Set Your Goals
First Step to Achieving Investing Lifestyle
Define Your Needs
Short-term, Mid-term and Long-term Strategies
I can't help but compare individuals to corporations. We possess all the qualities that a corporation would have - we have monthly income and expenses to satisfy our needs. We also have assets that either depreciate or grow within our lives. While we don't exactly scale to most corporations out there, if we can become the ideal CEO's of our own individual finances, we can start accumulating wealth like we haven't before.
First, we need to start thinking like a true CEO - what goals do we have set for short-term and long-term, and how can we accomplish them?
Let's start with short-term goals (less than a year), and how we can go about optimizing our short-term cash flow needs. For average individuals, employment is the most common source of income. If you are spending close to or more than your income on a monthly basis, we have a problem. One difficult solution is to grow your income, but the easiest of them all is to optimize your spending. I have seen numerous cases where the individual is earning a decent income but not fully maximizing their potential as a result of laziness and reluctance.
It is extremely important to be transparent with yourself to monitor your expenses - as you widen the gap between your income and expenses, they will carry over to your mid-term and long-term strategies. Some experts say saving 20% of your gross income is sufficient, while others say 80% is recommended. There is no golden rule, as everyone has different income and needs. The goal is to reach the maximum savings rate you can afford without sacrificing too much of your financial needs.
Let's break down how a typical expense summary would look like for most of us:
- Mortgage/Rental expense
- Medial/Health fees
- Telecommunication (cell phones, landline, internet, cable)
- Bank fees
- Dining out
As you probably realized, the goal is to cut as much discretionary (wants) spending as possible. This may take years to accomplish as you will be hard-pressed to find out how much of your old-time habits have contributed to your monthly and yearly spending. There are several free tools out there to track your spending, I recommend using Mint (for couch-potato approach), or the traditional approach of manually recording transactions in excel (you can find the tool here).
Once you have found your optimal spending, you can start saving towards your emergency fund. Typically, you should have 3-6 months worth of expenses allocated to your reserves, but if you are confident with your cash flows, you can progressively reduce this to 2 months over time. Just remember that whatever exceeds this amount will carry over to funds required for mid-term and long-term strategies, and you never want this process to go in the opposite direction.
I hate to be the party pooper, but mid-term outlook is something that I would definitely argue against having as they are likely to involve making large purchases that depreciate or disappear into thin air. They typically consist of saving for a new car, a nice wedding, or remodeling for your new contemporary kitchen. Although some of the mid-term strategies can consist of sensible ideas like saving for a down payment for your first real estate investment, this is a topic for later discussion. Either ways, this sort of outlook is difficult to plan for, as you will need to strike the perfect balance between short-term and long-term strategies without jeopardizing your long-term plans. In my opinion, they tend to hinder your goals of reaching financial freedom, and should be avoided if possible.
This is the best practice for reaching your financial freedom. Long-term strategies typically consist of five or more years of plans that are purposed to make you wealthier. Surely, you may find some individuals who stroke rich by practicing risky investment practices, but it's not for everyone. The most effective way of reaching your millionaire milestone is most likely to be a long and persistent one involving consistent investing aligned with efficient short-term strategies to expand your investment pool.
One proven approach to accelerating this process is by taking full advantage of the free money that's around you. If you have a 401k, or pension plan where the company matches your contribution rate, do it. If they offer stock options, or employment share purchase plan, take advantage of it. These are free money that contribute to your long-term goals without having you to sacrifice too much of your discretionary spending, you will be surprised with how much they can grow with magic of compounding interest.