Friday, June 10, 2016

Financial independence by collecting underpants? Are you serious?

This is a guest post from Tawcan, who writes about dividend investing and financial independence on his blog at

When it comes to the concept of early retirement, it is not a strange or unfamiliar idea for me. My dad semi-retired in his mid-40’s and fully retired in his early 50’s; my cousin retired before he turned 40. Having family members that retired early meant I knew early retirement is indeed possible; I just need to have a plan and put my mind to it.

Growing up, my parents have always taught me to be frugal, save money, so I can eventually retire early one day.

But like the underpants gnomes in South Park, I had an incomplete plan. You see, the gnomes had the following business plan:

1. Collect Underpants
2. ???
3. Profit
My early retirement plan was like below:
1. Save money
2. ???
3. Early retirement

I had no idea what it takes to go from step 1 to step 3. Step 2 was a complete mystery to me. Although my dad and cousin have gone through the three steps, I was too ignorant to ask them for advice. I wanted to figure this out for myself.

It wasn’t until I was in my late 20’s that I began to figure it out with my wife (whom I’ll call Mrs. T from now on). In late 2011 we had our financial epiphany in which we determined what we needed to do in step 2 to achieve early retirement.

The magic in step 2 is of course creating passive income… or in our case, dividend income! This is why I provide dividend income updates on my blog every month.

Before we get into more details about our dividend income, let’s step back a bit.

Early retirement vs. financial independence

First I want to define early retirement. I typically don’t like using the term early retirement. Rather, I like to use the word financial independence. Why? Because too many people associate the word early retirement with the image of someone sitting on the beach, sipping piƱa colada all day, collecting money from the government. But that’s not how I see early retirement.

To me, financial independence simply means that our passive income exceeds our total expenses so we can have more freedom and choice in our life. So the simplified formula for financial independence is as follows:

Passive income > expenses = Financial Independence

Financial independence means I can quit my job (we’re a single income family) and spend more time with Mrs. T and our children if I wanted to, it can also mean that I can continue working in some sort of capacity. What we want to do once we reach financial independence is entirely up to us. We’re the ones in full control of our life, rather than having to listen to the “boss man.”

Reasons for being financially independent

As mentioned above, I want to have more freedom and choice in determining what I want to do in my everyday life, not just the weekends and holidays.

A quick introduction of myself, I’m in my early 30’s living in beautiful Vancouver Canada. I’m happily married with an energetic 2.5 year old toddler and a brand new 2 month old baby. I’ve been working in the high tech industry for 10 years since graduating from university.

Working in high tech means things are moving very fast and there are new challenges every day. Because the fast moving nature, it is quite restrictive when it comes to taking a vacation. The unwritten rule at work is that 2 weeks is the maximum vacation time one can take. It doesn’t mean I can’t take a longer vacation if I wanted to. I can certainly take a 4 week vacation or longer if I wanted to, but taking a vacation for more than 2 weeks means it becomes extremely challenging and sometimes nearly impossible to catch up and perform the daily job tasks once returning to work. It also becomes extremely challenging for my co-workers to cover for me for any extended period of time. Unfortunately, this means vacations require a bit of planning. I can’t just drop work and go on a last minute trip.

It’s funny because work travels, on the other hand, are completely the opposite. Work travels are almost always on last minute notices. Due to my job, I travel regularly. When there’s a work trip, I usually have to work my life around the trip. With two little ones at home, it’s certainly a challenge for Mrs. T to handle both children if I’m gone for more than a couple days.

The one major reason to want to be financially independent is so Mrs. T, our children, and I can travel more. Mrs. T and I love to travel. We’ve been to quite a few countries separately before we met (20 for me, 24 for her) but we have only been to 6 countries together. One of our goals is to go to all 7 continents; so far we got 3 down, 4 to go. A personal goal of mine is to have travelled to more countries than my age one day. When we are financially independent, we’d love to travel around the world extensively and possibly living abroad. Instead of hopping cities to cities and only spending a few days in each city, we’d love to live in a foreign city for an extended period of time and learn more about the local culture. Living in a city extensively would also allow us to travel in the nearby areas while having a home base. When it comes to our children’s education, we’ll probably do a combination of home schooling, international schools and when living in Canada, public schools. I’m a true believer that one can learn more by traveling than only reading books.

Thanks to work, my weekday schedule is set. I get up in the morning, eat breakfast with my family, go to work, work hard, come home, have dinner, spend time with my family, go to bed, and repeat the process. I’m sure this is how most people run their lives these days. Because I deal with people all over the world, I often have early and late meetings, either at the office or at home. This really cuts into the amount of time I get to spend with my family. It’s only on weekends that I get to enjoy my life and dictate my own schedule. Wouldn’t it be great to have the flexibility to determine my “own schedule” every single day? I’m using this term loosely because when we’re financially independent, I probably wouldn’t be making set daily plans. Rather, we’ll probably be more spontaneous.

Furthermore, being financially independent would mean being able to spend more time with my family. It’s a shame that during weekdays I only get to spend a few hours with my son, daughter and wife each day. Although my children are still very young, I have noticed that they grow up very fast and are learning new things every single day. I want to be more involved in their growing up. Furthermore, I want to spend more time with Mrs. T and continue having a strong and healthy relationship.

The magic of dividend income

I mentioned above that magic in step 2 is passive income. To be more specific, dividend income, is the main contributor to our passive income.

We started focusing on dividend growth investing in late 2011. Currently our dividend portfolio consists of 61 companies and 2 index ETFs. Unlike some people, we don’t have a set magic number on how many stocks we should hold in our portfolio. These dividend stocks are distributed across both tax-advantage accounts like RRSP (401(k) equivalent) and TFSA (Roth IRA equivalent), as well as taxable accounts. Most of the dividend paying stocks that we own are Canadian stocks but we own some US and international dividend stocks as well.

To be tax efficient, we hold US and international dividend stocks in our RRSP accounts to avoid withholding tax; we hold REITs and income trusts in RRSP and TFSA to avoid figuring out the complicated tax consequences. We only hold eligible dividend stocks in our taxable accounts as these stocks provide tax credits and are the most tax efficient in the taxable accounts.

When can we become financially free?

According to the financial independence spreadsheet calculator that I created, we should be able to achieve financial independence in about 10 years. But we’re not fixed on a specific date. We understand it is necessary to be flexible, since things can change, especially with two young children in the family. Furthermore, we don’t want to be too rigid in our planning of our financial independence.

How much do we need?

In the last four years, we have been tracking our expenses closely. We have averaged about $2,400 per month or $28,800 per year in our core expenses, which includes expenses like groceries, insurance, housing, fuel, utilities, internet, and clothing. Basically necessities that we need to keep a roof above our heads and make sure we don’t go hungry. If we include other non-core expenses like eating out, donations, vacations, and side-business expenses, our average spending for the last four years is $3,900 per month or $46,800 per year. Knowing our average monthly spending provides us with valuable information when it comes to our financial independence planning.

In 2015 we received $10,318.02 in dividend income, which corresponds to 35.8% of our core expenses or 22% of our total expenses. This year we have a challenging and ambitious goal – to receive over $13,000 in dividend income. This would mean covering about 45% of core expenses and 27.8% of total expenses, assuming our expenses do not increase this year. If we just use a 3% dividend yield, we’d need over $1.5 million to cover our total expenses. However thanks to organic dividend growth and DRIP, we believe we only need in the range of $800k to $1.2 million in our dividend portfolio to become financially independent. Why such a big range? This is simply due to the difficulties of estimating the dividend growth rate of both existing investments and new investments.

Expediting our financial independence journey

$800k to $1.2 million is a lot of money to save. The reality is, we may not need that much to become financially independent. Although I define being financially independent as when passive income exceeds expenses, we can expedite the process by altering the formula slightly.

Passive income + part time work income > expenses = financial independence

If we can work part time and use the part time work income to supplement our passive income, we can certainly become financially independent earlier. As our passive income grows, we can slowly back off on the part time work, if we choose to.

Another way to see this is using passive income to cover our core expenses. Part time work income would then be used for discretionary expenses such as donations, eating out and vacations. This approach would allow us to reach financial independence much quicker.

There are many possibilities when it comes to part time work. I may continue working at my current job but at a part time function, if I still enjoy working, the environment, and the people I work with. I may decide to start a part time business with one of my hobbies. For example, I love photography, so I started a side photography business a few years ago, focusing on portraiture's, family, and weddings. Mrs. T and I love cooking food, so we started a food blog a few years ago, which eventually led us to publish two cookbooks. I started my personal finance blog as a way to write down my ideas and to express myself creatively and gradually the blog has become a small business. Mrs. T and I can certainly work on generating more income through these side businesses as a way to expedite our financial independence journey.

I think it is a shame that personal finance isn’t taught in schools. I suppose this is why so many adults get into debt problems and are clueless about simple personal finance concepts like living below your means and pay yourself first. While becoming financially independent is important, we also need to remember to be present and focus on who we are at this very moment in time. We can’t be constantly looking forward to the finish line, waiting to enjoy life until we reach the finish line. Instead we should focus being in the present, have a be-to-have mindset, and enjoy our lives to the fullest right at this very moment. Because we never know if we will be here tomorrow or not, it would be a shame to go through life and never enjoy it.

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