Financial independence: the ability to quit working and maintain the same standard of living that you had while working. Once you are financially independent, you can wake up each and every day and choose how to spend it, without having to answer to anyone.
I ask that you disassociate financial independence from images of massive wealth, Lamborghinis, and mansions. While those are perfectly fine goals to have, this post is solely concerned with getting to the point where you could quit your job and live off of your savings. Financial independence is synonymous with the ability to retire early.
The Financial Independence Equation
Believe it or not, the amount of money that you need to save up in order to be financially independent is quite simple. The equation contains 3 different factors:
- The expected stable rate of return for your portfolio
- your living expenses
- the total amount of savings you will need
The equation can be written out as follows- Living expenses *(100/stable rate of return)= Savings Needed
In my case I am confident that I could live on $20,000 a year. Especially if I didn’t have to commute to work everyday and could even give up my car completely and bike around. I’m not saying that I would ever do that, but the point is that I could. I’ll also be extremely conservative and say that my stable portfolio would only yield 4%.
George’s Financial Independence Equation: $20,000 * (100/4) = $500,000.
More About The Equation
As you may already be thinking, living expenses are really the main driver behind your personal financial independence equation. These living expenses are the same reason that the vast majority of Americans are chained to a desk their entire lives.
The day that society convinces me I need all the latest cars and gadgets, I need to go out to eat at fancy places and buy overpriced drinks, or that I need to pay $20 to go watch a movie is the day that my $20,000 cost of living isn’t good enough and now I need $50,000 a year. This cycle repeats itself not only causing you to feel less and less content at the standard you were perfectly happy living at before, but also causing you to save less and less of the money that you would need to live at a higher standard of living later on.
If you want a $50,000 standard of living, you need $1,250,000 for financial independence. Want $100,000 a year without working? That’ll be $2,500,000.
Conversely, If I could tighten my budget even further to living expenses of $15,000 a year (which plenty of people can live on by the way) I would only need to save $375,000 to reach financial independence.
Make Financial Independence Your First Big Financial Goal
While i’m not telling you to stop working I think everyone agrees that knowing you could is an accomplishment all on its own. Not only will it fill you with a sense of pride, but it should also create a sense of safety. Knowing that you could be laid off and still live at a comfortable level allows you to stress less and focus more. You may also feel empowered to take risks with any money that you earn beyond your financial independence goal. After all you have already saved all you need to be happy at that point.
While it may be an extreme example, Elon Musk lived on a food budget of $1 a day when he was a teenager to prove to himself that he could truly dedicate himself to his entrepreneurship ventures and not worry about his ability to get by if he went bust. This was basically him setting his standards for financial independence so low that he felt he already had it. Read more about that here.
What are you waiting for? You’ve got work to do.
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