Financial independence is actually a journey, not a destination. It took us 10 years to reach Middle class Financial Independence, so it’s important to know the Milestones- where you are, so you can keep motivated and stay on course.
How do we know where we are right now? What are the most common milestones we all cross on this journey, and when do we reach them? To answer these questions, you’ll need to first figure out your Financial Independence Number.
The financial independence number is the amount of money you need to be able to live off the returns on your net worth without depleting your net worth. Once you have money in Investments equivalent to your financial independence number, you can call yourself financially independent.
There are 2 Financial Ingredients involve to calculate your FI Number.
1) How much money will you spend?
Before we dive into the calculations, you need to find out how much money you will spend each month once you reach financial independence. A good starting point is to find out how much how much money you spend per month at the moment. If you don’t have a budget where this is visible, try to give an estimate of how much money you spend every month everything included (e.g. housing, transport, clothes etc.). Multiply your monthly spending by 12 to find out what your required yearly spending is when you become financially independent.
As an example, if you spend roughly $4,000 per month, this makes your yearly spending requirement of $48,000.
2) What is your safe withdrawal rate?
Next up is your safe withdrawal rate. This is used in combination with your yearly spending to calculate your financial independence number.
The safe withdrawal rate is the percentage of your net worth that you can withdraw each year without running out of money.
I personally use a 6% safe withdrawal rate, but others argue that you should be more conservative such as using a 4 % safe withdrawal rate.
Keep in mind that the safe withdrawal rate assumes that you don’t make any additional income apart from investment returns.
Calculating your financial independence number
Using the two financial ingredients from this post, you’ll be able to calculate your financial independence number.
You can calculate your FI number using this equation:
Financial independence number = Yearly spending / Safe withdrawal rate
As an example, financial independence number is:
$800,000 = $48,000 / 6%
Financial independence number is $800,000.
Having a number makes financial independence much more tangible for most people. It is a great motivation to have a clear goal, and track your progress every month.
Milestones of Financial Independence
Now let’s discuss the Milestones of Financial Independence you’ll pass along the way.
Financial Independence exists on a continuum. It’s not “all or nothing”, but an ever-increasing range of option. It’s a process. Each stage of financial freedom allows you greater autonomy and self-expression, and these are qualities that lead to happiness.
Stage 1 – Financial Independence Clock Starts
Your Financial Independence clock starts when you’ve repaid your consumer debt and/or $1 of positive net worth. You may still possess some “good debt” — college loans, a mortgage — but you’ve eliminated all your consumer debt.
Stage 2 – Solid Emergency Fund
Have 3 to 6 months of living expenses in case of emergency. It's usually liquid, either in a checking, savings, or money market account. This is a buffer of savings to protect you from unfortunate events.
Stage 3 - FU Money
This significant milestone on your journey to FI is saving up your FU Money. The specific dollar amount you need will depend on your expenses and risk tolerance. FU Money is the cash you need on hand to feel confident enough to walk away from your employer for a year or two, should the need arise. You'll want to save enough to cover one or two years of your regular expenses. This money doesn’t have to be as liquid as an emergency fund- it can be a percentage of your investment portfolio of stocks, bonds, or real estate. This FU money will travel with you throughout your Journey towards Financial Independence and the Confidence this brings is very liberating and Powerful!
Stage 4 – Half Financial Independence
You save up half your FI number ‘Half FI’ which puts you halfway to FI in total spending. You've actually completed significantly more than half of your journey! Because savings growth isn't linear, the time it takes you to save up this first 50% is noticeably longer than the time it takes you to save the next 50%.
This should give you significant peace of mind, and is the perfect motivation to try new things.
Stage 5 – Lean FI
Lean FI is the point where you can passively cover all your essential expense. Think food, shelter, and bills. This leaves off all the discretionary expenses such as travel, eating out at restaurants, etc. Lean FI number is about 70% of your full FI number. Lean FI is a huge milestone this is the stage where all your essentials are covered.
Around this milestone is the Crossover point where your money… if you think about it is working 24/7 every day to cover all your Essential Living Expenses!
Stage 6 – Flex Financial Independence
The Next Milestones along the way is Flex FI which is 80% of your Full FI number. Flex FI is the point where you can passively cover all your essential and miscellaneous living expenses. Flex FI is only viable for people who can build flexibility into their lives from year to year depending on the market returns, etc. For people with side hustles or a large percentage of discretionary spending in your annual budgets this is points when you’ve reach Flexible Financial Independence.
Stage 7 – Financial Independence
Financial independence is the term that describes “ the state of having sufficient personal wealth to live, without having to work actively for basic necessities. . At this stage, your investment income is sufficient to fund your current standard of living. You have Enough. Financial independence is just another milestone along the way. If you decide to keep working, your dollars are going to keep working too, earning more money faster than you can spend it. But if you decide to quit, your dollars will still keep working so you don’t have to!
When you are Financially Independent you work because you want to, Not because you have to. All the work you do after you reach FI is completely optional. Now you can do what you want with your time. When you reach FI you can pick and choose what you want to do at work and in life. This is so Liberating and empowering!
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