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Thursday, October 31, 2024

Third step to financial independence

The first step is having a financial fuel gauge. A gauge to track the rate of income vs expenses and developing the discipline to monitor the ratio and avoid running out of fuel. The second step is having 1 year worth of free cash or high liquidity assets. At this point, we have an accurate gauge of our cash flow, and a year's worth of cash on hand. You should congratulate yourself, you have done most of the hard part, the behavioral and psychology part developing your intuition on money, spending, and cash flow. The rest is the fun part. It’s time to put all your hard earned money to work and achieve the long term financial objectives. Everyone needs a holistic and practical plan to achieve their goals. 

Long term financial planning is difficult for 3 reasons: it’s an emotionally charged topic and difficult to think rationally about it, too many objectives competing for the same limited resources, and too much noise from the media and friends. Too often, people make big financial decisions in isolation or at spur of the moment or focused tactical detail of a specific stock and financial instrument. The best way to deal with these challenges is .. you guessed it .. have a financial decision making framework. 

I use the following process in a few steps to help me. 

  1. Make a list of financial objectives organized into time horizon buckets. 
  2. Decide on financial goals (growth or income) and preferred tax treatments (prepaid, deferred) for each item.
  3. Prioritize and allocate available cash flow. Generally, pick one time per time bucket and the use 60%, 20%, and 20% allocation respectively
  4. Select account type (529, IRA, etc) and instrument (VOO : Vanguard S&5 500 ETF, Bitcoin, etc)

The most important thing is to take action on the imperfect decision. There is no perfect or best decision, only good enough decisions. The more time the money is invested and put to work is almost always better than waiting for a better decision or time. Often financial decisions are reversible and reallocation is easy. To get better at managing finances is to make high velocity and high quality decisions. 

What is your financial decision framework? 

Ricky


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