tl;dr To achieve financial independence, you need to focus on generating enough passive income to cover your expenses. Three strategies to generate passive income are: (1) be a lessor, (2) create re-usable content, and (3) hire other people to work for you.
Financial independence is worth achieving because you will gain freedom and security.
I don’t know about you, but I really dislike worrying about money. Not having enough money makes me feel restricted and insecure. It can hinder my ability to provide for that ones I care about, prevent me from doing the things that I’m most passionate about, and control my life with incessant worry and stress. Too often we find ourselves grinding our lives away, just to earn enough to be able to wake up and do it again. And I want out, and so should you.
Picture this. Imagine you wake up the next day and you have all the money you need to satisfy your basic needs – money to buy a nice house, eat good food, pay your bills, etc. What would you do with your time? How would you feel? That’s the financial independence dream. You’ll be free to do whatever you like and you’ll feel secure because all of your basic needs will be provided for. It doesn’t necessarily mean you’re going to be happy, but it sure as heck will make it easier.
To achieve financial independence, you need to increase your revenue above your expenses without using up all of your time.
A simple definition of financial independence (FI) is the money you earn – your revenue – needs to be greater than the money you spend – your expenses – AND the way you earn that money is passive, i.e. does not eat up all of your time. The most common example of being able to cover your expenses, but still be financially dependent, is the typical 8+ hour-a-day job. You earn enough each year (hopefully) to cover your expenses, but it takes up roughly 70% of your time to do it (based on working 5 days a week). In order to maintain your financial security, you have to actively work, and the moment you stop working, then the revenue stops coming in. To achieve FI, you’ll have to find a way to earn revenue without actively working to earn that revenue.
To make this clear, let’s first start with the two ways to get your revenue to be greater than your expenses: (1) decrease your expenses and (2) increase your revenue.
Decreasing your expenses will definitely help toward FI – theoretically if you had no expenses, then you’d achieve FI – but in reality, there is a limit to how low your expenses can be. Attempting to live the rest of your life being extremely frugal to maintain minimal expenses is not the life most people want to live. Balancing expenses by setting priorities and budgeting to find your personal spending sweet spot would be a topic for another day, but the point is decreasing your expenses will only take you so far. To achieve FI, you’ll have to figure out how to increase your revenue.
The standard approach to increase your revenue is by increasing your revenue rate, $ / Time.
The standard approach to increase your revenue can be illustrated by this equation:
Revenue = $ / Time * Time
Where $ / Time could be your hourly rate, Time could be the number of hours you worked, and Revenue would be the amount of money you made in total.
One way to increase your revenue would be to increase $ / Time. This could be accomplished by going to school and getting an advanced degree. Then when you search for a job, companies will pay you a higher salary because of the unique value you are able to bring with your advanced skills. And as you gain more experience and seniority, your salary will increase even more and so will your revenue.
The other component in this equation, Time, can also be increased to increase revenue, but it has a hard limit. Similar to trying to decrease expenses, the amount of time spent working is limited both theoretically by the number of hours in a day, and emotionally and physically, by the amount of work a person can reasonably sustain. More importantly, FI is about trying to free up your time and spending more time actively working would be doing the exact opposite.
The problem with the standard approach is, regardless of how high you can reasonably increase your revenue rate, $ / Time, it will always require you to actively spend time working to generate revenue. The day when you become too old to work, or suffer a serious health calamity preventing you from working, then instantly your revenue drops to zero, and you’re once again financially dependent. Most of us are well aware of this issue and try to prepare for it by saving some money, while we’re still working, so when the day comes for us to retire and our revenue stops coming in, we will still have our savings to carry us through retirement. Unfortunately, many of us fail to save much money at all (65% of Americans have little or nothing). It’s hard enough just trying to support our expenses now to worry about our money problems in the future.
Instead of focusing on $/Time to maximize revenue, remove Time from the equation.
The solution is to stop following the standard approach and remove Time from the equation by replacing it with a completely different variable. For example, if you are a software engineer, instead of working for a company to complete their projects, where you are paid based on the hours you work, try to find a way to work for yourself and complete your own project, where you can be paid based on the number of times your software is used. This could be an app, like Flappy Bird, that you could sell and market through Apple’s App Store (Flappy Bird earned $50,000 dollars per day in advertising income!). The key change is you now would be paid by $ / Download or $ / App Purchase instead of $ / Time. The revenue you earn is no longer limited by the amount of time you can spend working, but is instead limited by the number of users you can get.
Another example of a feasible approach to FI is to combine the standard increase $ / Time approach with passive investing. If your active earnings well surpasses your expenses, then you’ll have money left over to build up a giant savings nest egg over time. By investing it in equities and bonds, you can create a growing source of passive revenue that one day replaces your active income. The reason this works is because you’ve gradually replace the revenue you used to earn based on $ / Time into revenue that is based on $ / Size of Nest Egg.
The key is the method you use to generate and increase your revenue must be scalable.
The underlying reason why the two examples are more effective than the standard approach of trying to increase your salary is that they are both scalable. This means that you aren’t restricted in repeating or expanding your method of generating revenue. In the standard approach, regardless of how high you increase your revenue, you are restricted by the amount of time you have available to work. There is no way (at least yet) to clone yourself to allow you to work more hours. In the other two cases, you don’t have that restriction since you’ve removed time from the equation; you can always make more popular apps or re-invest any savings you’ve accumulated. This doesn’t mean that’s it going to be easy to do, but it does mean once you have setup a revenue stream, you still be able to find a new revenue stream (or expand on the existing one) because you don’t have to actively spend all of your time to maintain the original one.
This scalability condition can be satisfied by searching for methods that can take in nearly unlimited resources, requires limited time to service, and generates a consistent return on investment.
When looking for potential methods to generate scalable revenue, important criteria to check for is: if it can take in nearly unlimited resources, requires limited time to service, and generates a consistent return on investment. For example, when creating a software app, this require you investing some initial resources – your time and money – for a limited period of time, which then generates a certain amount of revenue for an extended period of time. After app development and launch is over, you now have your time back with extra revenue that you can use to create another revenue-generating app. This process and be repeated over and over again, as long as there are users to buy your apps. Since it’s unlikely for you to run out of new users (and your user base refreshes every app), you can always re-invest more income and time into creating more revenue-generating apps.
An example of an approach that would not be scalable is a part-time gig as an Uber or Lyft driver. After you have made extra revenue as a driver, there’s no way for you to re-invest that income easily back into your driving to generate more income (maybe having a better phone or car could help a bit, but then what else could you do?). Also, driving for money is an active method to generate revenue, so it’s essentially amount to increase Time in the standard approach, except now you’re working two jobs instead of one.
3 strategies to find scalable revenue generating methods are:
- Be a lessor
- Produce re-usable content
- Build a business
Three potential strategies to achieve passive income by changing Time into a different variable are:
- Be a Lessor – a lessor is a person who owns an asset and rents it out to the borrower for a specified period of time and in return, the borrower pays the lessor a fee. This can be a property owner, who rents out their basement floor of their house, or a money lendor, who lends their money as a loan at a certain interest rate (investing is essentially lending to a business in return for a portion of their returns). The transformation is changing $ / Time into $ / Assets, where the amount of assets you own to lend is what drives the revenue generated.
- Produce re-usable content – this strategy is to utilize your creativity skills to create interesting content and charge a fee for users when they consume it. This can include blogs, youtube channels, e-books, etc. where people come to visit your site or channel and you make money per view through advertisements, or where people directly consume your content by purchasing your e-book. The advantage of this approach is you are only required to use a limited amount of time to first create the content, but afterwards the revenue you generate is mostly all passive. The transformation is changing $ / Time into $ / Use, where use is the amount of times your content is re-used.
- Build a business – this is all about paying people to create value for you. Using the standard day-job approach before, if you could out-source your job by finding someone to do the work you do for less pay, then you’ve immediately removed your time out of the equation and replaced it with their Although you’ve likely lowered the rate of pay per hours worked, but now that working hours are all derived from someone else’s time, you are free to find more work and more workers. Another advantage is typically there are powerful synergistic effects when building a larger business by creating value that is only possible from the focused cohesive effect of a large group of people. The transformation is changing $ / Your Time into $ / Other Person’s Time.
I’ll try to get into more details on tactics for each of these strategies in later blog posts, but I hope this general picture helps guide and encourage you toward achieving your financial freedom!