This article is the second in a series of seven that will discuss what it takes to reach financial independence. If you have not already read the first step, which covers budgeting, please take a minute to visit that post. This article will outline why you should create a passive income stream.
When I first started my career, it became apparent that I had many working years ahead of me. I had early dreams of becoming a millionaire by age 21 and living the rockstar lifestyle of the rich and famous. I soon discovered that I would have a long wait, if relying solely on my paycheck, before I could afford my desired standard of living. I realized that I needed to create another way to earn money to pay for this dream.
I was very industrious in my younger days—mowing lawns, shoveling snow, doing odd jobs, and running a paper route for a while. I embraced the concept of improving my lifestyle. Of course, I opened up a lemonade stand a couple times during summer vacations. In my early teens, I learned how to drive by working on an 80-acre ranch doing odd jobs, feeding horses, and occasionally plowing a field.
These childhood and teenage experiences had an impact on me. Some of my mentors encouraged me to save and invest, and introduced me to real estate. I did not know then how much impact these early passive income investments would have on the direction of my life.
Retirement from the day job could take some time
Once I discovered that my career “working for the man” could span forty years, I began to think that there had to be a better way to become financially independent. I needed to create a better plan.
It was time to make some changes. I took on roommates and a second job. I began to save even more money for my investments.
I was not afraid of doing hard work. When I was in my mid-teens, a family friend and mentor imparted some sage advice. He told me this:
“The more you use your brain and the less you use your back, the more money you will end up making.”
I was fortunate that I had some great role models in my youth who taught me the concept of working efficiently and thinking creatively, crafting better methods of getting work completed. One told me not to “make a career” out of accomplishing the task at hand, but rather to get it done quickly and efficiently.
We all need to save and invest to retire
I mentioned the importance of monitoring your expenses and saving in Step 1. This is a critical piece to control, that will have a direct impact on your ability to reach financial independence.
There has been a growing community of very frugal-minded people who are attempting to save 50% to 75% of their income. This concept did not really make an impact on my strategy until about six years ago. I discovered blogs like Early Retirement Extreme and read books like Your Money or Your Life that showed me that I didn’t need a six-figure income to retire early. Mr. Money Mustache explains it all quite well here in his “shockingly simple math” post on early retirement.
If you follow this strategy, your focus will be on lowering your actual living costs while saving the difference. It does not take long before you have enough saved to live on for the rest of your life. Speaking of saving…
Some important reasons to save money
My parents taught me the concepts of saving and compound interest, and helped me set up my first retirement account. The need to plan and save became an important focus for me with the birth of my first daughter. It reinforced the notion that I needed to save for her future—as well as our own. Depending on your situation, there are multiple reasons you should save for the future. Here are a few for us:
Funding for repairs, infrequent expenses, and cars
There are good reasons for funding for large and infrequent expenses. This helps the budgeting process by smoothing out the fluctuations on your expenses each month. Those semiannual insurance premiums and property taxes are good examples of expenses that make sense to budget 1/12th the annual cost each month and deposit into a separate account. Saving for your next car is another important reason. This helps build a discipline of anticipating future needs rather than reacting and using credit cards to manage your expenses.
A college fund
We started a college fund for each of my daughters right after they were born. For our oldest daughter, we contributed $200 per month directly into an S&P 500 index fund for fourteen years and then stopped. With only that small savings amount each month, there was enough to pay for her public four-year university, with money left over for her wedding. This was a simple investment approach we did not touch through all the market fluctuations. I am still shocked that we were able to do so much for my daughter. This is a good example of “dollar cost averaging” in practice.
Company-sponsored IRAs or Roths
I can’t say it enough times: take advantage of any company-sponsored retirement accounts regardless of whether they offer a match. For those starting out, it might be hard contributing $18K a year, but I would recommend you invest enough to receive any company match. Those who are over 50 can also contribute an additional catch-up of $6,000 each year. The more and earlier you invest, the less stressful it will be later in life.
Build passive income: Shorten your timeframe
Saving a significant amount of your income will tremendously improve your odds of reaching financial independence early. To turbo-charge your strategy, you may need to think in terms of starting a business or seeking out other forms of investment. I will stick with what I have had experience with in providing a couple of examples.
Start a business
I started my first business at age 18 with my brother and another friend. It was a small, niche company that taught me important lessons quickly—like managing cash flow and expenses while always searching for the next customer. After a few years we sold off the equipment, shut it down, and moved on to other things.
We can all think of people who have done well for themselves by opening their own business.
A former employee of mine comes to my mind. About ten years ago, an IT employee in his early twenties worked his way into a contracting position so he would not have to come in to the office five days a week. He asked to do this because he had recently picked up a couple of contracting work customers of his own. He did this part time customer work in the evenings. It has been nearly a year since we last spoke, but I believe he and his business partner now have over 30 employees. They also own their business’ building free and clear.
If you go this route, don’t underestimate the initial startup costs and cash flow requirements to keep your business solvent. It may take a number of years of dedicated work before the business will make a profit.
Real estate
In my late teens, I purchased my first rental property. Through some horrible market conditions, the construction company I was working for in the summer was stuck with houses they could not sell with 18% mortgage interest rates. One of the partners of this company was my father; he sold me a house at cost, and taught me how to manage a rental property. I owned that property for ten years before I sold it, relocating with the company I was working for at the time. That was the initial spark and foundation that introduced me to real estate. I have continued investing in real estate ever since.
Early on, I noticed that most wealthy people I knew tended to have built a large portion of their net worth in real estate. These people were friends of the family, doctors, dentists, and local business owners who had a variety of careers and backgrounds. What was amazing to me is that they all had some of their net worth invested in either commercial or residential real estate. In fact, some of the wealthiest people I know made their initial wealth in real estate and development.
This is a great way to leverage Other People’s Money (OPM) when you are just starting out. It is possible to buy properties with very little money out of pocket. The conventional approach with bank financing will require a 25% to 30% down payment for a non-owner occupied rental property. If you are handy and have aptitudes working on houses and their systems, this would be an excellent way to leverage your “sweat equity” by doing the work yourself.
I will get into the details of how to purchase rental properties in a different series of posts. For now, the point is that this is an excellent method to build net worth and a passive income.
The best time to start investing is now
If you are just starting out in the workforce, working forty years may get tiresome unless you truly enjoy your employer and career. For most of us who have worked many years and are closer to retirement age, we are ready to leave our paid jobs and live off a passive income.
There are several ways to reach financial independence early. The first approach is to cut your way to retirement by extreme saving of 50% to 75% of your income. At the 70% rate, in about seven years you can retire.
Another approach is to create the next “dot com” business that becomes successful. Then there are those of us who have company retirement plans where we have saved the maximum each year and have benefited by company matches. Save money for decades and you WILL build a solid retirement account.
Finally, you could jump into rental real estate like many others have done. We followed an approach leveraging a combination of savings, investing, and purchasing real estate for passive income.
The key point to Step 2 is that you need to both save and invest in a business outside of your job if you wish to reach financial independence in an aggressive time-frame.
Joe says
It’s such an advantage to have great role models and mentors early in life. You started so young and learned so much in your teenage years. I was just focusing on school and trying to get a profession when I was young. That’s good, but it’s too conventional. Passive income is the way to go and the younger you start the better.
I like both real estate and the stock market.
Bryan says
I am in agreement with you Joe, I like both real estate and the stock market. They require me to use different skill sets and have their own unique set of challenges. 🙂 The advantage with real estate is that you can leverage OPM and tenant’s rent payments to pay for the investment. With stock, it is pure brute force savings in order to buy shares…. unless you use margin.
I did have some great mentors early in my life. It has taken me awhile to fully comprehend those lessons!
Luke Fitzgerald @ FinanciallyFitz says
Great information! Times are changing, that’s for sure. At least a few decades ago “working for the man” actually worked lol (pensions, security, etc). Now, many people work 40 years and still dont have anything to show for (mostly their fault, I guess).
I started my career working for the man 3 years ago next week 🙂 One of the reasons I started blogging was because of how it could pivot to many other opportunities (years down the road).
So, as of right now i dont have anything planned – but that doesnt mean I wont soon 🙂 I’m trying to learn as much as I can about creating and running businesses, side hustles, or whatever else. Thats what gets me up in the morning!
Bryan @Just One More Year says
Luke,
You have such a huge jump on where I was when I first started in my career. The fact that you are understanding and embracing these personal finance concepts early in life will put you in a position of independence earlier than most.
I know that has to be tough for you when your peers are probably not doing this kind of planning. How are you able to handle that challenge?
Take care,
Bryan
Young says
I had just found out your blog from retireby40. Even though there are so many blogs on finance, only a few blogs worth my time. I will follow your blog from now on. I like your intelligence and passion for finance.
Bryan says
Young,
This was such a nice comment of you to make about our blog. I really appreciate your feedback and following our blog. 🙂
Joe at Retire by 40 has a great site and story about his journey to early retirement. It was quite an honor to be invited by him to guest post on his site. We now have a lot of new followers that have discovered us, just like you. I am glad you found us!
Please feel free to comment and ask questions.
Take care,
Bryan
Holly@ClubThrifty says
We have some passive income streams, including our rental properties which are “somewhat” passive. We are lucky that we had the sense to start saving a large percentage of our incomes by the time we were 30.
Bryan says
Holly,
You and Greg are doing great with your rental properties and the Club Thrifty business. It would be simple for you to inflate your lifestyle as your success and income grows. What is amazing about what you are doing is your commitment to saving, investing, and building your business. This focus is already paying dividends for your family.
I can only imagine your situation ten years from now! 🙂
Take care,
Bryan
Abigail @ipickuppennies says
Unfortunately, no passive income here, but rental property is in our future. It may take awhile, but it’s one of my goals to help pad income as we get older. Especially if you have a property manager — we’ll need one — it’s a great way to make some money without much effort. And people will always need a place to live.
Bryan says
I think you can do it! You have done excellent work with your blog for years. You have the temperament and tenacity to build a passive income business! 🙂
I plan on doing an entire series on residential real estate investing. It will probably be a couple months before my first post. I do look forward to your feedback and hope if will be helpful for you.
Erik says
Hey Bryan,
Amazing article. Your writing is very clear and this article considers all of what early retirement and future financial planning looks to achieve. I also like how you go into detail about what starting a business could look like and what you learned from your business.
Can you go into more detail about that business you started when you were 18?
Have a great day, I look forward to reading more insightful posts from you,
Erik
Bryan says
Erik,
Thanks very much for the compliment on the article – I appreciate that feedback! 🙂 I am hopeful that all seven steps will be enjoyed by my reading audience, providing them value.
Regarding the business at age 18…. My brother, his friend, and I started a video production business in Colorado. My brother was in TV and radio and had all the technical and artistic skills. I ran the business from a management, accounting, and worker perspective. We started out doing typical wedding gigs that branched out into other interesting work. We covered all the major class reunions, did special coverage of business events, and created a short documentary.
We used high-end video, audio, and mixing equipment at the time where we could blend multiple live camera angles from our crew of contractors. We would also complete major editing, voice-overs, and graphics in post-production. This great learning experience disbanded when I was transferred with my employer to Denver. We decided then to sell the equipment, close up shop, and pursue our separate careers.
Take care,
Bryan
DP says
Bryan,
I feel confident in my investing abilities in the stock market, but still lack in the real estate department. Therefore, I am looking forward to your series on real estate purchases. Do you tend to act as landlord in your rental properties or do you rent it out? That seems like the biggest drawback to me in purchasing rental property.
-DP
Bryan says
DP,
Thanks for the feedback on the real estate series. I will probably have the first post out in late September or early October. I will post an article every Thursday evening for multiple weeks.
I started in the business by doing nearly every aspect of managing the property myself. This included finding tenants, cleaning, repairing, painting, accounting, marketing, etc. For the heavy duty plumping and electrical work past my abilities, I would hire someone. It did this for about 15 years.
My career took off and required me to relocated around the country on multiple occasions. When that began I continued to manage the tenants, used vendors for repairs, and vendors to help me show properties. We continued to acquire more properties and it became too much for me to manage without a property manager. We also lived out of state from the properties.
We are using a team of people now the takes care of most aspects of the business. It requires about 8 to 10 hours a month of my time today.
I hope that was helpful.
Redeemed Finance says
The family has pretty much been heavy real-estate for the past 25 years. My parents did it in reverse with buying a 3 family home and living in it while also renting the other 2 units. Then purchased another, and another. Only recently have they begun to look at the investing/stock market side of it (529 for the grand kids and IRA for their retirements) but are still at least 75-80% real estate portfolio wise.
Looking forward I can see the importance of a property manager but here it seems that all the PM’s want 10-15% and then repairs are additional. Do you see the same types of fees involved with PM’s in your area? or your out of state areas?
Rich
Bryan says
Rich,
Our family has been involved with real estate for decades as well. I agree that it does make sense to diversify investments into other passive income opportunities…. so all those eggs are not in one basket, increasing your risk. 🙂
Regarding PM’s, when you have many properties you can negotiate rates in the 5% to 8% range at first. Slowly those rates can increase over time. I have not seen rates over 10% for residential property management in my history. The management cost covers marketing, showing to prospective tenants, creating leases, collecting security deposits, paying vendors, evictions (not legal fees), reporting, and managing all other aspects of tenant calls. The repairs are always in addition to the management cost, with the funds deducted from our rental income.
I hope that helps! Take care.
Bryan
Mr. Enchumbao says
Hi Bryan,
Great post. Passive income is definitely the way to go to achieve financial independence. Our passive income streams mostly come from real estate and stocks investments. We’re now less than 3 years away from reaching financial independence and it’s nice to see the money working for you instead of us just working for the money.
Bryan says
Mr. Enchumbao,
Stock and real estate appear to be a common approach for us in the FIRE camp. Those 3 years will go by much faster than you think. I have had a bunch of three-year plans that tend to morph into something different before all of our goals were achieved. 🙂 Who knows what wacky adventures are coming your way!
I noticed that your website mentions something that is a significant reason why I am blogging today: “That life is easier when we learn from others’ mistakes instead of our own”. I like those words of wisdom.
My hope is that through my articles I can share our experiences that were successful and failed, helping people with their own FI journey.
Bryan
Jenna L says
Some great ideas here. It sounds like you had lots of good advice about money and investing from people in your life.
I’m currently educating myself about personal finance and in particular, methods to reduce debt so that I can build a plan for the next five years.
Bryan says
Jenna,
Welcome to the community and thanks for commenting! 🙂 It appears equities are your preferred passive income choice looking at your website.
I have followed a multi-legged approach to my passive income stool that includes “legs” for cash, bonds, stocks, and rental real estate. We will also have a couple small pensions and Social Security as a bonus.
Our plan is to retire early with the ability to live on only our real estate income. This gives us a couple back up “legs” to draw on if things do not go as well as planned. I do plan to write a complete series of my experience with rental real estate with some valuable lessons learned. That should start sometime in October or November.
Take care,
Bryan
ARB says
My dad has suggested rental properties, but I’m sort of with Jason from Dividend Mantra in that they seem to be a bit of a pain for a passive income source. I’m not against the idea, but I really don’t want to deal with tenants and try to figure out their financial situation and motives while staying in compliance with a dizzying array of regulations designed to protect them at my expense. Dealing with people and playing the roles of friendly customer service rep, law enforcement agent, and psychologist, all while dealing with more regulations than should ever exist is what I’m trying to get AWAY from.
That said, if I ever owned my own home, I would try to purchase a 2-4 unit property and live in one of the units. “Monetize everything” is something I’ve been saying lately, and that includes your living situation.
I’m still making passive income and savings my mission. I invest in dividend-paying blue chips with some P2P lending on the side, and I invest a higher percentage into my 401k than necessary to get my employer match. I also am trying to build income with my blog, and I’m looking at a second job with a work-at-home company that I’ve discovered thankfully is not a scam. I’m also saving money by not buying fancy cars and gadgets (though I will be buying an Xbox One with the leftover change from the end of each day that I am building up) and by going on weeklong spending fasts at least once a month. I’m at the end of a three week spending fast right now, actually.
It’s very fortunate, Bryan, that you had some great roles models growing up. I couldn’t imagine starting a business at 18. I’d say I couldn’t imagine starting a business now, but me and a friend actually tried to start an investment seminar business last year. It didn’t work out. Hopefully this blog serves as a digital role model of sorts to those just starting out in their working lives. So many young people think that they can handle forty years at a job, not realizing that just because they aren’t sick of work NOW doesn’t mean that they won’t be sick of it in a few years. They’ll wish at that point that they had at least one passive income stream should they decide to make a change in their lives.
Sincerely,
ARB–Angry Retail Banker
Bryan says
ARB, I think you have a good understanding of all the different roles needed for rental properties. Jason is in the “renter for life” camp, not considering real estate as an investment approach. His dividend approach and frugal living is serving him well.
It is interesting that you are in fact considering owning a multifamily property. At least you will have your tenants nearby when you figure out their financial situation! 🙂
We were able to make progress in our financial independence by extra side jobs, working overtime, creating side hustles, and a variety of other methods. The passive income from our real estate has been the one area we focused the most to build earnings. In addition to this, we maxed out retirement accounts with our employers as a plan “B” – just in case the real estate did not provide the results we expected.
I learned a long time ago that to become wealthy, especially early, we would need to do more than work in a job for an employer. ARB, I know you understand that too and will do fine by sticking with it!
Take care!