free.

Then you would look to hire employees to help do the menial tasks that you don’t want to do. Then finally you would hire a manager to help oversee the employees and take care of the higher level duties that you don’t want to do.

This leaves you to plan for the future and grow, and takes you away from the day-to-day tasks that you would be doing at any typical 9 t
o 5 job.

For the second item, you would create a product that you only need to create once or can be created by others, and sell it to the masses.

Key Point: Learn How to Separate Time From Money

The key to building a passive income business is separating your time from money. Most jobs will pay you for every hour you work.

It has been engrained in us that we get paid when we work and don’t get paid when we don’t.

What if you did get paid when you didn’t work? How would you like to get paid when you didn’t work? When you are sleeping? When you are on vacation?

If you have an automated business, you will no longer trade your valuable time for money.

There are a ton of ideas to help you build up passive income streams. One of the best books to help you understand the different types of business systems is “The Millionaire Fastlane” by MJ Demarco.

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Check out The Millionaire Fastlane, one of my favorite business books that I’ve read recently

In that book he lays out the “Five Fastlane Business Seedlings” which are business systems which produce passive income for the owner. Those five systems are

  1. Rental Systems
  2. Computer Systems
  3. Content Systems
  4. Distribution Systems and,
  5. Human-resource Systems

If you want to find out more, check out the book on Amazon. It really is a great resource and I would recommend it to any entrepreneur or wantreprenuer looking to get started.

My Top Three Reasons for Wanting to Achieve Financial Freedom

I have told you what financially freedom is to me. Know I want to elaborate on why it is my goal to achieve financial freedom.

Reason #1: I want to have the freedom to do what I want when I want

If I want to sleep in until 12 I can.

If I want to meet friends for lunch on the other side of town at the last second I can.

If I want to go on vacation at the drop of a hat I can.

I would also have freedom to pursue hobbies that you enjoy but would never really make you money.

For example, I enjoy playing basketball and golf. I am not really good at either one of those. I could play those whenever I want.

Reason #2: I want to explore the world

Many folks don’t have to be financially free to explore the world, but I think it would be pretty amazing being able to travel all over without a timeline to get home like you would when you work.

I have never traveled much, and I think it would be great to be able to see the world.

Being financially free would allow me to travel on my own time, and have the money to do so.

Reason #3: Spend more time with those I love

I am personally not a workaholic. I’ll admit it.

I will work really hard doing the job the needs to be done. Once it is complete I go home and do the things that I want to do.

It’s not even that I am lazy, but I just like to enjoy life and do those things that I want to do.

I don’t want to feel obligated to go into some place five days a week for the next 35 years of my life.

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You now know my reasons for wanting to achieve financial freedom. What are yours?

I enjoy spending time with family and friends, and financial freedom will allow me to do this.

Down the road when I have kids, I want have the ability to spend time with them. I want to be a part of their life.

I don’t want to be at work all of the time and come home and be too tired to spend time with my family.

This is what financial freedom is to me. This is why I want to achieve it. What is financial freedom to you? Why do you want to achieve financial freedom?

Photo Credits (in order)

Flickr/Shari’s Berries, Flickr/Phil Whitehouse, Flickr/Kalyan Chakravarthy

First Time Investor: What do I do?

I was recently talking to a family friend about his finances. He seemed very interested in getting started in investing money. Keep in mind, the family friend is turning 30 this year built up an emergency fund and is now looking to invest $3,500.

On top of that, the family friend does not know anything about investing. Now, I could have gone on and told him about IRA’s, 401(k)’s, and individual brokerage accounts, but I knew two things would happen:

  1. He would get bored with what I was saying and just want me to tell him what to do
  2. I would overwhelm him and he probably would put investing on the backburner for a while until he was able to “figure it out.”

Getting Started

So, what I told him was that it was very simple to sign up. All he had to have was a computer, over $3,000 in his bank account, and his estimated retirement age. With all of this available, he would be well on his way to building his retirement account.

The very first thing I suggested to him was to sign up for an account at Vanguard. He didn’t ask why, but if he did I would have told him this: Vanguard charges the lowest fees of any other mutual fund provider. Lower fees means more money in your pocket when you retire.

So, he signed up for an account at Vanguard. The next thing I had him do was sign up for a Roth IRA account. You can read more about why you should always choose a Roth IRA here.

Account ready and Roth IRA set up, he deposited his $3,500 into his Vanguard account. Then he asked me “What should I invest my money in?” Once again, I could have gone on a tangent about exchange traded funds vs. mutual funds and asset allocation, but I skipped the lecture.

I asked him, “When do you plan on retiring?”

He responded, “I don’t know, maybe around 60 I guess?”

“Okay, that’s all I needed” I told him.

I showed him Vanguards mutual funds, filtered “Asset Class” for “Balanced”, selected “Target Retirement 2045” and we were done. He has just made his first investment into a wide variety of stocks and bonds which automatically balances over time based on his risk profile, without him ever having to lift a finger.

Do you want to get started?

If you are a newbie just getting started with investing, picking a “Target Retirement” dated mutual fund is the simplest way to get started.

All you have to do is figure out your target retirement date, subtract your current age, and add that to 2014 and you will know exactly which fund to invest your money in.

If you are 24 years old and plan on retiring at 65, your Target Retirement date would be 2055. Viola! You are done.

Now that you know what to do, here is why you are doing it

Target Retirement date mutual funds are attractive for a number of reasons:

1. They automatically balance your portfolio for you.

You already know that you don’t want to put all of your eggs in one basket. By investing in a Target Retirement date account, you are investing in a wide variety of stocks and bonds, and effectively spreading your dollar out everywhere. This limits your risk of loss because of diversification.

2. As you get older, your investments become less risky

When you get closer to retirement, the last thing you want to worry about it giant fluctuations in the stock market destroying your investments. Target Date mutual funds become less risky as you move closer to your retirement date, making it less likely that you lose money. As a result, you will have a more stable, predictable income stream in retirement.

3. They are extremely simple to set up and manage

With Target Retirement mutual funds, you literally do not have to do anything at all except put money into the account. Every month you invest your savings into these accounts, and everything else is all taken care of. This is ideal for those who don’t know much about investments and do not care to learn about investments, but still want to retire comfortable.

That’s it!

There you have it. You just set up a retirement account that will do all of the hard work of investing for you. All you have to do is sit back and wait to reap the benefits.

Traditional vs. Roth IRA, Which one should I choose?

What is a Traditional IRA?

An IRA stands for Individual Retirement Account. IRAs are held at banks and brokerages and allow you to invest in almost anything you can imagine. The benefit of having a Traditional IRA is that you can deduct your contributions on your tax return.

What is a Roth IRA?

A Roth IRA is very similar to a Traditional IRA. There is one exception: the money you contribute to a Roth IRA is taxed today (you cannot take a deduction on your tax return for contributions), but it is not taxed when you withdraw any money in the future. Therefore, all money you take out of an IRA, included gains on your investments, are not taxed in the future.

How much can I contribute to my IRA?

When you have an IRA, either Traditional or Roth, the most you can contribute is the lower of $5,500 or your taxable compensation for the year. If your taxable compensation is below $5,500, then you will be limited to the amount of your taxable income for the year. If you are over the age of 50, you are allowed to contribute $6,500 to your IRA.

How much can I deduct on my taxes for my IRA?

The amount you can deduct on your taxes depends on one condition: Do you or your spouse (if married filing jointly or separately) have a retirement plan at work? If the answer is no, they you are allowed to deduct the full amount of your contribution to your IRA. If the answer is yes then it can be a bit tricky.

I have a retirement plan at work, how much of my IRA contribution can I deduct?

The following chart is provided by the IRS to help determine how much of your IRA contribution you can deduct when you are provided with a retirement plan at work:

If Your Filing Status Is…

And Your Modified AGI Is…

Then You Can Take…

single or
head of household

$60,000 or less

a full deduction up to the amount of your contribution limit.

more than $60,000 but less than $70,000

a partial deduction.

$70,000 or more

no deduction.

married filing jointly orqualifying widow(er)

$96,000 or less

a full deduction up to the amount of your contribution limit.

 more than $96,000 but less than $116,000

  a partial deduction.

 $116,000 or more

 no deduction.

married filing separately

 less than $10,000

  a partial deduction .

 $10,000 or more

 no deduction.

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “single” filing status.
married filing jointly with a spouse who is covered by a plan at work

$181,000 or less

a full deduction up to the amount of your contribution limit.

more than $181,000 but less than $191,000

a partial deduction.

$191,000 or more

no deduction.

married filing separately with a spouse who is covered by a plan at work

 less than $10,000

 a partial deduction.

 $10,000 or more

 no deduction.

By utilizing this chart, take your filing status and adjusted gross income, and you can see if you are allowed to deduct the full amount, a partial amount, or no amount.

When can I withdraw money from my IRA?

The IRS allows you to withdraw from you IRA (Traditional and Roth) without any penalties after the age of 59 1/2. If you do withdraw from your IRA before this age you will be hit with a 10% penalty on top of the taxes you owe to the IRS. There are certain exceptions that will allow you to withdraw money penalty free before the age of 59 ½, which I will discuss below.

How can I withdraw money from my IRA without facing a penalty?

  1. You are over the age of 59 ½ you can withdraw money from your IRA penalty free. ‘
  2. You use withdrawals to pay higher education costs for your spouse, your children, or grandchildren.
  3. You can take up to $10,000 (or $20,000 if you are a couple) to buy, build or rebuild your first home.
  4. You use money from your IRA to pay for medical expenses in excess of 10% of your AGI which are not reimbursed during the taxable year.
  5. You become disable and can no longer be gainfully employed.
  6. You die and leave it to an heir.
  7. Roth IRA – You can withdraw your contributions but not your earnings (interest and dividends accumulated) from your Roth IRA at any point in time.

How long can I contribute to my IRA?

If you have a Traditional IRA, you are allowed to make contributions until the age of 70 ½ years old. If you have a Roth IRA, you are allowed to make contributions as long as you are alive.

Should I choose a Traditional IRA or a Roth IRA?

When deciding between a Traditional IRA and a Roth IRA, it could be tricky. With a Traditional IRA you can deduct your contributions in the current year that you make them. This is appealing if you want to lower to tax burden in the current year. You would also want to choose a Traditional IRA if you believe you will be in a lower tax bracket when you are older. That way you limit your tax payments to the lower future tax rate. In addition, you can contribute to a Traditional IRA at any time without income limitations. This differs from a Roth IRA which does not allow you to make contributions if you make over a certain income level.

With a Roth IRA, you cannot deduct your contributions in the current year that you make them. However, you will not be taxed on the money you take out of a Roth IRA in the future. This is appealing if you think you will be in the same or higher tax bracket when you are older. In addition, you can take out your principal contributions at any time without facing a penalty.

When it comes to choosing retirement accounts, take your time. Consult with your accountant or tax professional and make sure you pick the retirement account that best suits your needs.