What Does It Mean to Be Financially Independent?
I want you to imagine what your life would be like if you didn’t have to worry about money. Really picture it in your mind. You wake up each morning never wondering how the bills are going to be paid. You no longer work a job because you have to — you do it because it’s something you enjoy. Or, maybe you decide to focus on a new hobby, baking, gardening, or traveling. There are a lot of financial gurus that throw out terms like “financial freedom” and “financial independence”, but don’t take the time to explain what it actually means. To make matters worse, social media is full of influencers (gag) who claim they achieved financial independence and now live on a yacht off the coast of a remote tropical island. Unfortunately, this makes financial independence look like an unobtainable gimmick.
I have great news for you. It’s not a gimmick. In fact, reaching financial independence is very achievable for the average person. But, it’s not going to look the way you see it on social media. You probably aren’t going to pick up the kids from school in a brand new Lamborghini or taking a private jet to France for the weekend. The people who sell financial independence as getting a lot of nice things are completely missing the point. Financial independence is really about gaining control of your life and not living at the whim of other people because you need them for income (like an employer) or because you owe them money (like a bank or credit card company).
Defining Financial Independence
First, I want to clear up the misconceptions about what financial independence is and isn’t. Financial independence isn’t about how much money or stuff you have (not technically). True financial independence is about being self-sufficient. It’s the point where you have enough money saved and invested that the growth can sustain your standard of living. Most people assume that this is only possible if you are wealthy, and you’d be dead wrong. There are thousands of millionaires who aren’t financially independent. At the same time, there are middle class workers who make $30,000 a year and are financially independent. Don’t believe me? Let me explain.
I’m a huge proponent of the FIRE movement — which stands for Financially Independent; Retire Early (more on that in a minute). The general rule of thumb with FIRE is that you should be able to safely withdraw 4% of your savings and investments each year without depleting your life savings. This isn’t just some made up number. There are years and years of research that have gone into establishing this target. In other words, if you annual cost of living is $45,000 a year, you would need about $1,125,000 to maintain your standard of living without having to work. The great thing about a 4% withdraw rate is that it should (theoretically and with a 95% success rate based on historical data) last you indefinitely. How? The model assumes that despite good and bad years in the market, your investments will grow enough to replace the 4% you remove each year. If you’re lucky, it might grow a bit faster than that which would allow your nest egg to continue growing despite taking out money each year.
To calculate your own FIRE number all you have to do is to add up all your living expenses for the year (rent, groceries, car payments, bills, personal expenses, etc.) and take the number times 25. If you’ve never done this before, you might be shocked at how big your fire number actually is. I know I was. Because I live in one of the most expensive areas in the country, my FIRE number was well over $2 million! I know what you’re thinking. I told you that financial independence was achievable for the average person. I’m getting to that — just bear with me and keep reading.
Here’s the thing to understand — Your FIRE number is directly tied to you cost of living, not necessarily how much money you have. For example, a school teacher (let’s call him Joe) might have a nest egg of $500,000, they live in a low cost area where their total cost of living is about $20,000 a year. If they wanted, they could technically pull out 4% of their nest egg to cover their annual expenses. They no longer a required to work (although, they may continue to work because they love what they do). On the other hand, Rich works as an architect for a major firm in San Francisco. He lives in the most expensive area in the city. He drives expensive cars, sends his kids to private school, and enjoys his annual vacation at a 5-star resort in Bali. Despite having a net worth of $3 million, withdrawing 4% each year (or $120,000) isn’t sufficient to maintain his lifestyle. Even though his career is very stressful and he hates his boss, he’s a slave to his job. If he quits, it’s only a matter of time until the bank forecloses on his house and his cars are repossessed. Even with a pile of cash, Rich is nowhere near being financially independent.
Creating a Strategy to Reach Financial Independence
To reach financial independence, there are several things that you need to do. The FIRE movement encourages people to live frugally (aka, keep your FIRE number low), spend less than you make, and invest aggressively. Some claim that FIRE requires saving 60% or more of your income, but I disagree. You can still reach your FIRE number by saving less — it will simply take you longer to get there (and that’s ok). Also, I think there is too much emphasis on the “R” and “E” of FIRE. Sure, being able to retire early would be great, but that’s not interesting to most people. I’m more interested in people have the option to retire if they want, and that requires having enough financial backing to cover your expenses if needed. When you reach that magical point, your life will completely change. You’ll no longer do things because you have to, but because you want to.
Create a Budget — It’s impossible to reach financial independence if you are spending more than you make. If that’s the case, “the math isn’t mathing”, as I like to say. Once you have a budget, you can not only calculate your FIRE number but you can understand how much you can set aside each month and understand how long it will take you to get there.
Set FIRE Goals — I recommend using an online investment calculator to determine how long it will take you to reach your FIRE number (the one on Dave Ramsey’s website is my favorite). Once you have your goal date, is there anything you can do to improve that target?
Focus on Financial Literacy — I can’t understate how important it is to have solid financial literacy. The more you understand concepts like investing, financial concepts, economics, etc., the better chance you have of making smart financial decisions. Trust me, I’ve made my fair share of financial mistakes that have cost me thousands of dollars.
Understand the Various Levels of FIRE — There are actually a few alternative versions of the FIRE methodology — some of which are stepping stones to get to “Regular” FIRE discussed in this article. Understanding the difference between Coast FIRE, Lean FIRE, Barista FIRE, Regular FIRE, and Fat FIRE will completely change your mindset and will help you realize that FIRE can be isn’t a one and done objective.
I’m excited that you’re starting to think about what it will take to remove financial stress and worry from your life. Building a sufficient nest egg to reach financial independence is no easy task. It may take year (or even decades) to finally get there. Don’t buy into the social media gimmicks and numerous gurus out there that claim a quick and easy way to get rich overnight. Simply showing an interest in this topic is a major step toward achieving your goals. Now, it’s up to you to take action.
