Financial independence, from a mathematical point of view, is pretty straightforward. You need an investment portfolio 25 times your annual expenses. With some basic assumptions, confirmed by historical market performance, if you withdraw no more than 4% of this portfolio each year, it will last indefinitely.
Financial independence is not absolute; it depends on how much money you need to cover your annual expenses. If you can live on $40,000 a year, you need a million dollars in your investment portfolio. If you spend $100,000 a year, you will need $2.5 million. That is a lot of money but actually getting to financial independence is easier than it might seem because you don’t have to save all of that money on your own. Once you start investing, the market helps you along.
Suppose you save and invest $20K per year. It may seem that it would take you 50 years to get to 1 million dollars. But if we assume that your investment grows at 11% annually (a reasonable assumption based on historical averages), it will take you only 17 years. In other words, you will only have to actually save $340,000, and the rest of the money will come from the growth of your stocks. In the table below, notice that after year 7, the market is actually contributing more towards your portfolio growth than you are. The rich get richer!
Surprisingly, how long it takes you to reach financial independence does not depend on how much you make but only on what percent of your income you save. If you make $200,000 and you save 50% of your income (therefore, you can live on $100,000 per year), it will take you exactly as long to accumulate the $2.5 million you need as someone who earns $80,000 and can save $40,000 of their income to reach their financial independence number of one million dollars. Of course, making more money helps – it is much easier to figure out how to live on 50% of a $200,000 income than to figure out how to live on 50% of a $20,000 income. Nevertheless, the table below will tell you how long it will take you to reach financial independence assuming today you have no assets and no debt based on various level of saving. You can get information based on your specific situation with this straightforward calculator.
Do you feel inspired? What percent of your income are you willing to save? The average US household saves about 7% of their income which translates to 58.8 years until financial independence. Can you do better?