Path To Financial Independence
What Is Financial Independence?
Financial freedom and financial independence have been hot topics in the personal finance community for some time now. In fact, that is my primary theme behind this blog if you haven’t noticed. However, in case you don’t know what financial independence it is, let me take a stab at a formal definition. At the most basic level, financial independence is having enough passive income coming in to cover your expenses. A similar definition could be, if your safe withdrawal rate of your assets is greater than your cost of living, then you have achieved financial independence.
These are both extremely broad definitions that, although technically correct, do not leave a lot to visualize. Instead of this abstract idea of financial independence, I like to turn it into something more concrete. What does financial independence actually mean for you? I believe that if you have something tangible to look forward to, it will make your journey towards financial freedom that much more real. When you take time to lower your expenses, you will know in the back of your mind what lies at the end of the tunnel for you. You will also have a plan of how you are actually going to make it real! Isn’t that why we are all here? If you are ready to start turning dreams to reality, then keep reading.
Today let’s find out what your specific dream is and then make a plan to get you there. I want you to ask yourself five questions to find your dream and determine what you need to do in order to get there.
1. What Lifestyle Do I Want?
If you did not have to go to work tomorrow, what would you want your day to look like? Do not just imagine a typical one time event doing some crazy thing or something that does not truly reflect what you want out of life. I mean what would you want your average day to look like. So instead of just tomorrow, what would you want your day to look like two months from now if you didn’t have to go to work any day in between?
Personally, the first few days I would probably watch a lot of Netflix and play some old video games I haven’t touched in months. To be perfectly honest, I would probably get bored of this very quickly. My perfect average day looks more like something like this.
6:00 AM – 8:00 AM : Wake up after my face has enjoyed the warmth of the rising sun for as long as I’d like that morning and without ever hearing an alarm clock.
8:00 AM : Make my wife and myself a healthy and energizing breakfast. Mmmm grilled chicken and spinach omelette with some cheddar jack cheese
9:00 AM : Go for a run/bike/swim or go left some weights. I truly miss having the time to run 3 miles, swim 1 mile, then run back home 3 miles.
11:00 AM : Build something with my hands. I really want to build an aquaponics system and learn more about home construction
12:00 PM : Grill a few burgers and vegetables while playing some yard games and guitar with close friends. Bags/Cornhole anybody?
3:00 PM : Get involved in my community. I could volunteer to do some gardening at the community plot, help do some construction projects for local charities, or donate my time to the schools or recreational leagues.
5:00 PM : Go for a long nature walk with my wife. We used to walk and talk for hours when we were first dating and that is something I always want to do with her.
6:00 PM : Learn a brand new recipe and cook dinner with my wife.
7:00 PM : Read a book until I fall asleep
2. How Much Money Do I Need To Retire?
Now that you have your perfect average day mapped out, you need to go through the effort of figuring out how much that lifestyle is going to cost you. Try to come up with a yearly number. Make sure that you include those annual/semi-annual expenses like car insurance and holiday/birthday gifts. What does your perfect average day look like? You don’t have to plan it out step by step, but figure out what you actually want and what it is going to cost you to maintain that lifestyle.
When you have your number, you simply need to multiply that number by 25 based on having a safe withdrawal rate of 4%. Let’s assume that your lifestyle is going to cost $30,000 per year. Your will need $30,000 * 25 = $750,000 in order to retire. There it is. That is your number. Start focusing your efforts on reaching that tangible goal!
3. What Is My Current Financial Situation?
You know that you need to hit $750,000 in order to retire, but what does that mean? This is a far different number for somebody who is $100,000 in debt than the person who has $250,000 invested already. If you have already taken the 30 Day Financial Jumpstart then you should have this number handy. Let’s assume that you are 25 and have just started reading. Maybe you have zero invested at this point, but also zero debt.
4. When Do I Want To Retire?
There is one more number that you are going to need in order to figure out what your investing plan is going to look like. You need to decide when you want to retire. Be realistic here, but aggressive. You need to save up another $750,000. Let’s assume you want to retire in 15 years. For our 25 year old with 0 savings, that is still 25 years earlier than the standard road to a retirement at 65.
5. How Much Money Should I Be Saving?
Perfect! You know that you want to retire in 15 years, you need $750,000 invested using a 4% safe withdrawal rate, you assume 7% returns because you are invested entirely in a broad based stock index, you have no debt, and no investments right now. Using our hypothetical example, you would need to contribute $29,845.94 each year if you contribute once per year. If you contribute monthly like most people, you get an extra compounding effect. You would need to contribute approximately $2,366.21 each month (or $28,394.52 per year). Try adding in your own numbers here.
In order to use this calculator, there are a couple of things to note. If you are doing monthly contributions, you need to multiply the number of years by 12 (for months) and enter that number into N. You also need to divide your return rate by 12 (for monthly compounding) and enter that into I/Y. Below are the examples that I used.
Annual Contributions
Monthly Contributions
Summary
There is some extreme power here. If you start investing today you now have a tangible plan sitting right in front of you. Those are the numbers. If you want a larger margin of safety, then lower the expected return rate or increase your contributions. However, you now have a plan. I suggest that you review this exercise periodically to make sure that you are still on track.
Your dreams are out there and the path is laid out in front of you. If you think that you can’t possibly contribute that much every month then you need to do two things in order to reach your goals.
- Spend less money! Every dollar you save is another dollar that can be invested in your plan to reach that lifestyle from Step 1 above in the timeframe you laid out in Step 4.
- Earn more money! This is the other half of the equation after all. When you make more money, you must avoid the lifestyle inflation that tends to come with it. Every time you get a raise or start a new company, review this plan. Remind yourself that every extra dollar you earn has a place on your path.
If you keep focusing on both sides of the equation, you may just reach Financial Independence even faster than you had hoped. Maybe you will realize that you don’t actually need or want to spend as much as you originally planned. That is why it is important to keep reviewing this plan. Your goals will change over time, but having something tangible to always strive for can help to make it more real. Making goals real is what helps and motivates me, so maybe it will help you too.
What Is Financial Freedom To You
Why do you want financial freedom? What do you want to do on your perfect average day? How much do you need to invest regularly in order to reach that number? Remember, this is not just a wishing exercise. It is an action plan as well. Do not fall into the trap of just dreaming about a better future. This blog is not here to fulfill your daydreaming fantasies, it is here to inspire you to turn your dreams of early retirement into a reality and to give you the tools and confidence to get there.
Share Your Commitment
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Nice coverage, with sufficient detail, of what Financial Freedom means, how achieve it, and what it means in practical terms once it is achieved.
Thank you James. I appreciate the support!
Hey Larry, very clear and to the point article. It should be noted that young people these days need an estimated 2 million dollars for retirement! This is something I would try to stress in articles. The days of retiring on 500k-1m are over and people need to be educated on it.
I enjoy your topic on your current financial situation and when you want to retire. These are very important numbers to know and the tools you provided should be used by everybody. Keep up the good work 🙂
Thank you Stefan. I am curious as to where you are getting the 2 million dollar from. How much is needed in retirement is entirely dependent on investment returns and spending. Even we assume a more conservative withdrawal rate of 3%, at $30,000/yr spending from our example in the article would be $1,000,000 needed.
Thank you for adding to the discussion! I’m always interested to discuss these things
I totally agree with you that everything is subjective to one’s living style, financial expenditures etc. Let me be clear, retirement savings need to be customized for every individual case, there is no set number that people can say I “have to achieve.”
With that being said I am going off many articles I have read in the last week actually. Here is one example: http://money.usnews.com/money/personal-finance/articles/2016-03-31/is-2-million-the-new-1-million-for-retirement-savings. The reason I say we need such high prices, is because the price of assets, medical and other common resources such as water etc. are expected to significantly increase in the years to come (I’m talking like 30-40 years from now), if they stay at current growth rate. To maintain a “comfortable” life style 2m is the new 1m. At least this is according to many of the articles I have read. This of course is very debatable and should be taken with a grain of salt but I would always advise having more saved then less!
Would love to know your thoughts or anybody else on this subject!
I read the article and it is interesting. However, one thing to note is that the entire premise appears to be based on inflation. Inflation definitely needs to be taken into account, and it is true that at historic inflation rates around 3% that the value of the dollar is halved every few decades. When the 7% return number is thrown out, I believe that it typically takes into account inflation. Here are two articles that appear to support this Simple Stock Investing and Bogleheads. If that is true and future results mimic past results which is definitely NOT guaranteed, then we can use the 7% return rate in our calculations and base our expected future value required to be in today’s dollars.
That all being said, I think that you and I can both agree on a much larger point. That is that people should be reviewing these steps on a regular basis to track their progress. Investment returns may not pan out as well in the coming years, inflation may rise more than expected, taxes may increase a bunch, or a million other things may happen. The important thing is that we set a plan with the best information we can, then continue to review and revise that plan as we go on.
Can definitely agree to that. Having a plan is important, but constantly adjusting it to current scenarios is, in my opinion, the real key to success.
I find calculators like this so helpful! I think so many people get lost in recognizing that saving just a few dollars a day more (skip that morning coffee!) can add up to a LOT in the long run. Investment really matters. Compounding is just so incomprehensible to people, and calculators like these really bring the concept alive! 🙂
I totally agree! That is why I like linking to them. They turn something so difficult to comprehend into something a little bit more tangible. Also, for the people who already believe, it serves as a reminder of the power and a good planning tool. Thanks for commenting!
You have provided an excellent insight that I’ve had trouble finding elsewhere. Thanks for breaking it down into steps so that we can actually see how it’s possible to achieve results. I’ll definitely be bookmarking this for further studying!
Thank you so much Latoya! If you ever have any specific questions let me know!