Becoming financially independent is easier than you may think

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?

Our August Spending

Well, it is possible that writing this blog is good for our budget. I have been keeping track of how much we spend for several years now and this is our lowest spending month in recorded history! Which shows that way too much of our spending is really discretionary. Our average monthly spending for 2019 was almost $5000 a month excluding property taxes and donations which we tend to do on an annual basis.

Shopping this month included printer supplies (about $150 worth) due to the fact that we are both working from home and homeschooling, some clothes for me ($110, I did really need the clothes) and homeschooling workbooks for the Child. Kid expenses included the Child’s violin lessons (which she takes over Zoom) and school fees (public school). We made a small amount of donations as our area was hit by a major storm so we donated to some local charities.

One significant reason our spending is down is COVID and the fact that both of us are working from home. That decreases our transportation expenses (normally I pay $6-$7 per day for parking and we both drive to work) but it also decreases my random and totally optional daily purchases. When I am at work, I often end up buying lunch or buying coffee and these things add up!

During the first weeks of COVID, our spending didn’t go down, it shifted. I tried to buy things that I hoped would protect my family from the dangers. I stocked up on food, toilet paper, soap, and Clorox wipes. I also bought various masks that I hoped would be good enough to keep us healthy. I have reached the point where I have bought everything that can possibly be useful. All of these things are sitting in our basement as at the moment we simply don’t leave the house but I feel slightly better knowing they are there.

Our low spending (for us) is of course largely due to luck – nothing went wrong this month. The pets didn’t get sick, no appliances failed, no storms damaged our roof or flooded our basement. It is easier not to spend money when there are no emergencies. Still, I do think that writing about money helps me be more thoughtful about how I spend it. It’s a win!

Can we bring our spending lower and is it worth it? Probably we can and probably it is worth it.

Our main financial goal is to be financially independent. That means to be able to live entirely on the passive income generated by investments. The common rule is that to be financially independent, you need to have investments equal to 25 times your annual income. Making some reasonable (everyone hopes) assumptions about the return on stocks, this should allow you to live on passive income forever. I tend to be more conservative, so I am taking 30 times our annual spending to be our financial independence number. Small changes in your annual spending, can have a big effect on this number. For example, if we can live on $40K per year (an average of $3,300 a month) then we need $1.2 million in investments (this doesn’t count money that is not invested such as the value of your home, cars, or money you like to keep in cash). If we need $73K per year (the amount we spent last year), then we need $2.2 million. That is a big difference! In general, cutting your spending by $1000 a month, translates into a decrease of $360,000 in your financial independence number. And of course if you are spending less, you are saving more to reach that smaller number even faster.

FIRE

For the novice, FIRE stands for Financial Independence Retire Early. Followers of this movement often save 50%-80% of their income to accumulate enough invested capital to be able to retire early (sometimes as early as in their 30s) and live entirely on passive income. If you hang out in the FIRE circles, you will hear about the 4% rule, which says that you can safely withdraw 4% per year of your investments and, assuming the market doesn’t do anything crazy, your money should last forever. If you don’t like percentages, this means that you need to have 25 times your annual spending in investment accounts to be able to quit your job and never need to earn money again.


There are, of course, variations on this theme. Some people go to great lengths to cut their budget to be able to retire as early as possible (lean Fire), some work longer in exchange for higher spending ability (fat FIRE), and some retire from stressful jobs but still work at some low-stress job they enjoy to supplement their investment income (barista FIRE).
I am totally not interested in the RE (retire early) part of FIRE. I love my job and expect to continue working for many years, regardless of our net worth. I am, however, very interested in the FI (financial independence) part of FIRE.


Sometimes I wonder why to me, FI is such an important goal. My wife thinks FI is a good idea, but she certainly doesn’t obsess about our FI number and how close we are to it. And people around me seem perfectly happy buying stuff they don’t need, so I am pretty sure they don’t even know there is such a thing as an FI number.


I am an immigrant from a relatively poor country. I came to the US for College with $500 and my tuition for the first semester covered. From there, I needed to figure it out on my own. Without even the ability to borrow money (foreigners can’t take out student loans), I was in a pretty tight spot.


At some point in College, maybe in my sophomore year, I got a terrible toothache. I didn’t have dental insurance, so I did the only thing I could – I took lots and lots of painkillers. It lasted for weeks. Much of the time, I was so drowsy from the pills I could barely function. I got a permanent case of an upset stomach. Eventually, I saved about $100 and went to the dentist. For me, at that time, $100 was a huge amount of money. The dentist looked at my tooth, took a couple of X-rays, gave me a proposed plan for how he can fix it, and charged me $100 for the consult and the X-rays. I still had a terrible toothache and no money.

Eventually, I learned about a free dental clinic. I found someone with a car who drove me there. They fixed that tooth and all the other teeth that were rotting in my mouth (I used to have a lot of tooth problems, probably due to very poor dental care in my home country), and I could get off the pain pills.


This is the sort of experience I never want to have again. And so when I have a choice between getting the newest iPhone or increasing our money stash, I opt to add to the stash. The stash is what keeps my family and me safe from at least some of the bad things that can happen in life. The iPhone can’t do that.


Take a minute and figure out your FI number. Imagine having that amount of money and the freedom that would give you. Now, look at the latest gadget you bought. What optimizes your happiness profits?