Everything You (N)ever Wanted To Know About Financial Independence
Last week, I was delighted when my sister came to town for a conference. We had breakfast one morning and started talking about personal finance. But something you need to know about my sister is that she is not on the financial independence bandwagon. Despite our best efforts at converting each other to our ways of thinking, neither my sister nor I have persuaded the other to live differently. I call her spendy while she calls me a tightwad. Stubbornness appears to be a trait we share.
However, I realized as we were talking that I’d done a sub-par job of explaining the whole concept of financial independence in writing. I’d talked her ear off for ages, but without some quality reference material, how could I expect her (or anybody) to see the light? The only other post I’d written that begins to explain FI is here, but I figured it’s time for an in-depth post for old and new readers alike.
Without further ado, everything you need to know about Financial Independence in one post:
What Is Financial Independence?
FI means “never again needing to work for money.” This definition is important because it distinguishes FI from two other concepts.
First, FI is different from financial self-sufficiency. Financial self-sufficiency is where you get that first job after college and now mom and dad no longer pay your phone bill or your rent. Sure, financial self-sufficiency means independence from the parents, but not independence from the daily 9 to 5. If you lost your job, how many weeks could you survive? If the answer is less than infinity (give or take a week or two), you’re probably not FI.
Second, FI is different from retirement. Most people who are retired have reached FI. But retirement means you’re no longer working (at least in America). Americans are a judgy bunch of folks, and we have very strict rules for retirement — you can (1) drink Tiki drinks on the beach, or (2) take care of your grandchildren. You must be very old. If you decide to take a new job you think you’ll enjoy, people call that “coming out of retirement” as if any form of work and retirement are mutually exclusive. So think of FI as “retirement without all the bullshit baggage.”
Remember FI means “never again needing to work for money” — you can work for money if you’d like. Or not. You can work for other reasons, or not work at all. FI has no age requirement (although you’d be hard-pressed to achieve it before age 28 or 29 unless you’re a celebrity or an adept hunter/gatherer).
Why Would I Want To Achieve Financial Independence?
Have you ever complained about your boss or your job? Are there things you want to do in life that you’re currently putting on hold because of a lack of time, energy, or money? If you’re like 99% of people, the answer is yes. FI is basically the ultimate insurance policy. At the point you stop loving your job, you can quit without any repercussions whatsoever. At the point you feel like you’re not growing enough at work, or you need to spend more time at home, you can adjust your schedule easily to accommodate your needs.
The whole idea is that FI gives you the ability to decide what’s right for you without factoring money into your decision making process. I’ve had clients and friends who want to take year-long vacations but won’t quit their jobs (even if they saved up enough for the trip) for fear about what they’d do when they get back. Or folks whose relatives become sick, and they kick themselves for not being able to drop everything to be with them.
I’ve been hard-pressed to find someone who writes out “not working more” alongside “not spending enough time with family” or “not seeing the world” on their regrets list. Some people are overworked and some aren’t. Some love their jobs while others don’t. But pretty much everyone agrees that money (the reason many of us work) is not a more important value than family or happiness. And yet we often feel forced to make decisions that place money ahead of our other values.
All this is to say that FI is not a moment in time when you can say “yay, I don’t have to work anymore!” but rather a lifestyle choice, where one factor, money, no longer has control over your every impulse and thought. FI isn’t about money, it’s primarily about time and happiness. Being FI means choosing to do something (or to not do something) because it brings you joy, not because it’s necessary to keep the money train coming.
How Do I Achieve Financial Independence (In Theory)?
Step 1: Read this post to learn about the differences in earned income and passive income and how to convert the former into the latter.
Step 2: Put your money in a variety of well diversified tax-advantaged and taxable accounts based on your age, risk tolerance, income level, and life goals.
Step 3: Once you have enough money in those accounts, begin a sensible drawdown strategy that allows you to only live off the gains your investments produce without touching the principal. Then the account will exist in perpetuity and provide you with all the money you need.
How Do I Achieve Financial Independence (Practical Example)?
Let’s say Susan and Jake, a happily married couple, make $50K per year each ($100K combined) and are both 25 years old right now. If they have average monthly expenses of $2K per month because they live frugally, that’s $24K per year in expenses. We’ll say $25K to give them some wiggle room. And before you attack these numbers as unreasonable, this fake example closely mimics some real life people I’ve helped advise, with only a few adjustments to make the math easier.
$100K – $25K = $75K left to invest. So they invest $75K per year at long term historical market rates of 10% (remember this is an average, they’ll probably get very different returns on a year by year basis). If inflation is 2.8% per year, they are getting average returns of 7.2% per year, meaning their money will double in approximately 10 years. So the first $75K will be $150K by the time they turn 35. But remember they are putting money in every year, not just the first year. Using a financial formula to figure out investment returns, it looks like they’ll have approximately $1,068,750 after only 10 years of work.
Now let’s use the 4% rule. Mind you, this is just a rule of thumb, not something set in stone, but it can be a good place to start when calculating how much of your investments you can spend. The idea is that by spending less than 4% of your investments every year, the principal will continue to grow while you’ll only be spending the investment gains and interest, making the account last forever!
So…4% x $1,068,750 = $42,750. That’s how much they can spend each year without going bankrupt (and this number will increase with inflation). It’s good to note that inflation also increased their total spending too from $25K to $33,597 (10 years of inflation at 3%). However, since $42,750 is higher than $33,597, Susan and Jake are officially Financially Independent! And they’re 35! Now they no longer have to work for money if they don’t want to do so.
If the math of compound inflation and interest trips you up, don’t worry about it. The idea is that by saving a significant chunk of change and investing that money well, Susan and Jake became financially independent way, way before what most people would think of as “retirement age.” When applying these concepts to your life, it doesn’t matter if you make less or spend more. Investing and living within your means are key, and whether you reach FI at 35 or 45 or 55, the point is that you can do it much earlier than common wisdom dictates (and without government assistance like social security).
What Does The Journey To Financial Independence Look Like?
All of the above theory holds true. You’ll need your passive income to outstrip your spending by a healthy margin, and you’ll still need to adjust your lifestyle up and down with extreme market events if you haven’t laddered your investments properly (laddering is an advanced technique for the soon-to-be FI which I won’t discuss here). But there’s more than the dollars and cents calculations to make FI a reality.
Most importantly, to live a happy FI life, you have to be immune to peer pressure. On your journey to FI, people will tell you it isn’t possible. Once you’ve achieved FI, they’ll say you’re a freak and your results can’t be reproduced. FI doesn’t fit in well with mainstream financial advice or the way most Americans live their lives. I often joke that I sell a product people need rather than one people want, which is a very difficult business to be in.
Nobody wants to hear that you’ve achieved something they don’t understand. Nobody wants to hear that you get to do all of the things they can’t because you made better choices than they did earlier in life. This is easily the most difficult part of FI. Explaining your choices, your lifestyle, and your preferences to people who either don’t understand or actively disagree with you will become exhausting. Many people who strive toward FI learn not to talk about it very quickly.
FI will become the trait that many of the people that know you ascribe to you. You’re no longer the funny guy or talented athlete – you’re the guy who’s trying to retire by 35. It will become your identity in many people’s minds because it is considerably more unique than anything they are doing and is easy to speculate wildly about at parties. This will be worst during the first year of trying to achieve FI, when you have determination and the will to learn more, but little money to show for your efforts.
And in exchange for the immediate social toll and the self-doubt (yes, you will doubt that it’s even possible over and over again), you’ll be rewarded with riches untold. You’ll have a unique challenge to accomplish that none of your friends can compete with. You’ll have dozens of new communities to choose from. And more. And more. And you get the point. You’ll get to wake up every morning and do what you want to do. If you’ve got a significant other, you’ll get to share in this amazing journey with them (and quickly learn if they’re FI material or not). You will literally, by definition, have more money than you can spend.
You’ll gain a new perspective of the world. Very few people in the history of humanity could have achieved FI – for ages there were no financial markets, no way for the average man to accumulate wealth, and no guarantee that wealth wouldn’t be seized by corrupt rulers. Today, those barbaric, pre-market economy conditions still exist in many parts of the world. Many people are no closer to achieving FI than they were in the 1600s. More disturbing still is the speed with which citizens of wealthy countries, the only people who have a chance of accumulating wealth beyond what they need to sustain themselves, complain about their lives while shoveling money out of their bank accounts on frivolities.
You’ll gain patience and discipline. I firmly believe it is difficult to achieve FI if you don’t really want to do it. Even the most fervent disciples of FI make regretful purchases and learn to be patient with themselves and to acquire the discipline and introspection to learn from their mistakes. On the same note, you’ll get a constant feedback loop. Every month your war chest will slowly increase, and you’ll recalculate the years until you have enough money to permanently say “Fuck You” to any boss at any time for any reason.
You’ll gain power over people who traditionally have power over you. You’ll be more effective at negotiating with your employer, lender, or landlord. Your ideas, requests, and threats will be taken more seriously because you’ll have the time, energy, and resources to deliver on all three. You’ll become a better employee, refusing projects that don’t add value to the company (or your skill set), while selecting opportunities that do. You’ll become an essentialist, and you’ll get that book from the library and read it, because you’ll have the time to do so.
You’ll build deeper friendships because you’ll have the time to give to the people who matter most. You’ll be a better lover because you’ll have energy to devote to your partner. You’ll become a better person, giving more than your money to charities and nonprofits of your choosing. You’ll gain new skills, or at the very least get stupid good at Super Smash Bros and Settlers of Catan.
Hopefully this rather lengthy post has answered any outstanding questions you had on the subject and given you a greater insight into why I founded Monte Largo Financial. I’m damn passionate about this stuff, and I’m acutely aware of the struggles and joys that my clients face because I face them too. Becoming Financially Independent is a scary, exciting, and rewarding way of life.
Nathan is the Chief Financial Advisor at Monte Largo Financial and is not yet very good at Settlers of Catan. You can reach him at firstname.lastname@example.org.