Last November, I stumbled upon a podcast called Choose FI. I listened to several episodes before I understood what Financial Independence is. It took me about a month to really absorb the concepts and set a goal to achieve Financial Independence. Now it is certainly something I am committed to and want to help others understand.
What is Financial Independence?
Financial Independence is the state of having enough money or passive income so that one would not be required to work full time in order to survive. The other half of this community – the FIRE community – is about the second half of that statement and retiring early. You can become Financially Independent without retiring from full time work.
The ways that people become financially independent are 1) building up an investment portfolio that is large enough to sustain withdrawals of yearly expenses indefinitely, 2) own rental properties that generate enough cash flow each month that support fixes to the properties and paying personal expenses, 3) creating a passive business endeavor, or 4) some combination of the previous three. I personally am focused on the first way because it is the easiest for me. I own my home and will fix things around the house, but I don’t love it. I only like doing it because it is my own home; I know I don’t want to be a landlord and get calls about broken toilets or fix furnaces.
Financial Independence isn’t just about building up a bunch of money. It isn’t about becoming rich. It is about using money in the most efficient way possible. In order to become Financially Independent in a timely manner, you must pay attention to your spending and not waste money on useless or silly purchases. The other half of the journey is to save and invest a big percentage of your income, ideally 50%. So you start spending less and therefore you start saving more.
What I have discovered is that FI is very connected to frugal ideas; rejecting our consumer culture is essential. I never considered before how influenced I was by commercials, the media, and other people in just spending money. Our society tells us that if we can’t afford something (a new car) we can still have that thing and buy it on credit. Then we spend the next many months or years paying for that thing we couldn’t afford. Becoming involved with the FI movement has helped me understand consumerism on a deeper level and has me wanting to reject that consumerism.
Connected to that consumerism is the ideas about what a woman should be. We have so much body shaming going on in the United States and this has particularly affect me in my life. Advertisements subliminally tell us to be thin, do our hair a certain way, and wear makeup every day. These messages influence mental health and our spending habits. I am not to a point where I can stop wearing make up or stop worrying about what I wear or how I look, but I am reflecting on this all the time. I want to be as strong as one of my favorite personal finance writers, Mrs. Frugalwoods. She writes in her book, Meet the Frugalwoods, about the time she forgot her makeup bag, stopped off at a CVS on the way to work to buy $50 worth of cosemetics, and put on the makeup in a work bathroom. She realized it was incredibly useless; it didn’t change how well she did her job and as she slowly stopped wearing makeup, no one even noticed! So she could then save all the money she spent each year on makeup and put it toward her financial independence goals. It isn’t about giving up everything that isn’t truly essential to live, but it is about giving up the things that don’t truly add value to our lives. My goal is to become more and more mindful of my expenses and save as much as possible.
Anyone Can Pursue Financial Independence
My biggest concern when I first learned about financial independence is that I am living on a teacher’s salary and it’s a profession of modest incomes. I was convinced at first that you had to be a high income earner to achieve FI. But once I heard about the Millionaire Educator and I gave myself some creative freedom to think about different approaches, I realized achieving FI was completely possible for me. I might not get to do it in 5-10 years like higher income earners, but I can still acheive it eventually. In some future posts I will include details about my strategies and thought processes, but you can read a summary of them in my interview over at Financial Tool Belt. The most important thing I have come to realize over the summer is that even if I were never to reach my FI goal, it is still important to pursue it.
Pursuing financial independence provides more financial security earlier in your adult life. You seriously never know when you could lose your job and money can be just the security blanket you need to float you to your next job. Job searching is really stressful. Add having a mortgage in to that situation and you’ve got a recipe for a mental/emotional disaster. While I believe I will reach financial independence one day, just my pursuit of it has me already to the point of having 3 months worth of all bills in the bank so I wouldn’t have to stress out and find a job the very next day if I didn’t have my current job anymore.
Enough about the philosophy, let’s dive into some calculations. My favorite thing is problem solving with numbers, so I was naturally going to be open to FI.
How to Calculate a FI Number
I have two different ways of thinking about and calculating my FI number. And there is a third more general way of thinking about FI. Since I am just getting started on my journey, it is less about reaching a precise goal and more about saving a bunch and being smart with money. Even still, it is helpful to have a ballpark in mind.
All of these calculations outlined below, rely on the research from the Trinity Study in which “The 4% Rule” was established. In studies of retirement cohorts, withdrawing 4% of the investment portfolio led to appropriate drawdown of the funds in retirement in the majority of cases. In other words, the people did not run out of money before they died.
To invert the math of the 4% Rule, you need to have 100/4=25 times as much money in your account as you will draw out each year. People in the FIRE community talk about building up an portfolio of 25x annual spending.
Method 1: General Philosophy
In this methodology, the amount needed to reach financial independence is generalized so that any person can jump in and say “I want to reach FIRE!” This is a great way for people to get started or do some easy math. As you can see below, the lowest yearly spending rate used in the general philosophy is $40,000. So if you spend less, as I do, and plan to spend less in retirement, this calculation approach might not be specific enough. But it’s a place to start your thinking.
Lean FIRE: Covers $40k spending a year
$40,000 x 25 = $1,000,000
A person or family who spends $40,000 a year and wants to continue that level of spending in retirement. Since I spend about $12k – $13k less than this a year, I could reach regular FIRE before the general philosophy even would consider me Lean FIRE.
FIRE: Covers $60k spending a year
$60,000 x 25 = $1,500,000
To spend $20k more a year, you need half a million more in your portfolio. I don’t even make $60k a year, let alone spend it! I plan to keep my spending low and invest raises so I don’t need to reach this traditional level of FIRE to feel ready.
Fat FIRE: Covers $75k spending a year
$75,000 x 25 = $1,875,000
You need almost $2 million to cover this level of spending a year. I have never considered needing this amount.
Method 2: Multiples of Annual Spending
I like this method better than the general method because it looks a each person or family on a case by case basis. When you want to find the true numbers here you have to push yourself to really calculate your budget truthfully. Because of taking this approach to calculating my FIRE number over the past year, I have been tracking spending and creating a more honest budget. I used to just include all the main budget items and then if something popped up once or twice in a year I just paid for it and didn’t ever think about planning for it in the next year.
This method takes different approaches of withdrawal rates on the portfolio into account. In many cases, a 5% withdrawal rate on the portfolio will find success for a retiree. Or, you can stick to the 4% Rule. And in other cases, one should be more conservative and withdraw closer to 3% of the portfolio to maintain its ability to see you through retirement.
My annual spending level right now is $27,400. This of course includes things I won’t have to pay for in a few years and hopefully won’t have to pay for in retirement: student loans, auto loan, mortgage. I want to pay off my house before officially declaring myself to have reached Financial Independence, and definitely before retiring.
With those expenses dropping out, I could reduce my annual spending number by $10,716 to about $17,084. Since I’d like to do other things like travel in my retirement, I am going to keep the level of spending recorded as $21,000. I, of course, reserve the right to revise this number many times over the next 10 years. No matter how many times I revise, the formulas in my Sheet will remain the same. =20x, =25x, and = 30x for the method detailed below.
Lean FIRE: 20x Annual Spending
$21,000 x 20 = $420,000
A portfolio size of $420,000 would allow for a safe withdrawal rate of 5%. Personally, I prefer a more conservative approach so I don’t think I would consider my self ready to stop working at this level. However, I could switch to a lower paying job or a part time position so my portfolio could continue to grow but I don’t need to draw on it.
FIRE: 25x Annual Spending
$21,000 x 25 = $525,000
Again, because I am a little more conservative, I’d like to have a little bit more than this in my portfolio but this is one of the targets I keep in mind when I run spreadsheets to project the time it will take me to reach FI.
Fat FIRE: 30x Annual Spending
$21,000 x 30 = $630,000
This is a comfortable portfolio size for me. This is close to 25x my current spending level. $27,400 x 25 = $685,000. It was surprising to me when multiple approaches led me to this number because I had previously always desired to build a portfolio of $1 million. At the same time, it made me feel more comfortable to know I could sufficiently live on a portfolio less than $1 million.
Method 3: Building Fences of Spending
Lean FIRE: 25x the Need-Only-Budget
$21,000 x 25 = $525,000
My bills and grocery spending currently is abut $1750 a month which totals $21,000 a year. The idea here is that if I lost my job at any point, I could still survive. Nothing is guaranteed so I like having the emergency mindset in my FI considerations.
FIRE: 25x the Frugal-But-Fun Budget
$27,400 x 25 = $685,000
This is what I consider my current spending right now. I don’t overspend on some items but I still am enjoying life. I can buy things for my dog or buy a yoga membership if I want. I could still do many enjoyable things in retirement with this portfolio size.
Fat FIRE: 25x Inflated Budget
$35,000 x 25 = $875,000
This budget keeps my current level of spending and adds in more. It allows for a little lifestyle inflation. Who knows what I might do or spend money on in retirement. It’s good to calculate it in.
My FIRE Number Range
So it seems I need somewhere between $420,000 and $875,000 to reach FIRE. Depending on how my spending and life philosophy evolve and what the economic outlook is and where my career goes, any value in that range could be when I pull the trigger and stop working full time.
I use about $550,000 when I calculate projections. I do this because I use a conservative rate of return in my calculations of 8% even though I am very aggressively invested. I continue to increase my stock holdings over bonds.
Based on the variety of accounts I already have and what I project I can save in the next two years (and assuming I continue at that level in the subsequent years), I will reach Financial Independence by age 40.