The rat race. Most people want to escape it but it seems everyone is running in the opposite direction without realising it. Most people have been so consumed by cheap debt and consumerism that they are willing to work their entire lives, paycheck to paycheck, in order to fulfil their materialistic nature. Running with the crowd in this sense does not appeal to me as I do not want to work till I drop, I want to achieve financial freedom early in life so that I can do what I want like travel whilst I am still relatively young.
In order to get financially free, I will need to adapt a new set of rules – the rules of the rich. You see, the rich in every generation in every society throughout history have always acted the same, and the rich today are no different. The rich understand how money works and how to make money work for them.
‘Money is a good servant but a bad master’.
The rich who are finically free understand this and make money work for them. The people in the rat race on the other hand are servants to money and that is why many never get ahead.
The new set of rules state three things: don’t get into debt, spend less than you earn and invest the difference in money generating assets. By investing money, you get even more money in the future which you can invest again and you get even more money and this is a great cycle to be in.
The goal to be financially free is to invest in assets that produce a growing stream of passive income.
My ambition is for my passive income to be greater than my expenses.
Most people who are in a job, like myself, receive active income. With active income, the amount of money you earn is determined by the time you spend working. At most jobs, regardless of whether you’re earning £5 per hour or £50 per hour, there’s a linear relationship between time and money.
So in order to get paid, you need to go and work. The more time you spend working, the more money you earn. For passive income, this relationship disappears.
Passive income on the other hand is income received on a regular basis, that requires little effort from you to produce or maintain it. It is the money that flows into your pocket whilst you sleep, eat, vacation or just sit around watching TV. A stream of passive income essentially makes money for you without any effort
The goal for many people like myself who want to be financially free is obtaining a content steam of passive income. Passive income gives people the opportunity to do what they want to do as they get paid whether they decide to work or not.
The way I am aiming to achieve a constant stream of passive income is through ownership of dividend paying stocks. (There are a number of ways to achieve passive income and you can find them in an article i wrote on the subject.
Passive Income through ownership of wonderful business.
After reading every book I could get my hands on and countless articles online, I decided that the best way to build my passive income was through the stock market. After reading about various assets classes , I found stocks to be the highest returning of the lot. Stocks offer me the best possible investment opportunity out there.
When people say stocks are risky and say its akin to gambling at a casino, they could not be further from the truth. Yes, stocks are risky but if you know what you are doing, the risk is worth it as you are set to grow your money over time.
I always give this example to people who say stocks are risky. To a person who doesn’t have a driving licence, driving a car is risky. But if you have knowledge of how to drive, you can manage that risk and driving a car is safe for you. Similarly, if you have knowledge about investing and think about stocks as actual businesses rather than ticker symbols which randomly go up and down on a screen, you can manage your risk and became very wealthy over time.
My focus when investing is to have ownership stakes in wonderful business. Businesses that have been around forever, businesses that have a strong competitive advantage or as Warren Buffet likes to say ‘a wide economic moat’ and businesses that pay dividends.
My Investment Strategy: Dividend Paying Stocks
There are a number of different strategies when it comes to investing in the stock market. These strategies each have their own merits and drawbacks. Thus I researched the different strategies heavily and eve looked at portfolios of the most successful long term investors. As a result of this research, I found that investing in companies that pay ever increasing amounts of dividends was the best strategy for me to accumulate long term wealth.
With dividend paying stocks, providing you do adequate research before a purchase, all you have to do over time is sit back and watch the dividends roll in. I love the fact that dividend income can one day fund my expenses without having to sell my ownership stakes in these businesses (stocks) and that dividends from successful companies tend to grow faster than the rate of inflation.
Say if I have a portfolio of £300,000 and have a dividend yield of 4% which is easily attainable on the UK market, I would be getting £12,000 a year in dividend income. Given that many dividend growth companies seem to increase dividend payments every year, this amount of annual dividend received figure will grow over the years even if I don’t invest another cent. Let’s take a conservative 7% dividend increase across the portfolio. This means that in year 2 I will have £12,840 of dividends flowing into your bank account, in year 3 this figure will be £13,738, in year 5 it will be £15,729 and in the 10th year it will be £22,061.
Whilst the majority of my portfolio will be in dividend paying stocks, I don’t wasn’t to restrict myself. You get some wonderful companies like Berkshire Hathaway and Google/Alphabet or whatever they call themselves these days that don’t pay dividends but have fantastic economics.
Furthermore, I believe many dividend paying stocks are overvalued today due to investors reaching for income producing stocks in this low interest rate environment.Having stated that, I will maintain at least 90% of the stocks I invest in to be dividend paying.
My Goal is to get to Financial Independence as soon as possible, probably within the next 13 years or less.
To achieve this, I will looking to primarily invest in high-quality companies that have lengthy histories of paying and raising dividends. Buying into companies that raise dividends year after year, dividend growth stocks, is a very important part of the strategy. Dividend growth stocks can have a significant impact on portfolio performance.
With dividend growth stocks, the amazing thing is that over the long run, the return from the increase in stock price becomes less and less important. The dividend growth is what really matters. A stock yielding 3% that has a 7% dividend growth rate over 20 years will have a 176% accumulated return solely due to dividends. This means that the price of the stock could drop by a third during that time and the investor would still see an annual rate of return of 4.5%. For dividend investors, dividend growth is what will make your stock selection successful.
Another important aspect in determining how fast I reach my goal is to set the amount I will be investing annually. After looking at my income and expenses, I decided on a figure of £15,000.
£15,000 may sound a lot but in order to be finically free at a young age, you need to delay gratification and make sacrifices. Besides, what’s the bigger sacrifice – living below your means for a few years or working your entire life? For without delayed gratification and investing, you might just have to work in a job you hate till retirement
Another significance of £15,000 is it is within the Annual ISA allowance which is the account type I will be using to invest my money.
Tax Free Passive Income with an ISA
As I want to be Financially Free thirteen years from now, which would make me 37, using a pension as a primary investing mechanism is a bad idea for me. Even though you get tax relief when you invest in a pension, you have to be at least 55 years to start withdrawing any money for it. That’s a full 18 years after the date to which to be financially free. Investing via a pension os just not worth it for me.
An Investment and Saving Account (ISA) on the other hand is the perfect tool for me. With an ISA, you invest using after tax money but the great thing is any gains and income from an ISA is tax free. That means that any dividends I will receive and withdraw from my ISA will be tax free!
An ISA is a great tool for anybody who lives in the UK and wants to reach financial freedom early in life.