[Chad: This is a guest post from Scott Trench, the VP of Operations at BiggerPockets.com. I met Scott through my writing at Bigger Pockets, and I was quickly impressed with his intelligence, ambition, and quick progress towards financial independence before his 30th birthday.
Scott recently published a book with the lessons from his experience called Set For Life: Dominate Life, Money, and the American Dream. I read an early copy, and I thought it contained great advice. So, I asked Scott to share some of the best lessons from this book in this guest post.
Take it away, Scott!]
Suppose that you are a full-time wage earner starting out on the journey to early financial freedom. You have little to no wealth, except perhaps some home equity and retirement savings. But you have a pretty good job that pays at or near the median income.
Often, folks in this exact position want to dive into real estate without getting their ducks in a row on the personal financial front. They try to invest in real estate when all they have is a paltry amount of cash (maybe 2-3 months worth), a bit of home equity, and several years of 401(k) contributions.
The fact of the matter is that if this is your financial and life position going into real estate investing, you have your work cut out for you. You are not building wealth in a manner that is likely to benefit your early financial freedom. And you are certainly not in a strong position from which to begin investing in real estate.
[Chad: I wholeheartedly agree with Scott’s point here. Starting a business or investing with little cash or without a solid financial foundation is very difficult. With that said, it’s what I did! And it was an uphill battle at times. But I don’t recommend it for most people. I began right out of college with much less to lose. If I had to begin while supporting a family, I would likely follow Scott’s plan or something very similar.]
Here’s the problem—you have no financial runway. A financial runway can be defined as the number of months or years that you can survive without the need to actively work and earn wages.
Fix that problem, and then begin investing in real estate.
Fix that problem, and put yourself in a position where you have tens of thousands of dollars in cash or cash equivalents. Put yourself in the position where you are saving thousands of dollars per month. The person with this financial position is well-prepared to finance a rental property. The person with this financial position is in a strong position to tackle problems and challenges without being threatened financially.
Of course, building out this financial runway will involve hard work and saving your money. It will also involve thinking in terms of producing and acquiring real assets that can impact your financial position in the immediate future. That’s what this article is about. That’s what becoming Set for Life involves.
Step #1 – Building the First $25K Through Frugality
For the Average Joe seeking to go from $0 to $25K in net worth, the wealth building journey will begin with frugality. You have to start somewhere, and for most folks working a full-time job, the most efficient means to building out financial runway will involve lifestyle design. Penny pinching. Frugality, Savings. Whatever you want to call it.
How does one go about tackling frugality in an effective manner? It’s not about cutting back on your latte, your night out with your friends, or your entertainment budget. Instead, look at where you are really spending money. According to a 2015 report by the Bureau of Labor Statistics, the average American spends nearly two-thirds of his or her budget in the categories of housing, transportation, and food preparation. If you can make monumental changes in those areas of your budget, you can easily begin to save 50% or more of your income.
With that kind of savings rate, you’ll build out your first year of financial runway in about 12 months. Remember that your spending is the primary factor slowing you down here. The more you can cut back, the more you can accumulate and the less you need to accumulate to hit a year of financial runway. The person that spends $50K per year has to earn a ton of money to build out a $50K financial runway in one year. Compare that to the person that can spend $25K per year–only needs a $25K financial runway!
Remember, for wealth to count towards building out your financial runway, it must be accessible. It must be in cash, or in investments like stocks that you are ready and willing to convert to cash, should the opportunity to invest it arise.
The full-time employee starting with little to no wealth will have a hard time building a business in the few hours after work at night. He also has no capital with which to invest. While it’s certainly possible to moonlight or attempt a startup after core work hours, the simple truth for many full-time employees is that there is little else that they can effectively do to build up capital than simply save their pennies.
Step #2: From $25K to $100K Through Income Production and House-Hacking
What does your year of the financial runway do for you? It gives you flexibility. It will help you to feel comfortable taking some risks and making some investments that are significant relative to your spending.
The two things that you can layer in the next step of the journey towards early financial freedom are house-hacking and income production.
First, let’s talk about house-hacking. House-hacking is the concept of buying a property with extra units (like a duplex, triplex, or quadplex) or extra bedrooms and renting out the excess space. This allows the owner to live for free or very low cost relative to the other options in most markets.
[Chad – Regular readers won’t be surprised to see house hacking as a first step in your wealth building journey. It’s also what I recommend constantly. Scott began his own journey with a great duplex house hack in Denver, Colorado, and I began my own journey with a 4-plex in my home town. You can read my House Hacking Guide for more details about my deal and for a detailed, step-by-step explanation of the concept]
In order to house-hack, you will typically need to bring some money to the table. But you can often use a low down-payment loan like an FHA or even a VA loan.
So, for example, you can bring down $15,000 (5%) to purchase a $300,000 duplex. If you were able to rent out the other unit for enough to cover the mortgage, you completely eliminate your housing expense and automatically begin saving an even higher portion of your income! This allows you to quickly extend your financial runway and begin saving thousands of dollars per month from your wage income.
The other thing that your financial runway and low spending do is that it exposes you to opportunity. Many corporate career tracks are inefficient when one is progressing towards early financial freedom. Be honest with yourself. If you are an operations analyst II earning $60K per year, then you know that the next step on your career path is “Senior Operations Analyst” at $72K per year.
That’s the best case scenario.
If you want to earn a truly significant income and have a real shot at achieving early financial freedom rapidly, you will have to do better than that. You will have to find a scalable line of work. And often, but not always, the price of opportunity is a reduction in base salary. For example, someone that joins a startup and takes a low base salary but gets a piece of the company in the form of equity has a shot at doing very well. Or someone that transitions into a sales job or a role with a huge performance based component stands to benefit from a job well done.
Think about it. Let’s say you make $50K per year, spend $48K, and have just $5,000 in the bank. You can’t even consider a job that pays $40K that has strong potential to help you earn $100K+ in a year or two!
But, if you can live happily on $25K per year and have $30K in liquidity, the transition is a no-brainer.
Of course, once you make the transition to performance-based work, you will have to then perform in order to reap those potential rewards. Just understand that your financial position may be preventing you from taking advantage of opportunities that you hadn’t even considered!
Step #3: From $100K to Early Financial Freedom
If you are able to live on $25K per year and make substantial progress on the income front to where you are earning $100K+ per year, you stand a great shot at achieving a six figure net worth rapidly. Once you get to this point, you’ll begin to feel very comfortable with your financial position. As a result, opportunities will begin to multiply in front of you.
At this point, you have the option to leave work for years without running out of cash. You have the option to buy serious small businesses and real estate with ease. You have the option to continue to plow along and exponentially extend your financial runway until your portfolio grows to the point where it can support your lifestyle indefinitely.
From this point on, you will simply need to build, buy, and otherwise acquire income producing assets that will appreciate at a rate faster than inflation. Real estate is one obvious component of a strong financial plan for many employees seeking to transition to early financial freedom, but an opportunistic investor may find other investment opportunities to be more appropriate.
The point is that once you get here, you only have to maintain your high income and low spending and apply your savings towards the best investment opportunities you can fathom.
This discussion about early financial freedom is a brief synopsis of many of the points discussed in my book Set for Life. The book goes into far greater detail on the specifics of things like cutting back on your expenses, house-hacking, and earning more income. And it explains how to set yourself up for professional success and for success acquiring and managing investments.
I hope that Set for Life helps you to build out your financial runway rapidly so that you can pursue opportunities and early financial freedom as efficiently as possible.
[Chad – I really enjoyed this guest post from Scott Trench. I like his practical, logical, and flexible advice. It’s not far-fetched or difficult to understand. Anyone with ambition and self-discipline can achieve what he describes. I got to read an early copy of Scott’s book Set For Life, which was just launched on Amazon and Barnes and Noble If you are a wage earner who is trying to figure out the best path to financial independence, I highly recommend the book. I’ll be purchasing it as a gift for friends in that exact situation.]
I’d love to hear from you in the comments. If you are or were in a wage-earning job, what steps have you taken to transition to financial independence? Did you build a financial runway or use any of the steps outlined by Scott in this post? What tips did you find helpful?
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