This episode is Part 2 of the Financial Independence Series on the Millennial Life Admin podcast. To catch part 1, click here. These are the show notes for Episode 19 – for the full details about this topic – subscribe to the Millennial Life Admin Podcast.
Today we are going to be continuing down the path to financial independence with the 2nd part of this series. If you missed it, make sure you read Part 1 first where I talk all about what is financial independence, how to determine if it’s right for you, and why you should consider working towards financial independence even if you don’t ever reach it.
However, today we are going to be covering the numbers behind Financial Independence – how you calculate your financial independence number and the formula you need to follow to achieve it – let’s get started!
1. How To Calculate Your Financial Independence Number
Although Financial Independence seems like a daunting goal, how you calculate it is actually pretty simple.
The first thing you need to do to calculate your financial independence number is to understand your expenses. How much money does it take you to live? And how much money will you want to live on? I don’t think achieving Financial Independence should just sustain your life, with more free time, you might want to travel, pursue other hobbies (that may cost money – I’m a scuba diver!), etc.
Once you have that number, you divide it by 4%. This will give you a number to pursue: for example if your yearly expenses are $40,000, you divide it by 4% (0.04%), then your FI number is $1,000,0000. This will vary greatly depending on your lifestyle
4% is the standard rate most personal finance experts will tell you that is safe to withdraw from your investments and I agree. The stock market return is on average 7% but that can vary greatly so I think 4% is a fair and conservative number.
2. Determine The Number You Need To Invest Every Year
After you know you’re number, you need to evaluate what age you would like to achieve FI. For example, if you want to be FI in 15 years, you need to be looking at putting on average 67k for your FI goal. Of course, it doesn’t have to be super linear (you don’t need exactly 67k every year, you could put away more one year than the other, but you get the idea).
When you are determining the year you are looking to achieve financial independence, take an assessment of your current assets and factor in the number of investments you need to add.
So how do you get there?
3. The Financial Independence Formula: Maximize Income, Reduce Expenses, and Control Lifestyle Inflation For Investing
The financial independence formula is to essentially to maximize your income and reduce your expenses.
The goal to achieve financial independence is not to just have $1,000,000 sitting in a bank collecting interest that will barely keep up with inflation, it’s to have that money invested for withdrawal.
And the earlier you invest, the more time it will have to grow. So the first part of FI is to maximize your current income to invest/save the difference. We will cover this in more detail in the 3rd and final part of this series.
Let’s focus on maximizing your income first.
The easiest and quickest way to achieve financial independence is to ensure you maximize you’re earning potential in your current role. Trying to ma 10K is “side hustle” money and can come with a lot of work upfront. However, if you can negotiate a 10K raise in your current role, or work in another job that allows you to have a higher salary than you are essentially saving the same time for money.
I personally think it’s easier to first ensure that you are making the maximum salary you can in your current position than to focus so heavily on starting a side hustle, business, etc that can take a long time and investment to get started.
Make sure you making the most of your current salary and looking at other options such as side hustles and side businesses (we will covering more of that in Part 3!).
After that, look into reducing your expenses. However, I’m not a fan of living on “beans and rice” and cutting absolutely everything. I do highly believe that you should live within your means, but also within reason. You need to create a realistic budget when pursuing FI because again, this will take a few years to achieve.
Cut out the expenses that don’t bring meaning or joy in your life by budgeting and tracking your expenses.
Control Lifestyle Inflation
After you maximize your salary and reduce your expenses, the next part you really need to be aware of is controlling lifestyle inflation.
Remember, you are increasing your salary and reducing our expenses so you can use the difference to invest in streams of passive income.
This does not work if you spend the extra money. So as you are pursuing FI, you constantly have to have your lifestyle inflation in check. It can be so easy to get caught up in the “I deserve this mindset” and that’s what FI is difficult, it takes discipline, but it’s possible.
- Track your spending habits to examine patterns and compare your spending over time.
- Be clear with your budget and surround yourself with people that share and respect your spending habits.
- Ask yourself if it is a need or a want. Determine what basic needs you require in each purchase and what features you want (but
Financial Independence can be a daunting goal which is why I’m breaking it down piece by piece. In the next part of this series, we’ll be covering that money-making component – what you need to know about side hustles/businesses and the options of how to create a financial independence plan.
Talk to you then!