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Are you wondering what it takes to be financially independent? Learning how to FI, or achieve financial independence, takes careful planning and discipline. The good news is, though, achieving FI is easier than you think. I’m showing you how to reach FI, including how to calculate your FI number and how to develop a plan to achieve FI. Let’s get started!
What is Financial Independence?
If you’ve found your way to this article, I am willing to bet you already know what financial independence (or FI) is, but just in case, let’s recap.
While financial independence means different things to different people, we’re talking about having enough money not to work for our purposes. You know, sticking it to the man and quitting your job?
If you’ve reached FI, you should have enough income from your investments (or other passive income), whereby you no longer have to trade your time for money.
There are different definitions of FI, though. For example, lean FI means necessities like housing, transportation, and food are covered. Fat FI is the opposite – it means you have enough to live it up in retirement.
Notably, you’ll hear people say both FI and FIRE. FIRE stands for financial independence retire early. For this article, I will use these terms interchangeably.
You can adapt FI to your specific desires and circumstances, but as a working definition for purposes of today’s article, assume your desire for FI is to have enough where you could quit working and maintain your current lifestyle.
What is A Financial Independence Number?
When learning how to FI (yes, people do use FI as a verb), the first thing you’ll want to know is what is a FI number.
A financial independence number tells you exactly how much you need to have invested to achieve FI safely. Your FI number is how much money you need to retire.
Why does your FI number matter? Because once you achieve it, you can rest easy knowing that you can safely quit working and have enough income to cover your expenses in perpetuity.
I’ll cover how to calculate your FI number in just a minute, but first, we need to talk about an important rule of thumb: the 4% rule.
What is the 4% Rule?
The 4% rule is what is called a safe withdrawal rate. In 1994, researchers performed a study looking at historical market returns. This study determined that withdrawing 4% of your portfolio value each year would allow you to achieve a 30-year retirement. This rule of thumb was further popularized in a 1998 study often known as the Trinity study. The 4% rule states that 4% is the maximum you can withdraw annually from your portfolio without running out of money.
For example, let’s assume your investment portfolio is $1,000,000. The 4% rule states that if you were to withdraw $40,000 per year, ignoring inflation for this example, your portfolio should be sufficient to sustain you through retirement.
Now, the 4% rule comes with many embedded assumptions, so I’ll come back to that in a second. However, understanding the concept of a safe withdrawal rate, and in turn, the 4% rule, is key to understanding the financial independence formula and how to FI.
How to Calculate Your FI Number
Now that you have some background on the 4% rule, let’s talk about the financial independence formula or how much you need to reach financial independence.
Calculating your FI number is easy with the following formula:
Annual Spending / Safe Withdrawal Rate = FI Number
For example, if your annual spending is $50,000 and your safe withdrawal rate is 4%, your FI number would be as follows:
$50,000 / 0.04 = $1,250,000
So, if you have $1,250,000 invested, you will have achieved financial independence!
You can also use the inverse of the safe withdrawal rate (e.g., 1/0.04) to calculate your FI number. In this scenario, you’d take $50,000 * 25 (the inverse of the safe withdrawal rate), and you’d get to the same number.
Now, I want to dig a bit deeper into the three steps of calculating your FI number. Let’s walk through the details of the financial independence formula.
1) Calculate Your Annual Spending
To calculate your FI number, you’ll need to develop an accurate assessment of your annual spending. The best (and only) way to do this is by accurately tracking your spending using a budgeting app.
As you track your spending for purposes of FI, make sure to consider expenses that you don’t currently have but will likely have in retirement. For example, you may have higher healthcare costs in retirement (especially if you’re retiring earlier and no longer covered by an employer plan).
Of course, if you want to get to FI faster, there are only two variables you can change. One of those variables is your spending.
If you can reduce your annual spending, you’ll reach FI sooner. Let’s look at two examples, both of which assume you already have a $1,000,000 investment portfolio, save $30,000 per year, and want a 4% withdrawal rate.
Example A: $50,000 annual spending
$50,000 expenses per year / 0.04 = $1,250,000 FI number($1,250,000 – $1,000,000 already invested) / $30,000 annual savings = 8.3 years to FI
Example B: $45,000 annual spending
$45,000 expenses per year / 0.04 = $1,125,000 FI number($1,125,000 – $1,000,000 already invested) / $30,000 annual savings = 4.2 years to FI
Note the above examples do not account for investment growth, but they give you a good idea.
2) Choose Your Safe Withdrawal Rate: Is 4% the Right Number?
Researchers made simplifying assumptions in crafting the 4% rule. Some of these assumptions may impact whether you view the 4% rule as a safe withdrawal rate.
- 30-Year Horizon
- Implication: If you plan to retire early and have a time horizon longer than 30 years, the 4% rule may be too aggressive. For example, a 50/50 stock/bond portfolio has an 81.9% probability of success with a 30-year horizon but just a 36.0% probability of success with a 50-year horizon according to Vanguard.
- Historical Returns Used for Analysis
- Implication: If you believe future returns of stocks and bonds will be less than they have been historically (which candidly, many people believe), the 4% rule may lead to a shortfall in retirement. Relying on historical returns to predict future retirement probabilities carries risk.
- Withdrawals are Tax-Free
- Implication: The 4% rule assumes all withdrawals are tax-free (e.g., from a Roth IRA or 401(k)). If you owe taxes on your withdrawals (either from a traditional IRA/401(k) or a taxable brokerage account), the 4% rule may leave you with a shortfall.
- 4% Rule Doesn’t Account for Investment Fees
- Implication: Because of the drag of investment fees, the 4% rule is somewhat inadequate, particularly if you invest in higher-fee mutual funds or ETFs. When selecting investments for your portfolio, fees matter.
I would encourage you to read Vanguard’s study to learn more about some of the potential shortfalls of the 4% rule.
For our purposes, we’ll use the 4% rule, but it’s by no means a perfect rule, and something like a 3% rule is certainly worth considering if you want to be more conservative in your analysis of how to FI.
3) Divide Expenses by Safe Withdrawal Rate
Once you’ve calculated your expenses and safe withdrawal rate, all that’s left is to do the math.
Take your estimated annual expenses, divide by your safe withdrawal rate, and you’ll have calculated your FI number!
It’s that easy! This is how much money you need for FI!
Financial Independence Calculator
Many people look for a financial independence calculator to do the math. However, the truth is that you don’t need a FI number calculator because it’s just two numbers and division!
Divide annual spending (which you should know if you’re budgeting) by your withdrawal rate (expressed as a number).
However, if you really want to use a financial independence calculator to calculate your FIRE number, I like the one from Networthify.
So, what’s your FI number?
How Do You Calculate Years to FI?
If you’re in the process of learning how to FI, you probably want to know how many years it will take to achieve FI.
To do this FI number math, simply take your FI number, subtract your current savings/investment portfolio, and divide by your annual savings.
For example, if your FI number is a million dollars and you’ve saved $500,000 so far, you have $500,000 more to go. So, take this $500,000 divided by your annual savings (let’s assume $25,000 for example purposes), and this will tell you how many years you have left to FI (20 years in this example).
Of course, this math is based on your savings rate. Want to cut down the number of years to FI? Increase your savings rate or find ways to lower your FI number (such as by scaling back planned retirement spending).
Notably, this simple “years to FI” calculation does not account for investment returns. If you’re earning money on your investments along the way, compounding can significantly reduce this time. But again, you’re looking for a rule of thumb! So, if you assume no investment earnings, this math will give you a pretty good idea.
Developing a Plan to Achieve Financial Independence
Once you have calculated your FI number, the next step is to create a plan to achieve financial independence. When trying to save for financial independence, three main steps can help you in your journey.
Just remember, there are two parts of the financial independence formula – savings/portfolio value and expenses. These three steps will help you address both.
1) Pay Off Debt
If you want to achieve FIRE, one of the first things to focus on is paying off debt. Why? Because debt is a drag on your cash flow.
A drag on your cash flow = higher expenses = a bigger FI number.
Now, I do believe that there is such a thing as good debt, particularly as it relates to debt used to acquire income-producing assets (like real estate).
I also make an exception for home mortgages because it may not be feasible to pay off your home before retirement if you plan to retire early.
However, you should focus on paying off other types of debt before reaching FI.
The first type of debt you must address is credit card debt. The interest rates are high, causing this debt to eat you alive. If you want to pay off credit card debt, one of the easiest ways is to consolidate your debt at a lower monthly payment. My favorite service for this is called Tally. You can check out my full Tally review to learn more about how the Tally app can help you get your debt under control. Before you seek to consolidate your credit card debt, though, you need to make a plan to avoid credit card debt in the future!
Second, you must pay off your student loans. While I understand why student loans are necessary for many, they are also a cash flow drain for those looking to FIRE. Student loan interest rates vary, but it’s often possible to refinance them at a lower rate. Check out Splash, a service that helps you find the cheapest student loan refinancing solution based on your needs.
2) Reduce Expenses
The inverse of what I said about cash flow drains is also true. Lower expenses = a lower FI number = fewer years to FI.
Some of the budget areas to look for savings are:
- Can you refinance your mortgage?
- Would you consider moving into a less expensive property?
- Is house hacking an option?
- Check out this post about cutting your housing expenses to learn more.
- Can you pay off your car?
- Are you willing to trade in your car for a cheaper one?
- Can your family go from two cars to one?
- Can you scale back eating out by one or two times a month?
- Would you consider eating more meals that are vegetable-based? It sounds crazy, but meat is one of the most expensive things at the grocery store.
- Did you know you’re probably overpaying for cable, internet, and your cell phone? Using a service called Truebill, I have saved thousands with no change in service. Truebill negotiates with your providers to save you money.
- Do you use every streaming service to which you subscribe? If not, consider canceling a service or two to save a few bucks a month.
- Have you considered getting a smart thermostat that adjusts according to your usage patterns? My favorite is the Ecobee, and it’s the one I use in my home.
- Replace your most-used lightbulbs with LEDs. Doing so is good for your wallet and good for the planet.
Lastly, as I said, you need to be budgeting. If you don’t have a budget, you’ll have no clue what you’re spending. Not only is this bad for your wallet, but it makes it next to impossible to calculate your FI number.
There are budgeting apps for every different style of budgeting. Here are some of the most popular:
- Tiller Money
- Best for spreadsheet people
- You Need A Budget (YNAB)
- Best for changing your money habits
- One of the most advanced, customizable budgeting solutions
Truebill is a bill negotiation service that will help negotiate your regular bills, track your subscriptions, and help you save. You only pay when Truebill saves you money, so you have nothing to lose. Check out our review to learn more!
3) Increase Your Income
The last tip for learning how to FI relates to your income.
Remember, the spread between your income and expenses is the amount you can save and invest. Increasing this spread helps you get to FI faster.
Increasing your income can help you get to FI. However, everyone will have different preferences for how to increase their income.
Maybe you can boost your income by focusing on your W-2 job and making a push for that big promotion. There’s nothing wrong with seeking income-boosting opportunities in your day job.
However, the fastest path to boosting income is via side hustles for many people. There are countless side hustles to choose from (many of which I have written about here).
There are no wrong answers here. Just choose something that interests you and get started!
Finally, perhaps you want to pursue passive income to earn more. Passive income comes naturally as you build your investment portfolio. However, by reinvesting passive income into more investments, you’ll continue to build towards FI.
Investing for FI
In learning how to FI, one of the keys is learning how to invest. I have written about this extensively elsewhere, so I won’t delve into detail here, but here are some general tips.
- Invest More
- No matter your investing plan, investing more money (in a diversified, risk-appropriate way) is always a good strategy.
- Use Your Risk Tolerance as a Guide
- Know how much risk you can stomach and invest in a matter consistent with that comfort level.
- Keep it Simple
- A simple portfolio of index funds is all you need to be successful. Making investing complex by trying to pick individual stocks is a losing proposition. It’s far easier to diversify using index funds. You can also diversify across asset classes (for example, investing in real estate using a service like Fundrise).
- Avoid Fees
- Investing fees are one of the biggest drags on your portfolio there is. Even a 1% per year fee can equal 15%+ of your investment returns over the long run.
If you’re wondering where to put your money, chances are you need a brokerage account.
One of my favorites is M1 Finance. They offer commission-free trading, and they even provide robo-advisor-like services (called M1 Pies) to help you invest based on your investing goals. Check out my M1 Finance review to learn more.
There are other options if you want to start smaller. For example, Acorns is an automated investing app that helps you invest your “spare change,” which can add up to significant results over time.
While there are many financial independence strategies, I want to share a few more FI tips before we go.
- Track Your Progress
- Unfortunately, the road to achieving FI is not a short one. One of the best ways to stay motivated is to track your progress. Monitoring your net worth is one of the best ways to measure your progress. Personal Capital is one of my favorite net worth trackers and is the one I use to keep tabs on my progress!
- Make Your Investments Automatic
- The biggest enemy preventing you from achieving FI is you. By making your system automatic, you take yourself out of the equation. In your brokerage account, set up automatic investments, so you’re forced to put a certain amount of money away each month.
- Rebalance Regularly
- Your investment portfolio mix changes over time as certain assets outperform others. One of the best ways to improve your risk-adjusted returns is to rebalance your portfolio regularly. Check out this post on portfolio rebalancing to learn more.
- Get a Better Savings Account
- Unfortunately, cash is a drag on your investment portfolio. It’s not growing. It’s losing value due to inflation. While there are no perfect solutions, there are two I recommend. First, get a better savings account – one that pays more in interest. The CIT Money Market account is my favorite. Second, explore putting some cash reserves in Series I savings bonds. Series I bonds are indexed to inflation, so your money is not losing value in real terms. And the best part is the U.S. Treasury backs them!
Looking for more tips? Check out this post on FIRE movement tips!
Personal Capital is a comprehensive suite of financial tools that helps you track your net worth, make sure you stay on track for retirement, and much more! The best part about Personal Capital is it offers a FREE way to track your investment and cash accounts and plan your financial future! Check out this review to learn more!
How to FI: Summary
Are you able to reach financial independence? Of course, you are! Countless people with both low and high incomes have been able to do so. It just takes a little discipline.
What will financial independence look like for you? It looks different for everyone! Only you can decide what you’re trying to achieve.
While the formula for how to FI is relatively simple, you can (and should) tailor the approach to meet your needs.
However, no matter your specific FI goals, the key is to start taking action! Take one of the below steps today and start building towards FI!