Financial Independence

wealth Jul 13, 2020

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People talk a lot about "financial freedom" or "financial independence". But what does it really mean? There are so many different variations of this out there and different people use different terms. We will keep things simple. 

Financial independence means you can live entirely off of your investments. 

Some people utilize stages to describe financial independence. One example is the following:

- This means your investment returns could cover your bare minimum expenses, with no thrills or extras. Few people will quit their job at this stage (unless they have some source of additional income), but it allows you the security of knowing your investments could cover your major bills should you need them to. Some people call this "lean financial independence". 

- At this stage, your investment income is enough to cover your entire lifestyle. This counts your vacation, eating out, buying Christmas gifts, etc. This number is different for everyone, which we will touch on in a moment. 

- At this level, your investment income will cover your entire lifestyle AND leave leftovers for additional investing, charitable giving, or whatever your heart desires. 

Okay fine, but how much do I need?
This answer is different for everyone, and is entirely driven by your annual expenses. If your lifestyle costs $150,000 per year, your number is a lot larger. If your annual expenses are $50,000 because you're debt free and live frugally, your financial independence number is a lot lower. Note, this isn't based upon your INCOME. It is based upon your annual expenses. Especially if you have a high savings rate, these numbers may be quite different. 

There are a lot of factors that go into determining your number, but the easiest way to get a rough estimate is to multiply your annual expenses by 25. This total number would allow you to cover your annual expenses with a 4% withdrawal rate, which is classically considered a safe withdrawal rate in retirement. If you want to retire extremely early (like in your 30s-40s), 4% may be too high of a withdrawal rate. If you have additional income, like rental properties or a pension, your nest egg doesn't need to support your entire annual expenses and can be less. 

Remember, the same annual income won't buy you the same amount of stuff in 20 years that it will today. Don't forget to account for inflation. 

Can you imagine what life would be like if you had complete flexibility to choose how you spent all of your time? What if you didn't have to work for a living, but instead your money worked for you? Be encouraged that this is possible for everyone with consistent savings and wise investing over many years.

If you want to learn more on this topic, check out the books Retire Before Mom and Dad and The Simple Path To Wealth. ​

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