When Am I Financially Independent?
This is Part 3 in the series. Check out Part 1 and Part 2 first!
Does this all sound intriguing but overwhelming? Perhaps you feel you haven’t set up your life to now embark on this journey. Let’s take a quick look at defining financial independence and a few first steps to get you on your way. Most important of all, let’s highlight the shockingly abbreviated timeframe for putting away serious amounts of money.
The 4% Rule
The very general rule of thumb in the FIRE community states that I have reached financial independence when my liquid net worth is 25 times annual expenses, or put another way, when I can withdraw no more than 4% of my investments to fund my yearly expenses, supported by the Trinity Study.
For example, If my yearly expenses total $40,000, I can theoretically never make another dollar in my life if I have $1,000,000 in liquid assets, with at least 50% of those assets in stocks. The CC Family prefers not to include home equity or any other non-liquid assets in our net worth calculations, because frankly, we are relatively conservative and wish to only include readily available assets.
It thus becomes quickly apparent the importance of understanding where my money is going in any given year. If we can accomplish any single change in behavior of our readers, it would be to simply track one’s spending. The CC Family (and as individuals before Joining Hands in Holy Matrimony) has maintained a simple yearly budget and spending tracking spreadsheet since 2007. If your experience is anything like ours before creating those early budgets, you might need to check your pants after tracking spending for a month or more.
Expense Tracking and Budgets
Daammnn B! I eat A LOT!
Have you ever tracked calories? I’m mildly ashamed to admit I have on several occasions (strength-to-weight ratio, bro). Nothing makes me sadder to see that big number at the end of the day, especially when I thought I was doing so well. Budgeting is basically the same. It’s surely impossible to have even a remote grasp on where money is spent and on what until you track…Every. Single. Dollar.
After years of tracking our monthly spending, guided by a January budget, we are dialed in as tight as my hip flexors on how much we expect to spend in any given year, probably within a couple thousand bucks. That knowledge makes predicting future expenses easier and less worrisome.
We’ve tracked our spending in a simple Excel spreadsheet for years, but there are great online alternatives, including Mint or Personal Capital, fan favorites in the FI community. Mrs. CC’s unwavering distrust of the internet and stored passwords to financial institutions keeps us relegated to a spreadsheet. But it works for us. More on tracking your spending can be found here.
Future Spending
“Sure Mr. CC, you might spend $X today, but you’re going to be totally hosed when inflation sneaks up on ya buddy!”
Thanks for your constructive comment future reader, and you bring up a great point! Yes, our spending will certainly rise with inflation over the years (that couch will be more expensive next year in case you’re wondering). But the beauty of the 4% Rule is that it already captures the inevitable fact that more funds will be required tomorrow to provide for the life you live today. Let’s break it down in simple terms, shall we?
4% Rule = 7% (assumed average yearly market returns, long-term) – 4% (Upper limit on what you can spend of your investment portfolio each year) – 3% (average yearly inflation, long-term).
Risk
With all that being said, will the CC Family hit a 25X target, hand a two-week notice across the table and stamp it in for the rest of our lives, running through streams and frolicking in meadows until our days on this earth wind to an end?
There’s no way in hell, despite numerous simulations of all kinds of horrible past market conditions, that we would truly retire in our mid-30’s and never make another dime. We just won’t. We strive for purpose, and without the contrast of “work” (as we define it), fun doesn’t quite have the same appeal. The beauty of this approach is that by being “fully funded” on the front end, there exists a massive security net allowing for the pursuit of whatever it is that tickles the loins.
Any income whatsoever, however modest, allows for less withdrawal on the principal investments, reducing Sequence of Return Risk and thereby providing a further cushion for this sort of lifestyle.
Do you think we would also be so brainless to travel the globe and spend frivolously when the market is tanking 2008-style? No, we would not, but the Trinity Study assumes we would. Any rational human being would naturally cut their expenses in times of a depressed market, and we like to think we fall in the rational camp.
Maybe early retirement is not for you (is it even for us?). Perhaps you might consider a Fully Funded Lifestyle Change instead. With this outlook, you can operate from a very strong financial position, allowing for jobs or geographic locations much more suitable for you and your family.
Timeframe
How long does it take to become financially independent?
That question completely depends on your personal situation (i.e. are you starting in debt, at $0 net worth, positive net worth?). The biggest factor to consider is savings rate. Any financial advisor will first inquire of your income, because of course they are assuming your life is set around spending most of what you bring in. But in spending far less, you put the ball in your court and can drastically reduce time spent in the rat race.
While we have chosen to construct our lives around a relatively frugal existence to expedite our timeframe to financial independence and jive with our core values, you, dear reader, may steadfastly refuse to give up the morning Starbucks, the new Ann Taylor Fall arrivals, or a childhood love of fast cars. You’ll get nothing but two thumbs (and one paw) up from the CC Family on what brings value in your life.
Please understand, however, that by choosing to pursue this grand adventure, there’s going to need to be optimization somewhere. For those loving the finer things, there is still a path towards financial independence. That path, however, almost always requires either a much higher income or a longer timeframe towards financial independence, coincident with a lower savings rate. If the savings rate is too low, well, we’re basically talking about traditional retirement at that point. Another alternative path to FI might also include some other steady stream of passive income, such as real estate investment.
Our Timeline
To talk (write?) specifically about us, we chose to follow the more traditional path towards FI, which combines relative frugal living with high rates of savings. As discussed in the About US page, our tendency towards simple living “accidentally” netted a decent starting point in terms of net worth (~20% FI). From there, aggressive savings and investing has brought us to approximately “85% FI” at the time of writing. With an average savings rate of approximately 70%, we have socked away most of our ultimate target value in less than three years, admittedly riding a bitchin’ post-recession bull market wave.
Hence, a path towards financial independence is rooted not in income, but in the savings rate. It wouldn’t be fair to ignore that higher income earners have the clear advantage in terms of timeframe and can perhaps afford a less frugal lifestyle. However, anyone dedicated towards increasing their savings rate and investing in broad-based and low-cost index funds will almost certainly find themselves in a very strong financial position.
So how long for you? Without listing pages of assumptions, I’ll go out on a limb and say you could be FI in 10 years or less. If you can crush the savings and investing game and ride a good market, perhaps much less.
What small step will you take today to live the life you want?