We all want to be financially independent. But what does it really mean? And what can we do to achieve financial freedom early in life? Naturally, it's easier to start as young as possible. So, what would it take for a 25 year old to achieve this financial freedom by the age of 40?

1. What would it take for a 25 year old
to achieve financial freedom by 40?

2. To build wealth from investing make
sure to have high exposure to the
stock market when you are young

3. A young person who is
focused on achieving
financial freedom will need
to be very disciplined. I
have a pretty complex
financial simulation model
to try to answer this, but
I will try to keep it simple
with this post. The person’s
first step will be to take on
a very high level of equity
market risk, this cannot be
achieved by putting money
into a bond or the bank.
My advice is to hold
110 minus your age
in a highly diversified
passive equity fund.

4. If that choice is not available then consider a
diversified and as low cost equity fund as the
investor can get. This would mean that a 25 year
old should allocate about 85% to equity. Next a 25
year old would need to determine at what age they
want to target achieving financial independence.
Then they need to determine their per month
income target-there definition of financial
independence income. After that they must
estimate long term returns of stocks and bonds, as
well as their expectation of inflation over that time.
Finally, they would need to consider the amount of
savings or investments they already have which
can be applied to achieving this goal.

5. A 25 year old should
allocate about 85%
to equity

6. Questions to ask
What age do you want to achieve financial independence?
What does financial independence mean to you?
What are your long-term stock and bond return expectations?
What do you expect inflation to be over this time?
Do you already have some savings or investments in place?

7. It takes very high monthly
contributions and a long time
to build wealth in the stock market

8. So a person who wants to be financially
independent at 40 years old, should start by
thinking about the income in today’s dollars that
they would need to live on. Let’s assume that
US$5,000 per month would be enough passive
income.
Next they need to estimate their long term returns
in the stock market over their 15 year investment
horizon, let’s use 8% (maybe 5% from capital
gains and 3% from dividend yield-but remember
to reinvest those dividends!). And for bonds they
expect 4%. We next need an estimate of inflation to
see what US$5,000 per month would become at the
end of the period and let’s use 3% for that.
Finally, do they have any savings now, let’s say no.

9. We can now combine this info with other assumptions
that I make in my model of this and we can calculate
that to achieve this dream the person would need to
be investing about US$4,300 per month.
This amount is much larger than many would
think. Part of it is that the person’s investment
horizon is short.
If we extend it to 50 years old it would reduce to
US$2,500 per month. If the person was lucky and the
stock market returned 10%, it would require US$1,600
per month. Of course this is all based on assumptions
and things can always go differently than planned,
so an investor may want to exceed their predicted
contributions, especially in the early years.

10. Own a diversified equity portfolio,
invest regularly, don’t try to time
the market and don’t sell

11. A 25 year old dreaming about financial independence through investing at 40 is facing a very difficult
task. When it comes to investing, time is probably the most important factor. This is because over time
your money compounds by earning interest on the interest you earned in the prior periods.
The exponential increase from this really starts to take off after about 20 years.
So a 15 year time horizon does not really allow for this full benefit. To achieve this task you would need to
get high exposure to the equity market since that is the only place where you can get as high a return as
was need. Probably most important with regard to this is that you make regular purchases of the equity
fund or ETF and that you almost NEVER sell, only buy.

12. www.andrewstotz.com