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How to Build A Financial Dam

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In the quest for financial independence and potential early retirement, a fundamental transition needs to occur, transforming from a laborer to a capitalist.

What do I mean by this?

For the vast majority of people the way they “earn a living” is by getting a job and trading time/labor for money. It is a central tenet to how our economy works.

We try to maximize this compensation by developing skills that are in demand and in which society places as a premium. But even highly compensated individuals, such as physicians, are laborers at the very heart of the matter. When a laborer stops working, that income stream dries up.

Unfortunately in this scenario the expenses of living continue and thus the laborer must either rapidly resume working or decrease his or her lifestyle (much easier said than done).

We have all heard of the phrase, “living paycheck to paycheck.” This phrase describes a delicate balance for which an individual or family basically has no net positive cashflow with expenses either matching or exceeding the income stream. This is not a desirable situation to be in as the slightest external force can tip the scale into financial ruin.

High income professions are not immune to this phenomena. This most notably happens with “Lifestyle Creep.” I know of several of my physician colleagues that are operating on razor thin margins with their personal finances. Human behavior is ingrained with “live for the moment” mentality. When more money comes in, there is tendency to spend more to match it, and sometimes even exceed it.

In fact I would say that physicians are a group of individuals where there is extreme pressure to “be the Joneses.” Physicians are expected to have a certain level of housing (aka the physician mansion), drive a certain luxury level of car, and have other outward signs of wealth. Friends and family expect a physician to have this extravagant lifestyle because being a physician is supposed to denote success. By following this vicious cycle an individual will always be relegated to the role of a laborer.

The only hope of leaving this daily grind/rat race is by reaching an age where government social programs such as Social Security and Medicare can subsidize one’s lifestyle.

So what is a capitalist?

When I picture a capitalist I think of some rich guy wearing a monocle, but in reality, anyone can be a capitalist. A capitalist is someone who has his or her money work for him/her — what an amazing concept.

When you have your money (“the capital”) working for you what you have in essence is a tireless worker, one that works 24 hours a day, 7 days a week, 365 days a year. You have created an employee that doesn’t ask for vacation, doesn’t require a raise, and never has sick time. This “money employee” even puts the hardest working physician on the planet to shame.

“That’s great! Now where can I get this ‘money employee?’”

This is precisely why personal finance blogs such as this one are formed. To give examples and advice to help create the “capital in Capitalist.”

Unless you were born with a silver spoon in your mouth, won the lottery, or have received a large inheritance, the key to generating this capital is by creating positive cashflow. Positive cashflow can only occur when your income stream(s) surpass your expense outflow.

A great analogy is to think of money as flowing water (in fact this is the very basis of how cashflow came about). In the beginning of your career you trade time for money, creating an income stream.

Depending on your skills that initial income stream can be a creek (think resident’s salary), river (attending), or even rapids (high paying specialties). Regardless of the amount of water coming in there will never be any net gain if it continues to flow past you (i.e. expenses match income). For those wishing to start the path to financial independence and perhaps early retirement, you have to create ways of slowing the outflow of that water to create a reservoir (the capital). Creating obstacles in the outflow of water/cash can be best accomplished by reducing expenses.

The higher and stronger you can build a dam to retain this precious water, the more potential energy builds up in the system that can then be put to work, similar in concept to hydroelectric dams.

Similarly increasing the amount of water coming in (advancing in career, getting advanced degrees to increase compensation, or even side gigs) will help turbocharge the system even faster.

There are so many positive side effects that come during the process of this financial dam building. One of the most significant of these side effects is that this process forces an individual to analyze expenses in an effort to reduce them. The word “budget” likely causes negative thoughts to arise. People view budgets as restrictive and as humans we like to be free. But by utilizing a budget one can achieve freedom much faster. It is a means to an end and is therefore a remarkable positive tool.

If you do not take the time to analyze your personal cashflow and create a budget to maximize money retention, than you will relegate yourself to the role of a laborer and be far more restricted in your life.

Another beneficial side effect is that as you learn to reduce your negative cash outflow (i.e. expenses), you soon adapt to that lower expense lifestyle and thus require far less capital to maintain it.

Using the standard 4% safe withdrawal rate for retirement, every $10,000 of annual living expenses you can lower equates to $250,000 of less capital needed at retirement. The process of building your financial dam will also force you to first attack debt obligations that try to weaken your dam’s foundations.

By plugging these leaks (constant cash outflow from interest charges) you also set yourself to be more flexible in retirement as you no longer have these fixed obligations requiring money.

In Summary:

  1. The key to financial independence is to have money working for you so you don’t have to (making you a Capitalist rather than a Laborer)
  2. A strong financial dam will give your money vast potential energy that can be deployed to create more income streams.
  3. Creating a budget is a strong tool to maximize positive cashflow by highlighting unnecessary expenses.

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