The Ultimate Formula for Financial Independence

I spent the last few years reading book upon book about how to reach financial independence. After hundreds of hours of learning and thinking, I think this is IT.

But before jumping to a conclusion, let’s examine more common recipes for money and how they fail.

Note : Generally, when people say they want to be rich, they really mean “I want to spend a lot of money”. In this article, the goal is instead to make enough money to reach financial independence

1  - Get a high paying job

The most common way to see income.

Formula : Income = time worked x hourly wage (or years worked x annual wage)

How to increase income?

• Increase time worked
• Increase hourly wage = get a position with better salary

Mechanism to reach financial independence

• You save your disposable income to have enough to live the rest of your life without working.
• Disposable income = Income - Expenses

Problems

1. You disposable income must be huge to retire by saving money.

2. The positions with such high salaries are coveted by many = extreme competition. These positions include…

   • Some athletes : in sports like baseball, football, hockey, or be a super performer in a less popular sport.
   • Showbiz : top actors, screenwriters, producers, etc.
   • Top CEOs : for example, become the CEO of Google

3. Most people will never attain those positions, even they try their best

4. It assumes many other variables are constants. We'll see them in the next section (Investing).

Example

Jimmy  doesn't plan to spend the next 40 years of his life in a SCC (soul-crushing-cubicle). He realizes "I just need to make enough dough to eat until I die, then I'll be free!" Lacking the physique of an athlete or the looks of a Hollywood star, he becomes a lawyer. He ends up in a SCC (I'm going to keep using this, just so you know) and burns the midnight oil to rise through the ranks. Now with a family, his living expenses increase significantly. He doesn't manage to end up as CEO, but is confortable. His disposable income isn't high enough achieve his ambition, and he's already 50 anyway. "I guess I'll just retire at 65 like everyone else", he concludes.

2 - Investing

Second most common way to see income.

Most people are afraid of investing because they think it’s dangerous or technical. The truth is that it’s very simple (but not easy), and mostly psychological instead of technical (I’ll explore retail investing further in another article.)

Formula =  time worked x hourly wage  +  compound interest

How to increase income?

• Invest...
  • more money
    • Earn more (increase time worked / hourly wage)
    • Spend less
  • for a longer time
    • wasn't the point retiring early though?
  • in more lucrative assets
    • making more than the average returns of the market is a gamble that almost everyone loses

Mechanism to reach financial independence

• Invest your disposable income into the stock market / real estate until your returns pay for your living expenses.

Problems

Many, MANY things can go wrong :

1. Economic risk
   • You are at the mercy of the markets. If a recession or depression looms on the horizon, you might want to cry.

For example, in 2008-2009, the equity markets lost nearly 60%. If you saved for 15 years and amassed 100 000$, it would be worth 40 000$. It would take you 14 years at 8% yearly returns just to get back even! That equates to almost  30 years gone!  And this doesn't account for inflation, which makes your 100 000$ more like 50 000$                                                                                               - MJ DeMarco, The Millionaire Fastlane

2. Your Home

   • Many see their house as an investment. But house prices don't always go up. If that's where you money goes, cross your fingers to not be strangled in a housing crisis (or to forget turning off the stove after frying your chicken.)

3. Your Job

   • You job income is threatened by all directions,: layoffs, bad job markets, job skill degradation and poor industry cycles

4. Your Health

   • What if you get sick and are unable to work?
   • Worse : what if you become financially independent too late and just die as we've seen with Jimmy before? Surprise : getting rich through investing is still pretty slow.

5. Your Lifestyle

   • To invest enough, your expenses must be significantly lower than your income. Most people aren't able to espace debt because of bad financial decisions or burdens, let alone invest a lot of money.

Short summary : getting to financial independence through investing is possible, but risky. Even if you achieve it, you might be too old to enjoy it unless you're extremely dedicated and accept a monastic lifestyle.

It that interests you, check this book. Otherwise, bear with me.

Example

On his deathbed, Jimmy only has 1 regret. No, not missing his daughter's marriage because he's going to die at age 65 after having overworked his overweight, stroke inducing body. He regrets not "making enough dough" to retire early enough. He somehow gets hit by a truck and gets reincarnated into a young man by the name of Billy. He vows to not repeat his mistake. This time, he'll INVEST.

Jimmy, now Billy, achieves a high salary and invests every penny he can. Far from the absurdly large house he owned in his past life, he now lives in a hut in the woods to lower his living expenses (his wife divorced him for that). From here, a lot of different things could happen to Billy : he could face a recession or lose his job in his early career, which would cripple his long term gains*. Or need the money to pay for a costly medical emergency. Or get tired of living in his hut and splurge on luxuries, and so on. The road is dangerous, and Billy might make it through alive, but probably not.

——

By now you might have realized that formulas 1 and 2 are limited. You can't make money FAST enough in a way you CONTROL.

What is the secret sauce that is missing to increase income explosively? PERMISSIONLESS (control) LEVERAGE (scale, make money relatively fast).

What is leverage? You can see it as a multiplier of work. What if a 40h workweek could generate 10x the output? With enough leverage, your every effort could become a gigantic wave.

There exists multiple types of leverage, and not all are equal.  

Power and money are concentrated in the hands of those who successfully leverage whatever can be leveraged, be it people, capital or even media and code.

Labor leverage is people working for you. Think about a the relationship between a business owner and his employees. They must first agree to work for you, or be forced to (slavery was a terrible way to leverage people, and literal pyramids were built with it).

Capital leverage is when people give you money so you can make even more money, and give it back with interest. Banks use this leverage, as do venture capitalists or portfolio managers in finance.  If you want to use capital to build a company, you need to convince someone to give it to you first (unless you're already super rich, which would make this whole article pointless to you.)

Code and content are very special. They are a new and revolutionary form of leverage, because you don't have to ask anyone for anything. Anybody with a computer can code or write online. Anyone can create a Youtube channel and publish videos, even with a smartphone.

To use leverage is to switch teams : you become a PRODUCER instead of a CONSUMER.

——

3 - Create a business

Everyone knows what a business is, but rare are the ones willing to risk their future on one. The fear of failure and of "what-will-other-people-think-of-me" is real. But the true killer is thinking that to start a business you need a new idea or to be "original" (plenty of successful businesses do the exact opposite).

A business is a danger, yes, but if the goal is to become financially independent then a confortable job is probably much more dangerous. As you've seen, Jimmy has already spent 2 lifetimes trying to make this work (I'm really enjoying this Jimmy story I made up).  

At the core, business is solving other people's problems for a reward. The bigger the problem you solve, the better the reward.

Formula =  Net profit + Asset Value

How to increase income?

• Increase the number of customers your serve
• Increase the number of times each customer pays you
• Increase the cost of your products / services
• Decrease spending

Your asset value grows with your profit, but it also depends on your industry (valuation multiples), your intellectual property, your competition, etc.

Mechanisms to reach financial independence

• Create recurring revenue that can fund your lifestyle almost indefinitely
• Create a valuable company, then sell your shares to make a big stash of cash which can be invested (in real estate, bonds, etc.) to generate a recurring revenue.

Problems

• Most businesses fail
• You may need to get a loan (capital) to start a business and hire people (you need to ask for permission). Alternatively, you'll have to fish in your savings. In case of failure, you might end up in debt.

Example

Against all odds, Jimmy now Billy dies on a plane crash in the Pacific Ocean at age 65 during his first vacation ever. His last words : "Man, no this again dude, blurp blurp". He reincarnates bla bla bla and decides to create a business. He unfortunately chooses to open a restaurant (a species of Business better known as Ultimate Money Sinks). He somehow convinces a bank to lend him money and pours his own savings into making the best Italian restaurant in town (there's 5 others on the same street, but that's fine).

...yeah no.

After struggling for a few years, he gives up and joins the SCC again.

Note : I'm pretty unfair here, creating a business is doable, but the point is to choose the right type of business and to make sure there's a demand for your product or service before you even think of starting it.

4 - Create a business based with PERMISSIONLESS LEVERAGE

This is, to my knowledge, as close as the Holy Grail you can have in terms of reaching financial independence today.

1. It's permissionless : anyone can code with a computer. Anyone can write, create videos on internet and create an audience.
2. There’s no cost of reproduction for media or code. It means the margins of profit are super high. For a physical product, you would need to pay for the materials. For a service, you would need to pay employees for labor. Here, you pay NOTHING more than the initial cost of production.
3. With code and media, you can reach billions of people. The limit is the size of the internet of your language. You can scale MASSIVELY.
4. Your can decouple the time you work from your results. Your code or media content works for you 24h a day, whether you're on vacation, sick, or eating tuna with your cat.
5. By creating an audience through your work, you become a magnet for opportunities. People can email to collaborate on projects that go beyond your imagination. You might even make so lifelong friends.
6. Unless you start hiring people and burning through cash, you won't ever go into debt. The worse that could happen is to "waste your time" learning useful skills and trying to help people.
7. It's totally possible to create your software or media content while having a full-time job, which provides stability.

Peter Levels is a good example of leveraging code. If you're interested, check the Indie Hackers podcast which is all about this subject.

My favourite model is the expert model.  A great book on the subject is How to get paid for what you know, by Graham Cochrane.  

The idea is :

1. Create an audience by creating valuable content over a long period of time

2. Solve a problem your audience has by creating an adapted information product (or software)

Formula = Net profit + Asset Value

How to increase income?

• Same as #3

Mechanisms to reach financial independence

• Same as #3

How much does it take to make 1 million dollars? Only 1000 people to give 1000$. The hard part about this model is you could spend years working without seeing much growth. But when the growth happens, it happens FAST.

Conclusion

Jimmy, frightened by his 3 previous lifetimes, just wants to go back to his own SCC (soul-crushing-cubicle) and accept his fate. That's when he stumbled on this article you're reading. He doesn't appreciate the author sharing his secret past, "how does he know about the truck and plane crash anyway", he says, but finds himself wanting to try to fight for his freedom one last time. What happens next? We'll see...