If you've been following retirement trends in the news recently, then you know that the situation looks grim for a lot of Americans. For instance, a study by the global bank HSBC (released in September 2013) found that 18 percent of U.S. workers will never have enough money to retire. In other words, they'll keep working until they get sick or drop dead. For most of us, that's not a very appealing way to spend our twilight years. What can you do to avoid that fate?
To begin with, we need to discard the traditional notion of retirement and replace it with the idea of financial independence. Financial independence is the ability to support yourself without relying on a wage (or government assistance). Retirement tends to occur at a particular age -- maybe 55 or 65 -- whereas financial independence can happen at any age, once you've accumulated the resources.
Reaching financial independence requires some effort, sacrifice, and learning on your part. Many people shy away from planning their finances because they lack an understanding of economics and financial markets. In my own practice as a financial planner, however, I've found that managing finances wisely depends on some basic principles that anyone can understand. Whether you're 55 or 25, you need to follow these six principles to reach financial independence:
1. Know how much you own and how much you owe.
This principle of financial planning requires that you know your net worth -- your assets and liabilities. It also requires that you know the rate of return on your investments and the fees and commissions you pay on those investments. Just as importantly, it requires that you know the interest rates and annual fees on your mortgages, credit cards, auto loans and other debts. How long will it take you to pay off those debts? Is it possible for you to pay them off at a faster rate or transfer balances for a better rate?
2. Spend less than you make.
You probably could have figured this one out on your own. It's pretty obvious, yet so many people ignore this cardinal rule. Quite often the problem arises from housing and transportation costs, since these are the expenses that cause most people to fall into debt. Before locking yourself into a long and costly mortgage or auto loan, think about how much of your income will go into those categories, and what else you could do with that income.
3. Acquire appreciating assets, not depreciating ones.
Speaking of auto loans... cars are a good example of depreciating assets. The minute you drive a new car off the dealership lot, it loses thousands of dollars of its original value. As the car continues to age, its value slowly trickles away as the parts gradually wear out. Real estate or stocks, by contrast, are assets that usually appreciate in value; their values rise with time. This means that they're resources for helping you increase your wealth in the long term.
4. Utilize the value of your greatest asset: Time.
The earlier you start investing, the more time your money has to grow, and the more risk you can tolerate in your investments. Investing at age 25 gives you a huge advantage over someone who started investing at age 35. Because investments in stocks and bonds grow at an exponential rate, a difference of a few years can add up to staggering amounts. As some anonymous sage once said, "The best time to plant a tree was 20 years ago. The second best time is today."
5. Guard your assets against risk.
A life-threatening illness or a debilitating injury can wipe out your finances in a hurry. It takes most people months or years to save $10,000, but that money doesn't last long when you're in the hospital. We can't prevent ourselves from ever getting sick or injured. We can, however, get adequate medical and disability insurance to minimize the damage of health-related misfortunes.
In the investment realm, you can mitigate risk by diversifying your investments -- that is by divvying them up among different companies and types of assets (bonds, stocks, currencies, real estate and more). Diversification acts as a buffer that insulates you from the shockwaves of market disasters.
6. Improve your knowledge of finance each day.
Several academic studies have found that Americans with higher levels of financial literacy, on average, have lower debts and greater savings. The more your knowledge grows, the closer you'll come to reaching financial independence.
Some Americans are lucky enough to have jobs they enjoy. They find fulfillment in work and delay retirement for as long as their health allows them. As we saw earlier, though, not everybody is so lucky. Don't let yourself become one of the millions of workers who can't retire. If you channel your current income toward achieving financial independence, you always have the option of continuing to work if you like your job. Then your financial future will be determined by one thing alone: your personal choice.
It's no surprise that Omaha is consistently ranked a top place to live in publications like Parenting magazine and CNN.com, because this Midwestern city is actually incredibly easy on your wallet. The cost of living is 12 percent below the national average, with housing expenses 21 percent lower. According to Rent.com, average studio apartments cost just $440 per month, while a one-bedroom goes for about $515. To top it off, the average wage for full-time civilians in the Omaha-Council Bluffs area is $24.75 an hour--$2 more than national rates.
Seems like the classic Judy Garland film, Meet Me in St. Louis, was onto something. This port city on the border of Missouri and Illinois sports a cost of living that's a full ten percentage points below the national average. Rent is the main steal here--the cost of housing is 22 percent below the nation's average (that means you can look out for a median rent of just $535 a month, according to Rent.com). The best part? This manufacturing hub brings the city high wages, with the average full-time worker earning $22.63/hour, and those in manufacturing and construction faring even better--earning an average of $24.23/hour.
They say that everything's bigger in Texas, and in this aviation hub, your wallet could be too. That's because these Texas cities combine wages that are on-par with the national average ($22.52/hour for full-time civilians), but cost of living rates that are much lower--about 8 percent below the national average in Dallas. The state is also lucrative for union members, who make about $25.17/hour.
This Ohio city was named the best place in the nation to raise a family by Businessweek in 2009 and it's not hard to see why. The state capitol has a cost of living that's 8 percent below the national average, and it's also about 14 percent below the average for housing (two-bedroom apartments go for about $650-850, according to Rent.com). Full-time civilian wages in the Columbus-Marion-Chillicothe area come out at $22.31/hour, just under the national mean.
Another Texas city with big hair and big wages. Full-time civilian workers can expect to make $25.14 in the Houston-Baytown-Huntsville area, and in manufacturing and construction jobs the rate is much higher, at $29.12/hour. It doesn't hurt that the cost of living is 7.8 percent below the national average, with groceries especially cheap at 15 percent below. That means you can snag a dozen eggs for just $1.52, according to BankRate.com (the average price of eggs in May 2012 was $1.69, according to the Bureau of Labor Statistics).
While water may be scarce in this desert town, money isn't. Full-time civilian workers make an average of $23/hour, and the cost of living stays low at 3.5 percent below the national average, housing at 8 percent below and utility prices at 13.3 percent below the average.
The famed research triangle has a lot more going for it than just basketball rivalries. In the Raleigh-Durham-Cary area, full-time civilian workers make $24.56, nearly $2 above the national average. The total cost of living is 2 percent below the national average in Raleigh and more than 3 below in Durham, but housing costs are especially enticing. They're 11.2 percent lower than average in Raleigh and 13.4 percent lower in Durham, where the cost for a two-bedroom apartment is about $780, according to Rent.com.