Since discovering the financial independence or FI movement, have you asked yourself how much you will need to reach financial independence? In this post, I’ll explain how to calculate your FI number.
I first learned about the financial independence/retire early or FIRE community back in 2015. But it wasn’t until 2016 that I revisited the concept and began to take action. I wanted to understand how people in their 30s and 40s were actually retiring. I read a plethora of news articles and blog posts about people who left the traditional workforce to pursue a passion project, work part-time, or left the workforce completely. Along with reading online stories, I incorporated watching YouTube videos, listening to podcasts, and reading books about financial independence. I wanted to know more about the FIRE journey. But first, I needed to know if it was possible for me. What is my financial independence number?
The concept of financial independence had never occurred to me. Although it was amazing to learn there were 20-year-olds saving and investing enough to reach financial independence before they reached 40, I didn’t understand how it was possible. How were they accomplishing early retirement? How much did you have to earn to be financially free?
Were they all six-figure earners? No.
Did they live off ramen noodles? No.
Had they received some sort of windfall, like an inheritance? No.
Then what did they do? Every person’s journey to reaching financial independence is different. Some get there in 10 years or less. While for others, the journey is twice as long.
As I discovered the world of financial freedom, I realized that it was possible to leave the workforce much younger than 65. Retiring at 50 and 45 didn’t seem like such an unreasonable idea anymore. Reaching financial independence required that we decrease expenses, invest more, and earn more. Our financial lives had to change. It was time to take control of our finances and change our money story.
Before you can calculate your FI number, here are some things to consider:
I had been using the same Excel budget template since college so it was easy to see where we had been spending our money. Our income was high enough that even after our living expenses were paid, we had money leftover. Most of our disposable income was going towards eating out, clothing, shoes, parking tickets, and entertainment which included things like sporting events, concerts, and movies.
The parking tickets were a “stupid tax.” You know, the tax you pay for stupidly thinking you’ll find a non-metered parking spot downtown! ?♀️
Simply put, calculate your yearly expenses and multiply by 25 or if you want to be a little more conservative multiply by 33. If your yearly expenses are $40,000 a year, then you’ll need $1 million dollars. This is how to calculate your FI number:
Do not use your gross income! If you are in the 25% tax bracket and you make $100,000 you are not bringing home 100k, you’re bringing home $75,000. Out of that 75k, how much of this amount goes to paying off debt including student loans, credit card payments, and interest fees? The more expenses you have, the larger the amount of money you’ll need to reach financial independence.
The money you need to reach financial independence is determined by your expenses. This is why I emphasize reducing your expenses. Let’s not forget, reducing expenses is just one factor. Increasing your income is the other.
Some on the FIRE journey will live extremely frugally sacrificing their quality of life. While others, begin freelancing or start new side hustles. None of this was of interest to me as a long term plan. I didn’t mind sacrificing for a few months to reach a specific goal but I didn’t want to live a life of deprivation in order to reach financial independence.
Include anything you think is worth working for! Do you want to budget $500 a month for sporting events, entertainment, and eating out? Then do it! Want to keep that pricey and well-used gym membership, then go for it. Just know the true cost of that expense.
Here’s an example, a $125 monthly cable bill costs $3,125 a year. If you wanted to include this in your estimated expenses for FI, you would multiply $3,125 x 25. To afford the $125 cable bill, you would need to accumulate or allot $78,125. (Please note, this amount doesn’t include increases in prices for cable or satellite television over the long term.)
You can use this budget template to determine your expenses. Once you know your expenses, you can determine if there are expenses you can cut comfortably and eliminate. Are there leaks in your budget? Does the template say you should have $200 leftover every month but you never do? That’s a leak.
Living paycheck to paycheck won’t get you on the road to financial independence. There has to be a gap between the income you earn and your expenses. The gap between those two numbers is the money you will use to save and invest.
If your after-tax income is $5,000 a month and your expenses are $3,000, that $2,000 difference, or that gap, is what you would invest. The higher your income and the lower your expenses the more you have to save and invest.
Simple but not always easy, there are three ways to increase the gap.
Get rid of all high-interest rate debt. This means personal loans, credit cards, store cards, and any debt, particularly any debt higher than 6%. The interest you accrue monthly is an expense. We learned in tip #1 that decreasing expenses and increasing the income is what will get you where you need to go.
Paying off our student loans, credit card bills and car note made room in our budget to put those additional funds toward increasing the money we save and invested each month.
Focusing on high-interest debt is the priority but getting rid of any debt that is not earning you money is just as important. It doesn’t matter that your student loan interest rate is 4%, paying off that debt will be an instant return on your hard-earned dollars.
What is a savings rate? Your savings rate is the amount you save in relation to your income. I do not include short-term savings goal amounts, i.e., vacation funds, emergency funds, or holiday expenses. This can also be referred to as “sinking funds.” The amount saved is the amount solely going toward retirement or financial independence goals. If your pay is $3,000 and you save $150, that is a 5% savings rate.
When I began reading about savings rate, I was proud that I was contributing 12% of my salary to my employer-sponsored retirement account. At the start of my journey, I was a federal employee and had access to the Thrift Savings Plan. My employer contributed 5% to my retirement account. A whopping 17% was going into my retirement account. WooHoo!
I realized that contributing 12% would mean that I would have to save and invest for 40-plus years. If you start your career at 25 and contribute 12% of your salary every year into a retirement account, you could likely retire at 65. How does this sound to you? For some, this may be a realistic and satisfying plan. For me, I wanted to know if I could reduce my retirement age by a decade or more.
The truth was if I made adjustments to my weekly and monthly spending, I could contribute additional money to my retirement accounts and work towards having additional investment accounts.
Once you have a) increased the gap between your income and expenses, b) reduced your debt, and c) calculated your current savings rate, it’s time to invest.
Once you have extra cash in your budget, it’s time to invest. Simply putting money into your savings account will not give you the boost you need to grow your money. Saving money is no longer enough, you must invest.
Investing is key to getting your money working for you. I previously wrote about the magic of compound interest. Compound interest and growth in the stock market is the vehicle that will give you the boost you need on your journey to financial independence.
We are fortunate to have good retirement plans. For 2019, the IRS contribution limit into 401K, 403Bs, Thrift Savings Plans (TSP) and 457 (deferred compensation plans) for those under 50, is $19,500 per person. ($750 per bi-weekly paycheck for me.) If you have no idea what any of these plans are, schedule some time with your human resource department and ask for information regarding your company’s retirement options. Not all businesses offer retirement plans. Make sure to be familiar with the ones available to you. You must be proactive in getting information about your money. No one will care about your finances more than you do.
The Thrift Savings Plan (TSP) most 403B and 401K have investment fund options. A few key things to look at is the historical rate of returns and expense ratios. I like index funds or mutual funds that track the S&P500 or the total stock market. Rather than choose tech, communication, energy, or any specific sector, I prefer to track the top 500 companies or the stock market as a whole.
Picking individual stocks (companies) is the only thing I was aware of when I thought about investing. Trying to decipher which companies and sectors would have the best gains over the long-term seemed daunting. Will a company that exists today still exist and be profitable 10 years from now? What about 30 years from now? What exactly was I looking for when I looked at the annual reports?
Today, I prefer a simpler approach and invest in index funds. Rather than investing in a handful of companies, we invest in index funds that follow the performance of the stock market as a whole or of the top 500 companies. (VTSAX, VTI, VOO are a couple of the Vanguards I like the most.)
We choose to invest first in retirement accounts because there are tax advantages when you make contributions. After we contribute the maximum amount to our tax-advantaged retirement accounts, we invest in taxable brokerage accounts. I prefer to keep it simple and invest in index funds even in the taxable brokerage accounts. Mr. Miller prefers active investing and purchases individual stocks. I have a few companies in my investment portfolio but prefer to keep it simple.
Few people talk about the advantages of reducing your income tax burden by contributing to retirement plans like 401k, 403b, and the TSP. Justin at Root of Good, Go Curry Cracker and the MadFientist are some of my go-to resources when thinking about tax optimization strategies.
There are many ways to begin investing but my preferred investment vehicle is through tax-advantaged accounts. Your employer-sponsored accounts, like those listed above, are examples of tax-advantaged accounts.
The amount of money you contribute to your tax-advantaged retirement accounts shielded from being taxed. If you contribute $5,000 a year and earn $55,000 a year, your taxable income is only $50,000.
Calculating your FI number is just a start. Personal finance is more than spreadsheets and calculations it’s a mindset. Before you start your journey, think about your why of FI? Calculate your FI number but be sure to write down your dreams and goals.
Your financial independence goal should reflect what you value most. For some, FI looks like financial peace, others want to leave a financial legacy and create generational wealth.
As for me, financial independence isn’t luxury cars, a mansion, or any other item. What financial independence looks like to me is having options. Options to decide what to do with my time, energy, and money. It’s being able to pay for college and minimize or eliminate college debt for my family, it’s giving the next generation the opportunity to build businesses, own houses, and have meaningful work in the career fields they want without consideration of the pay.
Personal finance is personal. Your spending should reflect the things that are most important. I challenged myself and now I challenge you to be creative about acquiring things. Be intentional about what you spend money on. Spend money on the things that you value the most.
Get creative about finding affordable substitutes for those things or services you enjoy. Ask yourself if there are items you’ve purchased in the past year that didn’t add value to your life.
What are some things you’ve cut out of your budget in order to free up additional money to reach your FI goal? What does financial independence look like to you?
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