Building financial independence

Question

In my very late 20s I am working hard to become financially independent. I have a good job paying between 74-80k a year. I can live (pay rent, food, entertainment) for $1k a month.

So after taxes I am able to save almost 3k a month. I have no debt, everything is paid off. In fact I have close to 50k in my checking account, yes those money generate 0% now.

• Should I invest in stocks, in house (mortgage instead of rent)?

I do not have any 401k or IRA I don't like that you need to rely on government and keep the money there forever.

Soon, I am planning on spending 20k on a new car (paying cash), putting 10k in emergency fund and investing 20k.

I am seeking validation, whether my thinking is sound and for an advice how to take advantage of my situation and how to make investments so that I can get the highest passive income possible ...

Answer 1

For a young person with good income, 50k sitting in a savings account earning nothing is really bad. You're losing money because of inflation, and losing on the growth potential of investing.

Please rethink your aversion to retirement accounts. You will make more money in the long run through lower taxes by taking advantage of these accounts. At a minimum, make a Roth IRA contribution every year and max it out ($5500/yr right now). Time is of the essence! You have until April 15th to make your 2014 contribution!

Equities (stocks) do very well in the long run. If you don't want to actively manage your portfolio, there is nothing wrong (and you could do a lot worse) than simply investing in a low-fee S&P 500 index fund.

Answer 2

While I can appreciate you're coming from a strongly held philosophy, I disagree strongly with it.

I do not have any 401k or IRA I don't like that you need to rely on government and keep the money there forever.

A 401k and an IRA allows you to work within the IRS rules to allow your gains to grow tax free. Additionally, traditional 401ks and IRAs allow you to deduct income from your taxes, meaning you pay less taxes. Missing out on these benefits because the rules that established them were created by the IRS is very very misguided. Do you refuse to drive a car because you philosophically disagree with speed limits?

I am planning on spending 20k on a new car (paying cash)

Paying cash for a new car when you can very likely finance it for under 2% means you are loosing the opportunity to invest that money which can conservatively expect 4% returns annually if invested. Additionally, using dealership financing can often be additional leverage to negotiate a lower purchase price.

If for some reason, you have bad credit or are unable to secure a loan for under 4%, paying cash might be reasonable.

The best thing you have going for you is your low monthly expenses. That is commendable.

If early retirement is your goal, you should consider housing expenses as a part of your overall plan, but I would strongly suggest you start investing that money in stocks instead of a single house, especially when you can rent for such a low rate.

A 3 fund portfolio is a classic and simple way to get a diverse portfolio that should see returns in good years and stability in bad years. You can read more about them here: http://www.bogleheads.org/wiki/Three-fund_portfolio

You should never invest in individual stocks. People make lots of money to professionally guess what stocks will do better than others, and they are still very often wrong. You should purchase what are sometimes called "stocks" but are really very large funds that contain an assortment of stocks blended together. You should also purchase "bonds", which again are not individual bonds, but a blend of the entire bond market.

If you want to be very aggressive in your portfolio, go with 100-80% Stocks, the remainder in Bonds. If you are nearing retirement, you should be the inverse, 100-80% bonds, the remainder stocks.

The rule of thumb is that you need 25 times your yearly expenses (including taxes, but minus pension or social security income) invested before you can retire. Since you'll be retiring before age 65, you wont be getting social security, and will need to provide your own health insurance.

Answer 3

Another bit of advice specific to your scenario. Consider buying an ALMOST new car. Buying last year's model can knock a huge amount off the price and the car is going to still feel very new to you, especially if you buy from a dealer who has had it detailed.

Answer 4

It's important to have both long term goals and milestones along the way. In an article I wrote about saving 15% of one's income, I offered the following table:

This table shows savings starting at age 20 (young, I know, so shift 2 years out) and ending at 60 with 18-1/2 year's of income saved due to investment returns. The 18-1/2 results in 74% of one's income replaced at retirement if we follow the 4% rule. One can adjust this number, assuming Social Security will replace 30%, and that spending will go down in retirement, you might need to save less than this shows. What's important is that as a starting point, it shows 2X income saved by age 30. Perhaps 1X is more reasonable. You are at just over .5X and proposing to spend nearly half of that on a single purchase.

Financial independence means to somehow create an income you can live on without the need to work. There are many ways to do it, but it usually starts with a high saving rate. Your numbers suggest a good income now, but maybe this is only recently, else you'd have over $200K in the bank.

I suggest you read all you can about investments and the types of retirement accounts, including 401(k) (if you have that available to you), IRA, and Roth IRA. The details you offer don't allow me to get much more specific than this.