The term “financial independence” is always spotted in personal finance blogs and articles but everyone seems to have a different definition or idea of its meaning. To some people, earning enough money to pay bills is what financial independence while to some others it simply means being debt free.
However “Financial Independence,” or “FI” specifically means saving up enough money to support you for the rest of your life. You no longer need to work for a living once you are financially independent but this does not mean that you should stop working. It just means that you don’t have to anymore.
The Financial Independence Formula
Reaching Financial Independence It is quite an ambitious goal to reach financial independence but it is not a complicated or I possible goal. In fact, it simply involves a few calculations to get a rough estimate of how long it would take you to get there, taking into consideration your current income, savings and spending rates.
The Financial Independence Formula has two parts.
Your FI Number – the total amount of money needed to make you financially independent for life is calculated in the first part:
FI Number = Yearly Spending / Safe Withdrawal Rate
Your FI Number - How many years will it take to reach financial independence is calculated on the second part:
Years to FI = (FI Number – Funds Saved) / Yearly Saving
This is a rough estimation to give you a good idea of how far you are from FI. Here are steps you should start taking to reach your Financial Independence faster after getting your rough estimate.
Calculate Your Spending
You need to know the exact amount you are currently spending every year. Take a look at your household budget and multiply your total monthly expenses by 12. Make a budget if you don’t already have one because that is your first step to FI.
After adding multiplying by 12 you will get your first key number - your total spending for a whole year. The lower the amount of your yearly spending, the easier and faster it will be to reach Financial Independence.
Find Your FI Number
You can know your “FI Number” after you know how much income you would need each year to reach it. However, Your FI Number depends on how much you withdraw and your current spending.
Determine Years to Financial Independence
The last part of your Financial Independence Formula is how much money you should save each year in order to reach your FI. You can do this by subtracting your yearly spending from your yearly income.
Now you know how much you are saving and from there you decide if the amount you are saving will get you to financial independence at the rate you want. This is because a low savings rate means
If your FI figure is $800,000, and you’re managing to save $20,000 a yearly, then it’s going to take you 40 years to reach FI.
Saving for Financial Independence
Now you have made all the calculations and you know how long you will reach your Financial Independence at your present spending and saving rates. However, this is not to say that you should settle for that, you can make adjustments by finding ways to either reduce your yearly spending or increase your yearly savings. If you can do both too, that would be perfect.
Experts recommend three strategies in order to achieve better saving goals.
Paying off debts
Maximizing income
Cutting expenses
Paying Off Debts
Paying off your debt helps free up money that you can channel towards savings and investments.
Maximizing Income
You can invest more money if you bring in more income. There are a number of ways you can achieve this including:
Taking extra shifts or working overtime to earn extra money.
You can take a second job if you have enough time from your main job.
Selling your unwanted items and belongings on
Passive income streams like rent from properties, book royalties, revenue from blog or website etc.
Cutting Expenses
Reduce your expenses and get on a budget. You can save a lot by reducing spending in order to save as much as possible; focus on the biggest expenses in your budget, such as the following:
Housing: Find a cheaper, more affordable or smaller home
Transportation: Consider if you really need a car and take advantage of public transport or keep driving your old car.
Food: Try to cook your own meals instead of eating out.
Shopping: Make sure you really need everything you buy and buy only what is on the budget.
Entertainment: You can suspend your vacation or take a cheaper vacation instead of investing small and saving money.
Investing for Financial Independence
You can get to financial independence faster if you invest your savings and earn good returns. However, to be able to earn good returns you have to take some risks with your money. Investing in
On the other hand, you should determine your risk tolerance by considering your options, the period of time you want to invest and how much you want to invest.
Of course, you can set up your own portfolio as well. However, you must be willing to put in the time and effort to do the research and find suitable investments that match your risk tolerance and your long-term goals.
Create a “Lazy” Portfolio
Set up a “lazy” portfolio to hold a collection or array of investment covering a broad range of foreign and local stocks. Create a diversified and long term portfolio.
Make Investments Automatic
You can make automatic investments if you set up your lazy portfolio through an online brokerage. This is because automatic investment plans are offered by most online brokers.
Rebalance Once Per Year
Some funds will grow more than some in your portfolio even though you invested the same sum. You should
Track Your Progress
As your investments grow, you should track the progress of your investments and how far along it has taken you towards your Financial Independence.
Final Word
If you have always wanted to quit your job or start your own business, reaching your FI should give you the freedom and push to do so. Reaching Financial Independence before your retirement age is a great challenge, and while it is possible for some it is not possible for others. However, you should follow these steps to reach it with discipline.
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