Financial Freedom 101 - My Million Dollar Journey
Thank you for stopping by Million Dollar Journey. This blog started out in 2006 as a journal to help keep me accountable towards my financial goal of becoming a millionaire before the age of 35 (accomplished in 2014). Along the way and 1,500+ articles later, this site has evolved into much more than a simple journal. It has morphed into an educational personal finance site with visitors by the tens of millions over the years, but still a place where people can casually stop by, read the latest articles, and ask questions to the community.
So, you are just starting out on your financial journey - first, congratulations on making personal finance a priority. We (family of 4, two kids under age 7) started off just like most, regular 9-5 jobs, with lots of debt and little assets. However, with some focus, perseverance and time, we are now on our way to financial freedom. You know what? I believe that our financial success is repeatable. Yes, I believe that you can achieve your financial goals as well.
Ah yes, financial freedom - that's the name of the game right? To ultimately one day have enough income producing assets that distribute enough cash to cover your living expenses. Do you have that dream as well? Here are some of my financial philosophies that I have learned and followed over the years and I'm confident that they will help you on your own financial journey.
1. Set Goals
Before you get started, you need to have a vision of what you want, why you want it, and when do you want it by. It's difficult to achieve any success unless you have success clearly defined. I believe in setting SMART goals.
T: Time Based
For example, if you have a goal of reducing debt. Instead of simply setting the goal of "reducing debt", how much do you want to reduce specifically overall? By when? How much of that do you need to reduce it this month/quarter/year to meet your longer term deadline?
Or what if your goal is to save enough money for a down payment on your first home. That's a pretty good start, but what if we set a SMART goal around it? How much money do you exactly need? When do you need it by? How much would you need to save every month/quarterly/annually to reach your goal by your deadline? What changes are you willing to make to achieve your goal?
Once you start conquering these goals, you will find that your goals will only start to grow. However, no matter how big your goal, the same principles apply. Keep them SMART, then break them up into baby steps. This worked for me on my million dollar net worth journey, and if you commit to it, it will work for your own financial goals.
2. Track your Progress
If you want to improve on an aspect of your life - track it! The thing is, you can't know where you're going if you don't know where you are now. Once you have your goals set, track your progress and measure them against the SMART goals that you have set for yourself.
In this case, we are going after reducing your spending, reducing debt, growing your net worth, and growing your investment returns. It may sound counter intuitive, but we try to funnel our spending through a credit card (but pay it off in full monthly). First, it gives us the rewards points (some of my favorite cards), second, it allows us to track our spending with ease. Here are some articles that may help.
If you haven't been tracking your financial numbers, the numbers will surprise you. If you want to save money, you need to find out how much you are spending. If you want to grow your net worth, you need to benchmark your growth month after month.
3. Make Saving Money a Priority
Saving money is a tried and true, and perhaps easiest, way to build wealth. You may have been told to save 10% of your income. While 10% is a great start, I believe in being a little more aggressive if you want to build wealth.
I worked out that if you save 10% of your take home pay, then you could potentially reach financial independence in 51 years (shorter if counting government benefits). 10% is probably already covered with your work RRSP plan/pension. However, if you are reading this, you are probably interested in building wealth and retiring sooner.
If you can save 50% of your take home pay, then it will theoretically only take you 16 years to reach financial freedom. Save 65%, and now you are down to 10 years. If you have a spouse, what about the idea of living off one income while saving the rest? That's what we did, and it resulted in building significant wealth... and fast! See the full early retirement table here.
4. Pay off Debt
Now that you have some savings building in your bank account, what are you going to do with it? If you have debt, I'm a believer in paying that off ASAP, even if interest rates are low.
Debt is like having an anchor set while trying to win the sailing race. It's simply a drag on your finances. Use your savings to top up your payments, or pay in lump sums - starting with the loan with the highest interest rate. What works for some people is to pay off the lowest balance first to build momentum, however, if you have 20% credit card interest eating you alive, conquer that first. The key is to get aggressive and pay off debt as fast as possible.
5. Invest your Money
Now that your debts are paid off, you can celebrate a little, but it's time to get down to business with your increased cash flow. If you want to seriously build your wealth over time, you will need to buy appreciating assets. Everyone will have different ideas of appreciating assets, but to me, it's through buying businesses and/or real estate.
While many Canadians already have exposure to real estate due to home ownership, buying large businesses through the stock market is time-tested way to diversify and grow wealth. I know, the stock market is commonly known to be a risky place where investors can lose all their money. Don't get me wrong, you can lose all your money in the stock market! However, I want to show you a risk free method of investing in the market. The strategy will slowly, but steadily, grow your account over time.
Risk Free Investing
Invest in the market risk free? How? Let me show you. Did you know that the S&P 500 index (largest 500 stocks in the US) has never lost money over any 20 year period in history (even after inflation)? Yes, that includes the great depression, super inflation 80's, the dot com bubble, and the credit crisis. Over any 30 year period, the returns are even better. The longer you hold, the better it gets. Add a bond index to the portfolio mix, and now your portfolio has almost no risk of losing money over any 10 year period (assuming 40% bonds).
So what's the key message? Invest in the broad market (ie. index) over the long term and your wealth will grow. Here is an article that explains the basics of index investing.
Keys to Successful Investing
Investing is a pretty big topic, but here is a succinct article on the best strategies for long term investing success. These are the high points:
- Invest for the Long Term;
- Reduce your Management Expense Ratio (MER);
- Index your Portfolio;
- Reduce your Trading Fees; and,
- Reduce your Taxes.
Index Mutual Fund Investing
Many of you are already invested in mutual funds. Now there is nothing wrong with mutual funds as a category - I even hold some myself. The problem is that most mutual funds are over priced and under perform.
Unfortunately with mutual funds, you generally do not get what you pay for. Many funds charge a high MER and cannot keep up with the index. In fact, research shows that only a very small percentage of active mutual funds can beat the index over the long term.
If you want to keep it simple, and stick with mutual funds, you will do better by switching to "index" mutual funds. They have a much lower MER than their active counterparts which will result in a larger portfolio for you in the future. I've calculated that reducing your portfolio MER by as little as 1.7% will result in a 60% difference in portfolio size after 30 years. You can easily do this by switching from active funds to index funds.
To keep it as simple as possible, here is how to build an index mutual fund portfolio with your existing bank.
Index ETF Investing
If you have a larger account, and comfortable with the ins and outs of a self-directed discount brokerage account. you will save money by moving from index mutual funds to index ETFs.
Index ETFs and index mutual funds are almost identical, except that an index ETF will likely have a lower MER (eg. CIBC Canadian index 1% MER vs. Vanguard Canadian index 0.05% MER), and the ETF trades on the stock exchange. Since ETFs trade with a discount brokerage, there will be trading commission attached. To help reduce that barrier, a number of discount brokers offer commission free ETFs. I have a number of accounts, but Questrade is the favorite among MDJ readers.
If you do a google search, you may discover that there is a fairly large ETF selection out there. I have simplified the process by providing a number of example index ETF portfolios here.
Dividend Growth Investing
While I preach index investing to those who like to keep it simple, I'm also an advocate of dividend growth investing.
This strategy is for those who like being more involved with their portfolio (watching stocks, screening stocks, reading financial statements/annual reports), have a higher risk profile, and like the idea of receiving tax efficient dividends on a reliable and regular basis - all while keeping up with the market. Here is an article that explains why a number of investors choose dividend investing.
Dividend growth investing is where you buy individual stocks that have a history of increasing their dividend on an annual basis. The goal is to build a diversified portfolio that produces a tax efficient income stream that increases every year. How tax efficient is it? If you live in Canada, have no other income, and own Canadian dividend stocks in a non-registered portfolio, you can make up to $50,000 in dividend income without paying any income tax and double that if you have a spouse. $50,000 tax-free is equivalent to about $75,000 in gross working salary.
Some examples of dividend growth stocks - Fortis Inc, a power generation utility, has the longest history of dividend increases in Canada. They have increased their dividend for 40+ years straight. Canadian Utilities, another utility, has also increased their dividend for 40+ years straight. Proctor & Gamble, a US based consumer product titan, has increased their dividends 60+ years straight. Johnson and Johnson and Coca-Cola, large US companies, have increased their dividend for 50+ years, Kimberly-Clark for 40+ years, McDonald's for 33+ years and the list goes on.
The strategy can get quite detailed, but if you are interested, here are some articles that may help:
- How to build a dividend growth portfolio
- Canadian dividend growth stocks
- U.S dividend growth stocks
- Canadian dividend ETFs
- When should I buy dividend stocks?
- How to buy and sell dividend stocks
- How the dividend tax credit works
6. Earn More Income
Now that you've gotten into the game of setting goals, tracking your financial numbers, saving a large percentage of your income, paying off your debt, and investing, what's next? What's next is to super charge the cycle of saving and investing by increasing your income. If you are focused on your career, what can you do to add more value to your company? Can you increase value through education? What can you do to increase sales? What about a side business? Do you have something that you are passionate about, that you could share with others? I can tell you that our side online business has made an impact on our finances over the years.
For many though, increasing income equates to lifestyle inflation, however, if you can bank your raises, the faster you will reach your financial goals.
Here are some motivational stories that show that it is possible to build wealth at a young age and even leave the rat-race early if so desired.
- My story of getting to $1M in net worth by the age of 35
- 5 financial principles from a 34-year-old millionaire investor
- How a frugal lawyer reached $1M by age 34
- Lessons from a 50-year-old multi-millionaire
- Retired at age 36 with $1.5M in net worth
There are many ways to build wealth, but the strategies contained in this article have worked for me in obtaining my financial goals. The most important thing that you can do is to take the first step. Set some goals and start the process outlined above - your wealthier future-self will thank you for it.
See how I apply the principles above on my journey to financial freedom.