In celebration of our country’s independence this month, I thought it only fitting to write a blog post celebrating yours - your future financial independence, that is.
You’ve probably at least heard the term financial independence (FI) - it gets thrown around a lot in the media and personal finance blogosphere these days. Couples in their early 30s have been featured on TV, shouting to the heavens about how they’ve quit working and are now living entirely off of their investment portfolio. Or perhaps you know someone who retired at a very young age and have always wondered how that could become a reality for you too.
This exact topic came up recently while chatting with a friend. He had seen one of my Instagram posts referencing FI and stated that the concept had never really occurred to him, outside of retirement that is.
“How do they do it?” he asked. “Is it really possible for the average individual to achieve financial independence at a ‘young’ age?”
Absolutely. It simply depends on how bad you want it and what changes you’re willing to make to get there.
Society leads us to believe that we have to trudge through forty to forty-five years of work before reaching the shiny golden age called retirement. This idea is most notably perpetuated by the penalties and withdrawal eligibility criteria set forth in retirement plans. Currently, you have to reach 59 ½ years old before you can withdraw earnings from your retirement account without penalty.
Perhaps it’s the existentialist in me, but… Why is that the norm? Where did this societal construct come from? Don’t we all have a larger purpose on this earth than work? Presuming that’s true, how are we meant to achieve that purpose when half of our lives are spent toiling away behind a desk?
On the one hand, I get it - when we’re young, we’re most physically able to work. But we’re also most physically able to enjoy ourselves. So why do we waste four decades of youthful vigor, only to retire with a pile of money, less energy, and a slowing mind and body?
By achieving financial independence early, you don’t have to abide by that script. You’re free to write the chapters of your life as you see fit, not as society defines them.
What is financial independence?
Technically speaking, you reach financial independence when your assets can throw off enough income to support your current lifestyle. Assets are things that you own that generate income. That last part is the key difference between assets and belongings - assets increase in value and/or generate income over time, whereas belongings (material objects) depreciate or decrease in value over time. (If you want a fundamental, easy read on the topic, check out Robert Kiyosaki’s book Rich Dad, Poor Dad.)
When you’re financially independent, you work because you want to, not because you need to. Your assets generate enough income to pay for your non-discretionary (basic) and discretionary needs, which gives you the freedom to do whatever you want whenever you want.
Imagine not having to report to an office every day! Or not having your financial livelihood resting in someone else’s hands. Oh, what a luxury that would be, right?
How big of a nest egg do you need?
There is no magic number; everyone’s financial needs are unique. The first data point to determine is how much money you (and your family, if applicable) need to spend every year to maintain your “independent” lifestyle. This is the amount of income your investment portfolio would have to generate annually.
For one person, it may be $20,000. For you, it may be $40,000. Whatever the case, it’s okay. This number is adjustable and simply serves as a starting point for your calculations.
The next step is to divide your yearly income need by 4% (or multiply it by 25) to determine the necessary size of your nest egg. This is, not surprisingly, called The 4% Rule, and it’s considered the “holy grail” of nest egg calculations. The idea is that, if you initially withdraw 4% from your diversified portfolio of stocks and bonds, then increase your annual withdrawal every year after that to account for inflation, your nest egg should last you through retirement based on historical market returns.
For example, if you need $20,000 to cover expenses, you’ll need to have a beginning portfolio balance of roughly $500,000 according to this method. If you need $40,000 per year, your nest egg would need to be at least $1,000,000 in size to start in order to maintain your $40,000 per year lifestyle.
Don’t fall short
The major issue with this “rule”, however, is that it’s based off of a traditional retirement horizon of only 25 to 30 years. If you decide to stop working in your 30s or 40s, you’ll need to have enough money invested to last 50 or 60 years. Mathematically, the 4% method will almost surely leave you short.
If being financially independent from your 30s or 40s onward is truly your goal, you should use a lower withdrawal percentage, such as 2.5% or 3%, in your calculation. The lower the percentage used, the larger your nest egg will have to be to begin with. But the more you save, the more secure your plan will be.
Applying this logic to the above example ($20,000 per year), you’ll actually need a starting portfolio balance of $800,000 to ensure financial independence for five to six decades. If your expenses add up to $40,000 per year, you’d need $1.6 million.
How can you possibly save that much?
Trust me, I get it. $100,000, let alone $500,000 or $800,000, seems entirely out of reach for most of us. And for those with low income and/or terrible spending habits, it probably is. But that’s where priorities, discipline, and your personal decision-making power come into play.
If you’re serious about achieving financial independence at a young age, the number one factor that will determine your success is increasing your savings rate, or the percentage of your income that you save, not spend. The more you can save and invest, the faster you’ll be able to reach FI.
But if you feel like you’re already saving as much as you can, how can you possibly save more?
It comes down to your personal cash flow - what’s left after subtracting your expenses from your income. To increase your cash flow, you need to either increase the amount of money you have coming in, or decrease the amount of money going out (or both).
Ways to boost your cash flow
If you want to attack the problem from the income side, there are a number of things you can do. Ask for a raise, pick up a side hustle, take classes or certification programs that will increase your value to your employer, or rent out a room in your home on Airbnb.
To lower your expenses, get a roommate, walk or bike places instead of driving, get a cheaper and/or more fuel efficient vehicle, move to a lower cost area, downsize your home, refinance high cost debt, eat at home more often, cut back on vacations… The possibilities are endless and only limited by the tweaks you’re willing to make.
Would you sell your brand new car for a cheaper, used model if it meant being able to retire a few years earlier? Would you move from the city to the country if doing so would allow you to become financially independent at 45? It’s truly up to you.
Now, obviously, the higher your salary and/or more frugal a lifestyle you already lead, the easier it’s going to be to get there. But where there’s a will, there’s a way! Countless others empowered by the idea of financial independence have implemented changes to make their dreams a reality, and you can too. All it takes is dedication and some financial engineering.
If you’re reading this article and looking at your bank account wondering how in the hell you could possibly achieve financial independence, you’re not alone. If it’s any consolation, I’m nowhere near FI yet either. But I’ve had a taste of what it could look like - “working” remotely from anywhere - and the freedom and flexibility is intoxicating.
If you need inspiration, there are plenty of people sharing their attainment of and journeys to financial independence online. Just give it a quick Google search. One of my favorites I’ve found is Pete Adeney, also known as Mr. Money Mustache. He shared his story as a guest on Tim Ferriss’ podcast (which is awesome, by the way, and definitely worth listening to).
He and his family’s methods of frugality may seem outrageous to many (me included), but it’s a great example of the lengths to which someone is willing to go to live their best, most flexible and unencumbered financial life.
Does the idea of financial independence intrigue you? Does the potential freedom inspire you to ReisUP and change your financial habits? Do you think you could live off of a portfolio of invested assets for the rest of your life, presuming you could accumulate a large enough nest egg to begin with?
And, most importantly, what would you do with all of that of extra time?
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Psst... I created an awesome FI spreadsheet for you to monkey around with!
- Want help calculating your FI number? It can do that.
- Wondering when you could retire based on your current saving and spending habits? Yep, it'll tell you that too.
- Are you itching to retire by a certain age? Sweet. It'll tell you what percentage of your income you'd have to save every year to make that happen! (Its coolest feature, in my opinion.)
Just enter your contact info and the calculator is all yours :