If you have ever played Monopoly or the Kiyosaki Cash-flow Game, you know the most important part of winning either game is having enough assets that provide a stable income. In the case of Monopoly, it’s to build the biggest cash flow portfolio in the form of real estate. And in the case of the Kiyosaki Cash-flow Game, it’s making wise money decisions to be able to quit the rat race for good. Both are needed in the journey to financial independence.
Cash flow or (passive) income can be getting by, through several different sources. Of which savings isn’t one of them. The difference between a stockpile of money, and producing cash flow is that the latter is being generated from an asset without relying on the worth of the asset itself. This could be stocks that pay a dividend, real estate generating a monthly rent, trackers or whatever else investment you can think of.
A big savings account is perfect if you want to reduce it to none at some point. But, if you aim to build lifelong wealth, finding a way to let money work for you and produce an income is a far better method.
You want to get paid every month for the least amount of effort. Which doesn’t mean you shouldn’t put in any effort, only that while you do it should give you a reward in whatever form (money or another value). This could also be something where the money doesn’t matter too much, but you just like doing it. This is where joy, happiness or personal value drives the decisions to put the effort in it. Ideally, you should aim for both at the same time.
Net worth is an important metric to value something. But in order to continue to grow, even without hard work, you’ll need the fuel to keep it running, aka cash flow.
Without cash flow, you’ll have to tear in on your savings when you decide to stop working. The earlier you want to quit, the bigger the nest egg has to be. And the bigger the target for the nest egg, the longer it takes to get there. See the dilemma?
Then you have the issue of being asset rich, and cash poor. Meaning you could have a total net worth of a million, and technically be financially independent, but due to lack of cash flow, you can’t FIRE yet. This is also why many people fear they won’t have enough wealth build up -and add another year to their working life. Because they have nothing to fall back on.
One of the reasons for tracking your net worth is directly linked to the 4% rule. Which simply states that if you accumulate enough wealth you are able to retire early by withdrawing 4% of your net worth every year for the rest of your life. The only thing you need to do is decide on how much money you need per month and calculate how much money you need to save to acquire the target number or your net worth.
When following this approach, you’ll focus on detracting from your net worth, once you are FIRE’d. If this is your strategy, your focus probably is on increasing your savings rate as much as possible. Simply because the higher your savings rate, the faster you’ll reach financial independence. The concept follows from the ability to reach financial independence and retire early by having a high net worth which is sustainable to withhold for years when withdrawing money from it.
The whole financial picture
Looking at the broader picture, there are a couple of things that are important to look at when you want your financials to run as smooth as a car.
To have a solid basis just start with an overview of your income statement. This is the place where it all begins. But additionally, don’t forget about cash flow, money management, financial strategy and competition (in the case of investing).
All aspects are part of something bigger. And all need a certain amount of attention in order to get the wheels moving. It’s up to you where you focus on the most.
There is one simple reason why having a high net worth is less important to us: we aren’t going to withdraw money to fund our lives once we decide to quit the 9-to-5. Therefore, we don’t have the need to have a high net worth, let alone growing it.
Last week I had written that we aren’t going to publish our net worth. We do track it, but it doesn’t give us the insight into where we are on our journey towards financial independence.
The Cash Flow Index, however, will.
The Cash Flow Index to financial independence
With the cash flow index, we measure our progress of income by investing and how far we are in order to reach financial independence. Simply said, the index will measure when our non-job net income will exceed our expenses. Which is basically the same as a savings rate, just without the regular income. We only measure income derived from investments, like dividends (in the past year) or net rental income.
Our target number is based on the average monthly spending plus a margin of X% on top of it. The margin is meant for a certain lifestyle inflation in order to secure a Fat FIRE lifestyle and to make sure we can keep reinvesting a part of our profits over a longer period of time.
Because it is based on an average per month, the Cash Flow Index will be a moving target. Every month the underlying base will be different, as our expenses will not be the same for every month.
To have a certain starting point from where to measure, I checked how far we were at the end of 2017.
This ratio marks the starting point of a new way of tracking our progress towards financial independence.
After three years of investing, and building up dividend we had an average monthly income of 117 euro from mostly dividends. Note, that although it doesn’t look like much, this is additional income and only grows over time. With an increasing savings ratio every year, you would expect that we are well on our way to Financial Independence. Our cash flow index for the year 2017 is:
Not that amazing, to be honest. But a decent start to begin with. As we are still at the beginning of our financial independence journey, we can almost track our entire process via this method.
In order to track our index correctly, we will only use our net rental income (profits) as investment income. Meaning, profits where ALL costs (maintenance, mortgage, and other) are already deducted. That way we know we can continue the maintenance and other real estate relating costs, without having to deduct it from our ‘passive’ income once we choose to be FIRE’d.
Starting from next week, we will track our Cash Flow Index every month. Hopefully, it will motivate us to keep working hard to get there. And we will finally know where we are heading, and how far still to go.
How do you measure your financial independence progress?