Author: Jelle Huisman
Most people would like to have the freedom to do what they want. We prefer to decide for ourselves what we do with our time, what we buy and where we spend our day. In reality, however, this is often only partly possible. In most cases, our work determines how we spend our time, and what we can do with the income we receive from this. So we are dependent on a job or our employer. Almost everyone will indicate that, in order to be able to do what we want, sufficient money is needed. So we think we first need to be financially independent to make this possible.
What is financial independence?
Financial independence is the status of having a reliable source of income that is sufficient to cover the cost of living for the rest of our lives, without being dependent on others. The income earned without having to work is also called passive income. So financial independence allows you to live the life you want.
Achieving financial freedom can mean something different for everyone. Achieving financial freedom, for example, can mean that you can retire early. It can also mean that you can devote your time to meaningful work, without having to pay attention to a career. It may also mean that you don’t have to think as much about making big purchases, such as a car, or you simply book a holiday to that distant destination you’ve always wanted to go to. So we can say that people who are financially independent have more options, and therefore live more freely with possibly less stress.
Achieving financial independence is not easy and can take many years. This is clearly not a strategy to get rich quickly. And people who are financially independent need to handle their capital responsibly to make sure they stay that way. First of all, we will have to become the type of person who is able to become financially independent. This includes discipline and the development of certain knowledge and skills.
In this 6-part series of articles we describe 6 ways that can contribute to achieving financial independence:
- Starting a business
- Become a trader and investor
- Develop the right financial behaviour
- Stop consuming and start producing
- Read the right books
- Meet helpful people
Part 3: Developing the right financial behaviour
If you want to achieve financial freedom, you must first become the person who can make this possible. Your behaviour in the financial field is therefore decisive.
In the first instance, it is important to create insight into your current financial situation, so that you know where you stand financially. A good understanding of your financial situation will help you to set measurable and achievable financial goals. A clear plan will then help you to actually achieve these goals.
One of the most important goals in itself is to have control over your finances, instead of your finances being in control of you. Unfortunately, there are still a lot of people who live financially from month to month and from Paycheck to Paycheck.
People’s financial behaviour is often impulsive and unstructured. To learn more about people’s financial behavior, or your own financial behavior, it is useful to know more about so-called “behavioral finance”. Behavioral finance studies the influence of psychology on investors and financial analysts. Investors do not always act rationally, often lose their self-control and are influenced by their own prejudices. Behavioral finance applies behavioral psychology to economic decisions in order to better understand why rational people often make irrational money and investment decisions.
Studying behavioral finance and reading books on personal finance can help you to create more awareness and insight into your financial behavior.
Tips and to do’s for developing the right financial behavior
What is actually the definition of correct financial behaviour? There are several possible answers to this question. For this article we assume financial behaviour that contributes to achieving financial independence. Below are a number of tips and to do’s for developing the right financial behaviour.
Spend less than you earn
Spending less than you earn is often described as the simplest way to build up a capital.
These are the main advantages of spending less than you earn:
- You have more financial security
- You have more money left to invest
- You have fewer worries
- You’re left with money to pay yourself first
When you want to spend less, you can look at possible savings on fixed costs and saving on unnecessary expenses. Fixed expenses include insurances, subscriptions (internet, Netflix, etc.), energy costs and, for example, a mortgage. Examples of unnecessary expenses are: coffee and food on the go, clothing, restaurant visits and impulse purchases.
Create a budget to keep track of expenses
When you want to draw up a budget, you first need to make an overview of all your income and expenses per month. Make a distinction between fixed expenses and other expenses. Fixed expenses are the same every month and other expenses can differ from month to month. This overview will give you a good insight into your finances and allow you to determine a budget. Money left over can be used for investments.
Tip: Also take into account periodic income and expenses such as dividend payments and annual contributions.
Create a personal emergency fund
An emergency fund is intended to cover unexpected or sudden expenses. The aim is to prevent debts. How large your emergency fund should be is up to you. Make sure that the balance of your emergency fund is 3 to 6 times as high as your monthly costs and that you have access to your emergency fund at all times.
Pay off your debts
Having debts is very expensive. The problem is not only the high interest rate charged on loans. Interest on loans can be seen as interest on interest with a counterproductive effect. Because of the continuous interest on a loan, the loan amount can increase further and further. Therefore it goes without saying that having loans is not part of good financial behaviour.
There are many forms of loan such as: a personal loan, a revolving credit, credit card debt, private lease, study debt or for example a loan with repayment in monthly installments for a smartphone. Try to avoid borrowing money at all times. Don’t buy things you can’t afford.
If you did take out a loan or a few loans, give priority to repaying these loans as soon as possible. If possible, start with the loan for which the highest interest rate is charged.
Create a strategy to save or invest a certain amount each month
Pay yourself first
Pay yourself first means that you put a fixed part of your income in a savings account or in investments, before you make other payments such as your monthly bills.
Imagine that you want to pay yourself € 400 per period. What remains of your income you will use to pay your rent or mortgage, your fixed expenses, food and drink, mobility and other expenses. If it turns out that the amount remaining per period is not enough to cover these costs, you will be forced to work on improving your income potential.
By paying yourself first, you guarantee that you will always invest money in yourself and improve your capital position. If you would only want to save or invest with the amount you have left over each period, you probably won’t be able to invest the amounts that lead to financial freedom in the long run.
Create multiple sources of income
Many people only have one source of income, namely income from work. Income from work is often seen as a secure and fixed source of income, whereas the reverse is actually the case. Imagine that you pay for all your expenses from your income from work, and then you lose your job. Certainly in recent months we have seen again that job security is actually a false security. Millions of people worldwide have lost their jobs due to the consequences of the corona crisis, and the end is far from in sight. People who show good financial behaviour have multiple sources of income.
There are many ways to generate income. For this article, we will briefly list the most common sources of income which millionaires have at their disposal:
- Income from work. In practice, people who are already financially independent are often working for an employer or in a profession.
- Company profits. In order to generate company profits, you need to be an entrepreneur or at least (partly) owner of a company.
- Interest income. This refers to income arising from outstanding loans such as bonds or business loans. Interest on a savings account also falls under interest income.
- Dividend income. Dividend income is a very attractive form of passive income. Dividend is a profit distribution from a company to its shareholders.
- Rental income. Rental income includes all income derived from the rental of property, usually real estate.
- Capital gains. Includes all increases in the value of your assets. These can be shares, but also real estate or an old-timer.
Take fewer financial risks as you get older
As you get older, your investment horizon will become shorter. It is therefore advisable to take less financial risks as you get older. You can imagine that someone 20 years old has more time to make up for the negative results of a failed investment than a 55-year-old.
There are countless examples of correct financial behaviour. We can say that proper financial behaviour always pays off and certainly contributes to achieving financial independence. The tips and to do’s mentioned are meant to create awareness, but will also change your life in a positive way.
Insight into your financial situation will help you to set clear and achievable goals. Live below your means financially. Stop spending money you don’t have. Automate your spending and investments. Start today!Leave a comment