This article is the fourth in a series of seven that will discuss our approach to reaching financial independence, and determining key criteria for success. If you have not already read the third step covering replacement costs, please take a minute to visit that post. This article will discuss the reasons you should test-drive living on less income before retirement.
In Step 1, we outlined the many benefits of setting up a budget to take control of your financial life. In Step 2, we discussed why it is important to have a side hustle and create a passive income. In Step 3, we covered the need to plan for replacement and maintenance costs in the journey toward financial independence and retirement.
These steps are designed to help you see that if you do not manage your expenses and create income sources independent of work, you may be choosing a long and rough road to achieve financial independence.
You arrived at the finish line; is it time to quit?
The market, your job, and investments may have all worked out well for you. Over years of saving and investing while living frugally, you have grown your net worth and passive income stream. Frugality and planning has paid off and life is good!
In fact, it looks like your passive income could now cover all of your expenses, including any remaining debt payments. Is it time to quit because it appears you are “FI”?
What about taking a victory lap while you continue to work and stash your entire paycheck?
This test-driving concept suggests that you should build a safety buffer after you have reached the theoretical FI point. This is the strategy that “those fat cats on Wall Street” or your boss, for that matter, would like to keep secret. 🙂 Why stop work when you can continue to pad your E-Fund, savings, replacement and bucket list costs?
Consider these challenges with less income.
What happens if the finish line just moved out to the future? We all recognize that things do not always go as planned. According to your calculations, planning, and strategies, it looked like you had reached FI. But, do you know with absolute certainty that you have a stable foundation? Here are a few items to consider:
Is your passive income sustainable?
- If you are relying on stock dividends, are they consistent?
- How will your bonds fare with the expected interest rate increases? Do you have the yield you need?
- Are we heading into a bear market for stocks?
- Can you afford not selling any shares for many years?
- Business owners: is your business profitable and providing all the cash you need?
We have decades of experience working with rental real estate. In this business, there can be some good times and some very bad times. Sometimes the economy can have a huge impact on the performance of this business. There can also be a series of poor tenants and property managers. Properties can incur significant repair and maintenance costs.
For us, this year so far has been subpar for several of these reasons. Our passive income has dropped significantly this year, which has us scurrying back to our retirement spreadsheets. Had we stopped working when we reached FI, we would have been troubled by this latest trend with our rental real estate.
In our case, we have funneled all of one income straight into our debt snowball. In addition, our budgets for the past two years were based on a reduced passive income projection. We know that if we can plan to live on a reduced income, we can live through all the peaks and valleys that will certainly affect real estate and stock values in the years ahead.
Turbo-charge your debt snowball, savings, or investments
When you continue to work past your FI point, you are proving that it is possible to live on less than you earn. Should you have any remaining debt, this is an excellent time to focus on paying it off. The extra available income has the effect of turbo-charging a debt snowball. The debt snowball continues to gather strength, growing as each debt is paid. This allows the recently paid-off loan payment to be stacked on the next targeted debt, gaining more and more momentum. When one income stream is earmarked for the snowball, debts can disappear very rapidly.
There are those who are already debt free at this point in their financial journey. Congratulations! Now would be an excellent time to continue saving to build your passive income stream. If you invest in real estate, consider buying another property with cash. If stocks or bonds are your thing, take the time to research good picks and buy more. Consider peer-to-peer lending as another passive income option to feed the growing nest egg. The investment choices are limited only by your imagination.
You could have the enviable problem that your money is simply rolling in so fast you don’t know what to do with it. You could use the surplus to fund your future. Why not begin fully funding your replacement and bucket list items now? The idea of retiring early with enough money to experience all your dreams sounds quite exciting to me!
Strength in needing only one income source
There is a certain level of satisfaction and confidence in living on just one income source. You know that you have options: whether to continue working, or find other work that is more exciting. If you are at your breaking point with your employer, this could be a good time to stop working.
If you have felt stuck, this is a liberating point to begin your FI journey. You may see a shift in your attitude and motivation to retire early. The other aspects of your financial life may now start to fall into place.
The experience of living below your means is empowering. The budgeting process demonstrates that your finances are predictable. You know you can live on less money than your household brings in and that your expenses are covered.
Living a life with expenses that are reasonable for you helps lower the amount needed in the nest egg. The less you spend, the less your need to save. Needing to save less effectively lowers the timeframe and amount you need to work.
The financial independence steps are gaining momentum
We have discussed the importance of budgeting, managing expenses, saving, investing, passive income, and planning for replacements and bucket list costs. These topics are all vital considerations in the steps for our FI and retirement planning.
Now, in Step 4, let’s explore the concept of a “test-drive,” living on less income. This could mean one person in a two-income family no longer working, or (if you are single, or if you and your spouse are a one-income household) beginning to live on a passive income stream. You could also choose to budget your expenses as if you have one income source, and saving the rest.
Living on one income source and piling the difference into your E-Fund, replacement cost, and bucket list funds can help take years off future savings goals. This strategy of living on one less income stream ensures the other income sources are secure. Should you find your income or expenses are not as expected, you still have the safety valve of an additional income source to make up the difference.
In the next step of this progression toward retirement, we will consider the impact of becoming debt-free prior to financial independence. Thanks for stopping by and continuing with the series.