Blog | Personal Finance
How to Achieve Financial Independence
Spoiler: It requires learning your wealth number and discovering the power of cash flow
Rich Dad Personal Finance Team
September 17, 2024
Summary
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Having money doesn’t equal financial independence
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True financial independence doesn't come from a 9-5
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The secret to financial independence is all in a formula
When Robert Kiyosaki was a young boy, he had two dads. His poor dad could never answer the question, “how do you become financially independent?” But his rich dad, however, showed him the answer...over time.
Poor dad was Robert’s natural father. He was not poor in the sense that he had no money. Rather he was poor in his mindset when it came to money. The superintendent of the Hawaii school system, poor dad was actually a well-paid employee. To many he was “rich.” Yet, he didn’t like money and often said things like, “We can’t afford that.” Towards the end of his life, one of the biggest regrets he shared was that he had very little to pass onto his kids.
Rich dad was Robert’s best-friend’s father. He had a rich mindset when it came to money and he went on to be very wealthy. He started by owning his own convenience store and ended up owning a number of hotels in Hawaii on the beach. Instead of saying, “we can’t afford that,” he asked, “how can we afford that?” At the end of his life, he left his kids a big business empire and a lot of wealth. He was financially independent and so were his kids.
The difference between rich dad and poor dad is that one was just “rich” while the other was wealthy.
As a young boy, Robert knew that he wanted to be like rich dad—wealthy and financially independent. There were many things Robert loved and appreciated about poor dad, but he did not want his mindset on money, nor did he want the stress that poor dad experienced around money for most of his life.
Having money doesn’t make you financially independent
What do Burt Reynolds, Michael Jackson, Walt Disney, MC Hammer, Elton John, Mike Tyson, and Wayne Newton all have in common? They were once incredibly wealthy celebrities worth millions who have since filed for bankruptcy. Lottery winners often suffer the same fate, and are more likely to declare bankruptcy within three to five years than the average American.
As these examples illustrate, having millions of dollars doesn’t equate to financial freedom. Why? Because even if you have a lot of money, if you don’t know what to do with it, it will empty out of your bank account far faster than you can replenish it.
So, what is financial independence?
This begs the question: what is financial independence? Is it having a high-paying job so that you can support yourself? Is it based on an anticipated inheritance? Or even an alimony? For many people, it translates to: “I’m going to work until I’m 65, and then I’m going to retire.”
These, unfortunately, are not good definitions. If you have a high-paying job, you can lose it. And waiting on an inheritance, alimony, or retirement (essentially, living on the hope others will take care of you) will not help you answer what is financial independence.
Discover your wealth number
Financial independence means so much more than just having money, or saving for retirement. The first concept you need to understand when it comes to financial independence is your wealth number, which is using time (not money!) to calculate how much you actually need to be financially free. After all, if you don’t know how much you need, how do you know when you’ve achieved your goal?
To discover your wealth number, you’ll need to figure out how long you could survive financially if you stopped working today (that means no more paychecks, whether it’s due to losing your job, retirement, illness, divorce or whatever).
Here’s the simple mathematical equation:
Your available money ÷ Your monthly expenses = Your wealth number
Your wealth number is measured in time, so this calculation determines the number of months you could go without any income coming in. So, for example, if your number is 8, then you could last 8 months before going broke. Is your number scary? Sobering? Upsetting? Far less than the number of years you think you’ll still be living?
This is why savings ≠ financial independence
As stated earlier, many people assume that the path to financial independence is money. That’s because most so-called experts drill this into them from a young age. They hear it at school, from parents, in the books they read on money management…it’s everywhere. Save, save, save!
For many, the golden number for savings is $1 million. As far as round numbers go, it’s a good one. And $1 million is a lot more money than most people have. But it’s also not what it used to be…and it’s probably not enough to be financially independent for a lifetime.
And even if you could save $1 million and live the rest of your life on it, the mindset about how to get there—and how to stretch that money—is, well, depressing.
Remember, financial sacrifice ≠ financial independence
A true test of financial independence
A very simple test to add to your wealth number—even if you have a high salary or lots of savings—to determine if you are financially independent is to take out a piece of paper and make two columns. In the left column write down how much money you make each month. In the right column write down all your monthly expenses. Now, cover the left column with your hand and pretend you are no longer making that money. How does the column on the right make you feel? If you’re like most people, you’re having a minor panic attack right now.
This holds true even if you live on savings. Because drawing from your savings is not the same as generating income. It’s simply pulling down your assets. And it’s a very poor mindset about money that sees the world as scarce, not abundant.
Take for instance the thoughts on this article: “30 easy money hacks to get a little richer every single day this month.”
They include things like:
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Shop generic
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Check for Health Savings Account eligibility
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Review your 401(k) fees
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Grow your own herbs
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Transfer $10 a week to an IRA
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Buy a slow cooker (on sale no less)
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Use cloth napkins
Of the entire list of 30 ideas to get “rich,” only one has to do with generating income. The rest are all ways to downsize and cut expenses.
So if having a high-paying job or saving lots of money isn’t financial independence, then what is?
Three types of income
Before answering that question, it’s important to understand that there are three types of income.
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Earned income: If you have a job and receive a paycheck, you make your money through earned income.
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Portfolio income:Where earned income is acquired by exchanging time for money, portfolio income is made through capital gains.
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Passive income: Rich dad used the formula of “four green houses, one red hotel,” in the game of Monopoly to describe how you can make passive income, that is by having your assets create income for you.
Many people think they can get rich with a high salary (earned income). But as mentioned before, you can lose your job. What is more, you trade your time for money and that is finite.
Portfolio income is nice but you only make money on a sale, and it’s taxed higher than passive income. So you are at the mercy of the markets and you give more of what you earn to the market. It is not a predictable income for wealth.
It’s only passive income that provides true financial freedom. And it only takes three steps.
Let’s talk about a surefire way to make sure you’re constantly generating passive income: cash flow.
Cash flow is an ongoing stream of income you receive from an investment. For instance, if you own a house or apartment building, collect rent from tenants each month, pay your operating expenses and mortgage, and end up with an overflow of money after all that, then that’s a positive cash flow. Now, let’s say you have $5,000 of cash flow coming in every month from your real estate investments, but your living expenses are only $3,000 — then you are financially free, because your cash flow is paying for all of your expenses and you aren’t dependent on anyone or anything to survive.
The following formula is whatRobert and Kim Kiyosaki used to be financially free for nearly thirty years. The formula is this:
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Buy and create assets that generate cash flow
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The cash flow from assets pay for living expenses
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Once monthly cash flow from assets is equal to or greater than monthly living expenses, that is financial independence because assets are cash flowing and generating passive income.
When the formula is completed, you no longer have to work for money. When you no longer have to work for money, I’m financially independent.
Robert and Kim became financially free by investing in real estate. To be clear, they did not have the money to do this. Rather, they created the money by paying themselves first. What does this mean? It means that they treated investing as their first and most important expense. Each month, they would pay their investing expense and then figure out how to pay all their other expenses. It was nerve-wracking at times, but they always figured out a way.
Once they had enough money saved up to buy a property, they would find a great deal where the income from the property would cover their expenses as well as the debt they would take on in the form of a mortgage. They continued to pay themselves their investing expenses as well as adding the cash flow from the property to the pot. This accelerated their ability to purchase yet another property. This then led to more properties. Eventually, they sold many of those and invested in even bigger projects like apartment buildings.
They also expanded out to other assets. For instance, Robert’s book, Rich Dad Poor Dad is the best-selling personal finance book of all time. It has sold over 32 million copies. And their business, Rich Dad, offers financial education in the form of books, coaching, seminars, and digital products.
Robert and Kim never have to work a day again in their lives and the cash flow from their assets covers their expenses—and some. This is very different from savings, for instance. Savings can run out. Cash flow keeps coming no matter what. Savings can lose its value relative to inflation. Assets grow in value along with inflation. That is why the formula makes you truly financially independent.
Your mindset about money counts
As mentioned at the beginning of this article, poor dad would say, “we can’t afford that.” Rich dad asked a very different question. He would ask, “how can I afford that?”
The difference between poor dad and rich dad’s mindset about money was fundamentally one of saving versus earning.
Poor dad always looked to be saving money and cutting expenses. Rich dad always looked to be making money and investing in both his wealth and his quality of life.
Now, which person do you think lived a happier, fuller life?
Unfortunately, it was rich dad. It’s unfortunate because Rpbert found it very difficult to watch poor dad later in life when he had no money, struggling financially. He had worked hard his whole life, but his mindset about money did not serve him well in the end.
Savers are losers; spenders are winners
All of this goes to show that the Rich Dad mantra of “savers are losers” is a vital thing to understand if you want to be truly rich. In today’s financial world, spenders are winners and savers are still losers. Of course, by spenders, this means those who use their money to build their business or invest in cash flowing assets. And to spend wisely this way, you need financial intelligence that goes beyond just downsizing and cutting expenses. You need to understand how to create wealth, and in your own way, actually make money grow on trees.
What is financial independence for you?
Though it didn't happen overnight, these were the steps Robert and Kim took to become truly financially independent. All it took was a plan to generate cash flow and determination to channel that cash flow to cover their expenses.
What actions are you taking today to get you closer to achieving your definition of financial independence?
Original publish date:
May 06, 2014