I consider myself a pretty financially savvy guy, but my CPA just introduced me to something that opened my eyes…
Dave observed that I will not truly be free until I no longer have to work to cover my overhead. If my passive income doesn’t cover my monthly expenses, I’m controlled by my need to make money.
I’ve heard this concept before, but he really opened my eyes in a different way.
What if I invested my money in such a way that it creates cash flow sufficient to cover my monthly expenses? Then my time will truly be my time. I could do whatever I wanted to do…
I could choose to work.
I could choose to kick back in Hawaii wearing a Speedo and eating bananas on the beach.
I could choose to become an avid stamp collector.
I could choose to make teeny, tiny little birds out of paper.
I could do whatever I wanted to do because I wouldn’t have to worry about monthly overhead.
Some of us have investments, but Dave made an important observation…
If your investments aren’t creating cash flow, then they don’t give you freedom over your day-to-day life. Instead, they exist as some far-off abstraction and may or may not fluctuate upward or downward when you finally need them.
The Freedom Ratio basically tells you what percent of overhead your passive income covers. So if your passive income is $150 a month and your expenses are $6,000 a month, your Freedom Ratio is 2.5 percent. In other words, your passive income covers 2.5 percent of your monthly expenses.
Once I looked at it this way, I started asking myself: What are the investments I can make that help my Freedom Ratio.
What am I spending money on that really doesn’t serve me?
See, if I can bring my monthly overhead down and in turn invest that saved money so that it produces cash flow, my Freedom Ratio will go up… which would make my life a lot easier.
Lily and I have created a plan to build our Freedom Ratio. Here is what it entails:
First, we went through our credit card bills and realized that we were spending money on things that made no long-term differences in our lives. So as a test, we have vowed to be “cash only” on day-to-day expenses. I’m really curious to see how much we are going to save.
We use the “envelope” system for our day-to-day expenses. Instead of putting anything on credit cards, we put cash into envelopes and we spend money based on the money we pre-planned for the week.
We started this week with three envelopes:
- Lily and kids
Just this morning, Lily came to me and said, “I picked up your dry cleaning. You owe me $37 out of your envelope.”
I said,“$37 for dry cleaning! That’s a rip off.”
She said, “Philip, you had 17 shirts.”
I said, “Next time, I want to take it to a place that charges .99 cents per shirt.”
She said, “Great, you find that place and let me know.” 🙂
My point is this… we have NEVER had a conversation about the cost of dry cleaning, so I didn’t know it cost me that much money every time I wore a “dry clean” shirt instead of a washable shirt.
Now that I think about my money in terms of the Freedom Ratio, I’m going to work (and spend) smarter. It just makes sense.
At the end of the week, we will:
Take any leftover money and put it in our investment savings account, and then review the receipts and make a plan to spend even less money next week (if possible).
Like I said, this is Week One. I’ll let you know how it goes in future weeks.
What do you think?
What questions do you have?
Do you and your family want to do this with Lily and me?
If so, let’s do it!
Post any questions or comments you have, and by next week, I’ll record a conference call with the most asked questions and ideas.
I will teach you what I’ve learned… and at the same time, teach me what you have learned.
Let’s rock this idea and become free! Isn’t that what life is about?
P.S. David Fenton, my CPA and the creator of the Freedom Ratio, is a rock star. I’ll have him do a blog post in the future.