What distinguishes a leader from a follower?
Steve Jobs, the founder of Apple, once said, “Innovation distinguishes between a leader and a follower.” And one of the most famous minds ever, Albert Einstein, once said, “We cannot solve our problems with the same thinking we used when we created them.” You need to listen to these two titans of innovation and start thinking outside the box as well. Especially when it comes to saving and investing for your financial freedom.
Successful corporations such as Apple know that innovation is key to increasing their company’s value. The same is true with regards to achieving financial freedom. If you are a follower and do the same tired old things that everyone else does (spending everything, saving nothing, and never creating multiple streams of income), then you will end up achieving financial freedom at the same time everyone else does, much later in life. If you refuse to follow the herd and think outside the box to speed up your time to financial freedom, you will retire well ahead of everyone else.
Thinking outside the box
My wife and I did a lot of things to help us retire early that many of our friends and family would never consider doing. For one, we have always shared our home with either tenants or other family members. Sure, we give up a small amount of privacy and sacrifice some of our living space, however the financial gains we have received have more than compensated us for any small inconveniences we might have faced. Let me illustrate.
We have received about $1,000 a month for the past 10 years by renting out the lower level of our house and/or sharing it with other family members. All of this money got invested and earned us even more money. If you do the math, $1,000 a month invested for 10 years at a compound annual growth rate (CAGR) of 7% a year, adds up to total savings of roughly $173,000. Assuming this $173,000 continues to earn a 7% return, we will generate an income stream of roughly $12,000 a year from all these savings.
So now, even If we were to stop saving all the rental income we generate from this suite, we would still have a passive income stream of $24,000 a year for the rest of our lives ($12,000 rental income and $12,000 return from all the rental income we previously saved). This one decision alone, to share some of our living space, probably generates 1/3 of the passive income we have created for ourselves. I discuss more simple strategies like this, which many people never consider, in my book and plan to blog about many of them here. Over the years, we never really noticed the lack of living space. We did, however, notice that we were able to retire decades earlier.
Financial acumen is the ability to make good financial decisions. The decisions that will help you to achieve financial freedom decades before everyone else. The fact that finance departments exist and the fact that many CEO’s come from a financial background, underscores the importance corporations place on financial acumen. Given you are now the CEO of your financial freedom, just like a successful corporation, you need to make sure you exercise your financial acumen regularly and that you possess the ability to make smart financial decisions. Financial acumen isn’t hard to build, it just requires a little practice.
Choosing your mortgage
One of the biggest purchases you ever make in your life will be your home. As well, one of the biggest debts you will ever have in your life will be your mortgage. Given this fact, it makes sense to be sure you understand the financial implications of any mortgage you chose. It’s your life and you get to chose how much mortgage debt you want and how you are going to pay it off, just make sure you really understand the financial implications of the choices you make.
I’m not sure as many people would chose to buy the most expensive house they could afford and use the longest amortization period available to them, if they really understood just how much more money they stood to lose in interest payments.
One of the main reasons my wife and I were able to retire early was that we got a smaller mortgage then we could afford and we paid this mortgage off extremely fast. Because of this we saved hundreds of thousands of dollars in interest payments. Let me illustrate.
Let’s assume that based on your income you are able to afford monthly mortgage payments of roughly $2,500 a month. Given these monthly mortgage payments, let’s assume you would be able to buy a $400,000 home using a 20 year amortization period or a $600,000 home using a 40 year amortization period. Let’s see what the total cost of these two options works out to be if we assume a fixed rate mortgage of 4%. The results of this analysis are illustrated in the table below.
|Mortgage Amount||Amortization Period||Monthly Payments||Total Principle Paid||Total Interest Paid||Total Cost|
Even though the monthly payments of both options work out to be roughly equivalent (approximately $2,500 per month), the total cost of the $600,000 home with the 40 year amortization period is a staggering $1.2 million and ends up costing $620,000 more than the $580,000 total cost for the $400,000 home with the 20 year amortization period. The $600,000 home does not, therefore, cost $200,000 more than the $400,000 home. It costs over $600,000 more!
Making your mortgage tax deductible
One of the other major things my wife and I did that probably resulted in over a hundred thousands dollars in extra savings over the years is we made our mortgage interest tax-deductible. If you live in the US, you are already eligible to claim your mortgage interest as a tax deductible expense (under certain situations and up to certain limits), however, if you live in Canada, you need a little financial acumen to achieve this feat.
Nonetheless, if you are a Canadian in a 40% tax bracket, imagine the financial benefit of being able to get 40% of your mortgage interest payments back as a tax refund. At the same time, imagine the benefit of having an investment portfolio that generates another stream of income for you that gets taxed at less than half your marginal tax bracket. Picturing these two things gives you some sort of idea of how much potential savings we are talking about. I go over this strategy in my book and plan to blog about it here in future posts.