“This friend of yours saves $5000 a year and spends the rest. In order for your friend, once he turns 65 years old to retire…it would take him a mere 1416 years.”
Welcome to The Wealthy Healthy, the podcast and blog dedicated to inspiring better mental, physical, and financial health. I’m your host, Riki Newton, and today’s Financial Fridays episode is going to be an introduction to the concept of “financial independence.” The reason I want to talk about this before anything else is that this concept has been the primary driver of a huge shift in how I view and approach my own finances, and I’ve watched a number of my close friends develop a similar interest in better understanding what it means and how it works.
So with that being said today’s episode is pretty ground floor in the sense that we aren’t yet going to dive too deep into the math or into how it relates to early and semi-retirement; the focus here is simply to get on the same page with a few different definitions of the term and to get you thinking about whether some form of financial independence would be a priority for you. Along the way we’ll dive into a few very simple mathematical examples for how financial independence, early retirement, and traditional retirement work. Over the course of the show I’ll refer back to this concept, and will spend more time in other episodes focused on the math, actions to speed up this process, whether it’s possible with a late start or with debt, and so on.
So in simple terms, financial independence is generally defined as the accumulation of enough wealth to cover living expenses with income generated passively from the interest on investments. Or in other words, having enough money that you could quit your job and never go broke. A lot of the time you’ll hear of this referred to as FI, or sometimes FI/RE or FIRE, which stands for financial independence, early retirement.
There are several common motivations for achieving financial independence. Perhaps you desire to simply feel free from the stress of work — if you are completely financially independent, you can continue to work under whatever load or circumstances or stress level you desire, because you no longer rely on that job for your expenses. This means you can design your work the way you’d like.
Now maybe you love your job. What achieving financial independence means, if you love your job, is that now you can go on and enjoy it regardless of pay. If you work in an office and hate office politics, you can now feel safe in not partaking. If you work in an on-call or overnight profession like healthcare or construction, you can start to pick and choose your hours, which allows you more and better sleep, which ultimately improves your quality of life. You could switch to working part-time and enjoy the continuation of keeping busy with a career you enjoy, but afford yourself more time with your kids. You could dedicate more of your time and energy to healthy exercise habits or outdoor activities that you enjoy. Redouble your efforts toward hobbies that you only have time to do on the weekends. Maybe you’d like to be able to take more frequent vacations, or pursue a career you’d otherwise deem unrealistic due to smaller pay or lower pay ceilings.
If you love absolutely every single thing about your job and there’s nothing in the world you’d rather be doing, then I truly, deeply, genuinely applaud you for making your passion into a profession. I know people like that — heck, my dad is a textbook workaholic type. He dedicates most of his energy to work and he wouldn’t and probably couldn’t have it any other way. He doesn’t really pursue artistic hobbies like painting or music, though he does write, it generally for or about work. He genuinely enjoys the mental stimulation of a career and finds ways to exercise creativity in his role there. Without work he’d feel completely bored out of his wits within three or four days. Guaranteed. But even if that does describe you, let me ask this: would you be even happier if you knew you can make your rent or mortgage payments no matter what happened to you or your job? If you could afford education for your family without strain? That you had the peace of mind that, if you or a loved one developed a health issue or sustained an injury, you could attend to fixing it without the added stress of wondering how you’ll ever pay for it? Perhaps you could make reasonable increases to your quality of life with the money you continue to earn from your salary — you could safely blow every dollar you made after financial independence on extravagant or indulgent spending because you’ve already built a nest egg you can retire on. If any of those reasons resonate with you at all, then perhaps achieving financial independence, or even partial financial independence, is a worthwhile pursuit for you. Because there is nothing wrong with loving your work. You should ideally love many aspects of your work. I don’t think anyone should choose financial independence as a goal for the purpose of vegging out in front of the TV 40 hours a week. Hard work is fulfilling. It can improve individual lives or entire communities. The sense of achievement is valuable and for some may be difficult to find outside of work. And even outside of those more philosophical and psychological benefits to work, there are also literal and direct benefits, such as your benefits! You access health care, often paid for in part or in full. You may have access to an employer 401k, perhaps with a match. But just like there is nothing wrong with loving work or dedicating yourself to your work or building your life around your work, there is also nothing wrong with being prepared and having a plan with your finances so that you can design your present and your future in whatever vision you see fit. The flexibility to follow life’s shifting priorities is an amazing advantage afforded by having some extra money.
Now, some are motivated by financial independence for entirely different reasons. Perhaps you hate your job. You are someone who, if you could avoid ever waking up to an alarm, you would. Maybe you’d like the freedom to take a nap in the middle of the day, or go for a hike with your dogs as your lunch break. Perhaps you haven’t found your career choice to be as fulfilling as you’d hoped, or you’ve tried multiple different career paths already in search of that. I read online all the time that many cite sheer laziness as their motivation to work hard now, to improve their incomes and their savings rates so that they can spend as much of their lives simply relaxing.
Or perhaps you’re somewhere in the middle. You enjoy your job, but sometimes think about other areas you could be using your time. You have multiple hobbies that you’d like to dedicate more time to. Maybe you genuinely love your colleagues and the social aspect of your job and you’re enjoying mental health benefits of achieving at something — but on the other hand you feel like you’re missing out on watching your kids grow up, or you’re not developing or learning other skills due to spending your time at work. All of these three different scenarios can benefit from achieving financial independence, or at the very, very least developing some understanding of what that term even means and the different levels of it, so that at least with some exposure to the idea you can find way to make your relationship with money a healthy one that suits your desired lifestyle.
A few times now I’ve referenced partial financial independence or semi-retirement. What I mean by this is essentially reaching about half of your “FI number” in savings such that your investment income can indefinitely cover half of your living expenses, leaving you responsible to make up the other half. So let’s step back a minute and run a quick, simple-math scenario and go over a few easy rules of thumb on how to get your money to work for you. As a quick disclaimer here, I’ll use some approximations of my own expenses as an example, and they may be very different from some listening. If you’ve gotten this far and all you’re wondering is if this is even possible given your income or your expense level or your debt, I will tell you now the answer is “yes.” Yes to all of the above, and I’ll explain why that’s true in a moment as well. But it’s always important to keep in mind that everybody is being dealt different cards. The very fact that you are listening to the sound of my voice right now tells me you have internet access and a device on which to consume this type of content. That alone is an advantage many do not have. You could take this idea to many, many levels — the point I’m making is, I want you to focus on the PRINCIPLES and CONCEPTS that underlie this math, and figure out how it fits into your life and your situation and assess whether you need to make any changes for financial independence or early retirement, or even retirement at all, is possible. Many, many people get close to retirement age and realize they haven’t saved a single penny — blown every dollar they’ve made. And by that point it may be too late to even enjoy the “standard” retirement at around age 65. Anyway I’m getting on a total tangent here so I’ll step off my soapbox and get back to the point, which is that there are some pretty simple ways to figure out your “FI number.”
The easiest way to know your FI number — the number at which working for money becomes optional to you, assuming you maintain the same lifestyle — is to multiply your annual expenses by 25. This is the same exact math as assuming a 4% safe withdrawal rate from your nest egg each year for expenses. I’ll dive deeper into safe withdrawal rates in another episode of the podcast, but to put it simply this is the amount you can reliably take out of your investment accounts without the total amount of your nest egg shrinking at all year over year. Again, something I’ll deconstruct more thoroughly in another episode.
When you’re trying to calculate your expenses, I highly recommend you take the time to really look closely at the past 2 or 3 months, category by category, in a spreadsheet or on paper, however you prefer. Don’t just guess. I think most people do not correctly estimate monthly and annual expenses. I can tell you from personal experience, I think about this stuff constantly and I’ve still shocked myself with how much more or less I spend in certain categories compared to what I thought. Not two months before the time of this podcast did I really break down my expenses in a spreadsheet to find that I was spending an average of $650 a month on food and beverage. That’s $650 just for myself, when I thought I was spending $400 or less. I immediately cut back and for absolutely no noticeable decrease to my quality of life, I’ve dropped my spending in that category to $200-300 a month. That’s with a trip wine tasting in Napa, and with a weekend lunch or dinner date here and there. So that’s around $400 each month, or $4800 a year that I can dedicate to savings.
I also found that I spent about $300-400 a month on non-vital “fun” things. For me this is generally upgrades to things I already own, like a nicer electric razor, a new pair of shoes, new jeans, new cell phone battery, mostly things that I can easily get by without. I also include some expenses there like weekend travel and entertainment such as concerts and sporting events. I personally get a better morale and happiness boost from entertainment expenses compared to most material expenses. So I forced myself to cut down in that category by about half as well, which I also found easy. It basically came down to just fewer impulse buys on Amazon and things of that nature. I still went out most weekends to enjoy a concert or a trip to the movies, but was able to bring that spending down to about $200 a month without much struggle. So that’s another, say $150 a month $1800 a year to save. I’ll break down more of my monthly expenses in another episode dedicated to the value of understanding and building a budget with some strategies how to go about it, but these two examples are enough to give you a sense of what happened — because I took the hour or two necessary to track my spending in a spreadsheet, I was able to get myself on a track to save an additional $6600 a year without working any harder, without getting a raise, and with maybe a very very marginal decrease to my quality of life. So I highly, highly recommend you figure out your current spending habits before trying to calculate this number.
Now, why does that $6600 a year matter so much? Well, it’s the difference between my annual expenses being $38,600 versus $32,000. That’s all in — Bay Area rent, utilities, paying down a reasonable car, insurance, food, phone bills, the whole shabang. Let’s figure out my FI number in both scenarios. At $38,600 a year, I would need to save $965,000 in order to quit my job and potentially never work for money again. At $32,000 a year, I need to save $800,000 to reach complete financial independence. A $165,000 difference. If I’m saving, say, $20,000 a year, the latter example gets me to a retirement-safe position about 8 years earlier.
There’s one very important thing to recognize, though, which is that the only thing that determines when I reach financial independence, is savings RATE. Not the AMOUNT, the RATE. If you make $50,000 a year take-home pay, and your expenses are $20,000, you’re able to save $30,000, or 60%. That’s your savings RATE. In this scenario, it would take you 16 years and 8 months to retire, assuming a start point of $0 in net worth. So if you graduate from a 4 year school at 22 years old with $50,000 take-home pay, and you never, ever get a raise, and you never increase your lifestyle needs from $20,000 a year, you would be free to retire, if you desired, before your 39th birthday. Again, this is simple math and doesn’t consider super normal life events like home purchase or having a kid or two, and it essentially ignores major benefits of compounding interest during your path, and you may graduate with some debt, and you may not take home 50 grand right out of school, but at the same time you’ll probably get a few raises along the way. Again this is just to illustrate savings math in a really clean way. The point is your savings rate is 60%. If your friend graduates same day as you but earns $100,000 a year take-home pay, and her expenses are $40,000, and she saves the remaining $60,000, then it takes her the exact same amount of time to retire, because she also has a savings RATE of 60%. To support her lifestyle, she needs $1 million saved in investments, and it would take her 16 years and 8 months to achieve that.
Let’s run one more example. You know a guy, say, a wall street investment banker type, or maybe a successful surgeon, who makes $300,000 a year take-home pay. But this guy lives a crazy, high consumption lifestyle. He rents a center-of-downtown condo alone. He drives a Maserati, and buys a new high-performance car every few years, which he stores in a private garage he pays hundreds a month per car to access. He spends thousands a month on food and bottle service and just as much on entertainment, and takes extravagant trips. Now, I know this lifestyle sounds like a good deal of fun to a lot of people, and undeniably it has its perks. But this friend of yours saves $5000 a year and spends the rest. In order for your friend, once he turns 65 years old, to retire, but maintain his outrageous lifestyle, he would need about $7,080,000 saved. At his savings rate of $5000 a year, it would take him a mere 1416 years to retire. Even if he reduced his post-retirement expenses to $100,000 a year but maintained that $5000 a year savings rate, he would need to work for another 457 years before he could comfortably retire. But, let’s say he saves 60%, just like you making $50,000, and just like your friend making $100,000 — this wealthy friend of yours saves $180,000 a year, and lives on $120,000. He needs $3 million to retire. And, saving $180,000 a year, it would take him……….. 16 years and 8 months, to be financially able to leave his job indefinitely. Again, I want to stress that obviously these examples ignore a bunch of factors. Compounding interest is an important one that this math doesn’t account for. But no amount of compounding interest, nor no amount of high earnings, can save you if you’re spending considerably more than you’re saving. Yes, the amount you earn is an important factor in achieving financial independence, early retirement, and certainly in saving for traditional retirement as well. But there is no replacement for SAVING more than you SPEND.
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