This is the third part of our six-part intensive series on the Freedom Generator. If you missed the first article, you can read it here.
The Income Generator—the epicenter of your Freedom Generator’s power. Up until your Freedom Day, your focus is set on building up this important bucket. And once that day comes, your generator is the money machine cranking out a reliable “salary” for you month after month without the need for you to trade your time for money.
Sound good? Let’s dive into the Income Generator and discuss how you’ll bankroll your Freedom!
How The Magic Works
The Income Generator is the true powerhouse in your Freedom Generator. It’s the engine that keeps your Freedom running at full speed. If you peek under the hood, you’ll see the quality, dividend-yielding investments that regularly support your Financial Freedom.
Keep in mind this bucket does not represent retirement savings you can’t touch until your golden years. Instead, the assets in this bucket have one job—to generate a consistent passive income to maintain your Financial Freedom.
Constructing an Income Generator may not be quick or easy, but with a little know-how and a good plan, you have a guaranteed method for creating Financial Freedom. And it’s entirely achievable if you make building your generator a priority.
There is one important “trick” for getting there faster though! The secret to supercharging the growth of your Freedom Generator is this: Reinvest your dividends automatically. Until your Freedom Day, you should be extracting exactly zero dollars from your Income Generator. Your investments will produce dividends, but–instead of pocketing those returns–set up your portfolio so that the money paid out is automatically reinvested.
The Big Question: How Much Is Enough?
To maintain your Financial Freedom, your Income Generator must–at a minimum–generate enough income to cover your monthly expenses completely. Keep in mind that, when we talk about the income that your assets produce, we’re talking purely about dividends. You shouldn’t need to sell your actual investments in order to meet your monthly expense bill.
But squeaking by from one month to the next can put you in a precarious financial position. After all, the returns on your investments can change from month to month, and your expenses may vary as well. As a result, we recommend that you fund your Income Generator so that it provides you with at least 25% more income than what you need to cover your expenses.
How Much Money Should My Income Generator Produce?
We’re always asked: What’s a “good” return on my investments?
Our rule of thumb is simple. Your pool of investments should, on average, return a dividend of 5% of your investment balance each year. If your assets aren’t consistently producing at that level, it’s time to swap out the loser investments for winners.
We’ve thrown a few numbers at you so far, so let’s boil it down to a simple formula. Plug in the dollar value of your monthly expenses to calculate how much money your Income Generator should hold in order for you to be Financially Free:
Recommended Balance of Income Generator = 1.25 x 12 x (Average Monthly Expenses) / 0.05
Now that you’ve got your own number in hand, let’s review two fundamental principles of constructing an Income Generator wisely and efficiently.
Principle 1: Create Balance
You’ve probably heard of the Taoist concept of yin and yang, which together represent harmony and balance. It may sound funny, but I’d like you to channel your inner Taoist when you approach your investment strategy.
The yin represents “cloudy” economic times. Stocks dip (or tumble) downward, and many people succumb to panic and sell their assets at a loss. But, during these times, fixed income investments in the form of quality bonds creep up or even skyrocket in value.
The yang meanwhile represents “sunny” economic times. Stock shares thrive, retail investments flourish, and everyone seems a little happier.
To create a balanced, yin-yang portfolio that withstands the test of time, you need a mixture of assets from sunny and cloudy economic climates. This concept is the crux of diversification.
Principle 2: Create Diversity
Diversifying your investments does three things:
- Distributes your risk;
- Reduces the choppiness of your anticipated returns; and
- Increases the predictability of your Freedom Generator’s consistent output.
What does diversification look like? As a rough rule of thumb, we suggest you invest no more than 10% of your available capital in a single investment–a certain stock, a particular bond, a piece of property, etc. Additionally, we recommend you invest no more than 10% of your capital in a single business sector–the banking industry, the real estate industry, etc.
Your Income Generator is working and healthy when producing a consistent income for you and is not the place for risky investments that promise sky-high returns. Remember: Return of your money is more important than return on your money.
Instead of betting the house, seek a solid portfolio of quality assets that put money in your pocket. And, when you follow these principles, you’ll be on the road to Financial Freedom.
Community Question: How do you motivate yourself to keep at the long (but rewarding) process of building your Income Generator? Inspire us in the Financial Foundations community!
image credit: Bigstock/Gustavo Frazao
Dr. Tony is the co-founder of MindShift.money and the best-selling author of three books on personal and business finances. Having achieved Financial Freedom at 27, Dr. Tony believes that through Financially Fit Bootcamp and Cash Flow Cure everyone can get there. He has made it his life’s mission to help others live a life where their money works for them—not the other way around.