Financial freedom is passive cash flow from assets that are greater than your monthly expenses. When looking at this formula, typically people focus on increasing the passive income from assets, which is essential. However, it is just as important to keep expenses to a minimum. While this may seem obvious, one of main reasons to keep expenses down is because of an important fact that I learned on my journey, which is that every dollar spent costs more than the dollar. Sounds weird? Let me explain.
Let’s assume that someone named Tommy is looking to sell a rental property that he has owned for 30 years. Tommy has the ability to do a tax deferred exchange (also known as a 1031 exchange) of the proceeds from the sale, which would allow him to defer the taxes paid on the sale and use all of the proceeds from the sale to purchase another property.
Now imagine that Tommy says that he does not want to do an exchange as he does not want to spend the extra time setting up the exchange. Instead, Tommy simply wants to “cash out” and is willing to pay the capital gains tax. Tommy estimates that those taxes will be “only” $50,000.
It is important to note that Tommy, much like any of us, can spend his money as he pleases. The only thing that I believe is essential is that, before we spend, we know what is the true cost of that expenditure. While Tommy believes that he is paying “just” $50,000, the truth is that he is paying much more.
This idea was first introduced to me by one of my mentors, Jimmy Napier, when he said, “You don’t ever lose just a dollar, you don’t ever pay just $15 too much for the motel, you pay $15 plus all future growth of the $15.”
So, Tommy is not paying “just” $50,000. Rather he is paying $50,000, plus all future growth (aka interest earned) of that $50,000.
Next, let’s figure out how much Tommy is actually paying? To know this, one must determine the future growth of the $50,000. So, assume that Tommy, rather than cashing out, did a tax deferred exchange as discussed above and deferred the $50,000 in taxes. Further assume that he was able to earn 15% on the money. (I know what you are thinking, “15%!!! That is impossible!” Actually, it is possible, and I will discuss principles later that will show you how it is possible).
If Tommy reinvested the $50,000 at 15% for 30 years, that $50,000 would grow to $4,377,049.76!!!! I am certain that Tommy would think twice about not deferring his taxes if he realized that the true amount that he was spending was over $4.3 million dollars.
Like I have said before, financial freedom is a two way street: Increase income and decrease outgo. When looking at the “outgo,” we often times spend money today, not thinking of what it is truly costing us down the road.
Remember, that for every dollar that you spend, you not only spend that dollar, but you spend all future interest which that dollar could have earned. For all of us, it is imperative to examine our spending and make sure that we are not spending unnecessarily.
After reading this, is there anywhere in your life where you are spending and it is costing you much more than you initially thought? Please post your comments below.