There is only one rule that should direct your personal finances. If you are able to understand and apply this rule you have mastered all that you need to achieve financial independence.
The rule is:
FINANCIAL INDEPENDENCE = PASSIVE INCOME - EXPENSES
If you are able to earn passive income and spend less than you earn you are not only financially independent but you are also wealthy.
You probably have seen this formula before in terms of cash flow. To manage your cash flow well you need to spend less than you earn.
The challenge in becoming financially independent is how to earn passive income.
Passive income can be simply defined as money that you earn without working for it. There is a very famous author in the personal finances space that says that you have to setup several streams of passive income to minimise your risks and increase your potential for income. In other words, don't put all of your income eggs in one basket.
But how exactly can you earn passive income? A basic list of potential sources of passive income follows:
- Rental property
- Shares and bonds
- Royalties (on inventions or artistic work)
The list above is by no means complete. Have a quick look on the internet and you can find many sources of passive income.
Earning passive income is the hardest item in the formula. Nevertheless many people struggle with the second component, spending.
Spending less than you earn is essential. In some ways it is so basic that it goes without saying it. Nevertheless, our society is impregnated with credit card debt, individuals and organisations filing for bankruptcy. So maybe is not that simple.
If you really want to achieve financial independence, you must spend less than what you earn. Even if you have passive income you still have to spend less than what you earn.
The last component in the formula is FINANCIAL INDEPENDENCE.
Financial Independence should be your ultimate goal. Being financially independent means that you have enough passive income to cover your expenses. Once the passive income is setup, you don't have to work for it. In addition, if you have more passive income than what you spend then you are financial independent.