Financial Independence: Investing

Introduction 

Investing in assets that generate cash flow is a key component of achieving financial independence. However, before making any investments, it's crucial to have a solid budgeting plan in place to save up for them. By using budgeting techniques such as setting financial goals, tracking expenses, and creating a savings plan, you can ensure that you have the necessary funds to invest in cash-flow-generating assets. View our post about this here. After you have a positive cash-flowing budget, you can start investing in different assets that compound. 

Compounding Interest 

A key concept to understand when investing in assets is "compounding interest." Compound interest is the interest on a loan or deposit calculated based on the initial principal and the accumulated interest from previous periods. In other words, the interest earned in one period is added to the principal, so that the next period's interest is earned on the new, higher principal. Adding interest to the principal is the mechanism that makes compound interest "compound." 

For example, you invest $10,000 at a 5% annual interest rate. After one year, you would earn $500 in interest ($10,000 x 5%). However, if you leave that $500 in the account to earn interest in the second year, you would earn 5% interest on $10,500, which is $525. As you can see, the amount of interest earned increases as the principal grows. This is why compound interest can be a powerful tool for building wealth over time. It's important to note that the power of compound interest is maximized when the interest is earned and reinvested over a long time. 

Investment Types 

Several types of investments can provide a steady stream of income through interest, including dividends, bonds, savings accounts, and Certificates of Deposit (CDs). Additional types of investments include real estate, and also starting or purchasing your own business. In this post, we will explore the different types of investments that can provide cash flow, the risks, and yields associated with each, and examples of how much you would need to invest to live off the income generated from these assets. 

Business

Starting your own business or purchasing an existing one can also be a great way to generate cash flow. By becoming an entrepreneur, you have the potential to not only generate income from your business operations, but also from the appreciation of the business. However, starting or purchasing a business also comes with its own set of risks and requires a significant amount of capital and hard work. Depending on the business, it can be lucrative but certainly isn't passive by any means. You would need to generate enough profit to pay yourself a salary while maintaining the business. If the business is successful, you can also sell shares of your company to generate income. Yields and capital requirements vary by industry and so examples are not provided. Before starting a business, it might be wise to read this: https://playbook.samaltman.com/. It is a very informative playbook by the former president of Y Combinator. 

Dividends

Dividends are a type of investment that pays out a portion of a company's profits to shareholders. These payments can be made on a monthly, quarterly, or annual basis, and are usually paid in the form of cash or stock. Dividend-paying stocks are a popular choice for investors looking for steady income, as they tend to be more stable and less volatile than non-dividend-paying stocks. The average yield for dividend-paying stocks in the S&P 500 index is currently around 1.5%. This means that if you invested $1.25 million in a diversified portfolio of dividend-paying stocks, you could expect to receive around $18,750 in annual dividends. Dividends can also compound if you reinvest them into the same assets. For example, You own 100 shares of a stock, and this stock pays out dividends monthly. If you take the cash from these dividends and buy more shares of the stock, you will get more cash the following month leading to a compounding effect every month. This is called DRIP (Dividend Reinvestment Plan). Some companies will even allow you to purchase shares at a discount if you automate it with them. This provides an incentive for shareholders to retain owning the stock which keeps the price up. 

There are also some newer assets in the market called ETFs (or Exchange Traded Funds) which purchase shares in stocks and then may produce income through various strategies. These ETFs are marketed to have higher yields so you might be able to achieve your goals with less capital. There are some caveats to this which we will cover in future posts. 

Bonds 

Bonds are another type of investment that can provide cash flow. When you buy a bond, you are essentially lending money to a government or a corporation. In exchange, they promise to pay you a fixed rate of interest over a certain time. The yield on bonds can be higher or lower than that of dividends, depending on the bond's credit rating, maturity, and other factors. The current yield on 10-year U.S. Treasury bonds, for example, is around 1.1%, while the yield on corporate bonds can be higher or lower depending on the creditworthiness of the issuer. Bonds are generally considered less risky than stocks, but they can still be affected by changes in interest rates and credit conditions. Note: The past few years have been uncommonly tumultuous for the bond markets combined with the increasing interest rates, leading to increased volatility. If you invested $1 million in bonds and they had a 1.1% yield. You would collect $11,000 per year for the duration of the bonds. 

Real Estate 

Real estate can also be a great source of cash flow. When you invest in real estate, you can earn rental income from tenants, as well as potential appreciation in property values. The yield on real estate investments can vary widely, depending on the property and the local real estate market, and it's difficult to provide a specific yield rate. Real estate investing can be more complex than investing in stocks or bonds, as it requires a significant amount of capital and can be affected by a variety of local economic factors. To get started you would need to identify a property that you deem investable and purchase it with a down payment. Then you would rent it for an amount greater than the mortgage. If you spread $1 million across several properties, depending on your cash flow on average you could expect $80,000 per year IF you find the right properties. There are some risks, however, because things can happen to the house, you could have bad tenants, natural disasters can occur, the housing market could crash, etc. Note: For those people that don't want to go through all of this, there is an asset class called a REIT (Real Estate Investment Trust) that you can invest in. These companies pool money and purchase/manage real estate. More on this in a future post. If you are interested in learning more about Real Estate, there is an organization purely dedicated to teaching people how to invest in Real Estate called Bigger Pockets. https://www.biggerpockets.com/ 

Conclusion 

To achieve financial independence through cash flow investing, you will need to invest a significant amount of money. The amount you need to invest will depend on several factors, including your desired level of income, your age, and your risk tolerance. As a general rule of thumb, you will need to have at least 25 to 30 times your desired annual income saved up before you can begin living off the income generated from your investments. 

It's important to remember that these are rough estimates. The actual figures may vary widely. It's also important to note that investing in cash-flow-generating assets is not a get-rich-quick scheme, and it takes time and effort to accomplish. 

If you want to track your progress towards financial independence or if you are already financially independent and have a tough time keeping track of your finances, then consider using Income Reign to keep track of these things. You can sign up at https://www.incomereign.com.

This blog post is for informational purposes only and is not intended to provide financial advice. All readers should consult a qualified financial professional before making any financial decisions. The author of this blog post makes no representations as to the accuracy, completeness, suitability, or validity of any information on this site and will not be liable for any errors, omissions, or any losses, injuries, or damages arising from its display or use.