Financial independence is the state of being free to live your life the way you want, without having to worry about money.
Imagine having all the time in the world to pursue your passion, do whatever you want, meet friends and family while having a steady income flow coming in each month.
You don’t have to work for this income. If you enjoy work, you can do so occasionally or even full time and earn some additional $$. All your lifestyle expenses are covered because your past-self has worked hard for it already. You know… just like retired, only 30 years younger.
That sounds like the ultimate dream to many of us, and it is indeed. But having read many books and met people who have achieved this, we’re on to something here.
Many years ago, financial independence was nearly impossible. It was only a privilege of the rich. You would usually work for 40 years until the age of 65-68 and then live comfortably thanks to your accumulated savings. The single company you worked most of your career for would take care of paying you a pension for the rest of your life.
In our times, things have changed. It’s not unusual for someone to earn income from multiple sources. There are a million different ways to make money. I know people who have a part-time job, rent out a small property, sell their expertise doing online courses, rent their parking space, and sell stuff on Amazon made in China. And that’s just a few options.
We live in the Information age where there are plenty of remote options thanks to this big big network called the Internet. Not because the Internet is a money machine (can be..), but because we can educate ourselves for free, anytime, forever.
This allows us to smoothly transition into retirement rather than cutting off a single job and switch gears immediately. As you would expect, having multiple income sources doesn’t mean we are getting richer compared to previous decades. It means we have the flexibility of earning more or earning less.
You still need to save, invest and plan for early retirement.
When can I retire?
There is only one number that matters to becoming financially independent:
Your savings rate.
Really, simply that. Not your return on investment, and not how much more you can make. Of course, making more helps to save more (and increase your savings rate).
Your expected retirement age depends entirely on the percentage of the income you can live off of.
Are you a family of 4 with two working parents, monthly expenses of 2,500 and a household net income of 45k? Congratulations! You are 25 years away from retirement.
Play with the numbers and this amazing calculator and find out what works for you.
The amount you will have saved in those 25.2 years is enough to keep you and your family going assuming your expenses will increase with inflation. (See end of the post for why the 4% withdrawal rule makes sure you’ll never run out of money).
There’s no magic here. Monthly expenses of 2,500, one parent earning 40k annual salary, and another on 20k gives us an annual household income of 45k after tax. That’s typical here in London. Obviously, London wages are higher but so are the expenses.
What happens if the household net income is slightly higher, let’s say 60k? 16.6 years to retirement. 70k? 13 years!
So if a couple starts working when they’re 23 years old and they make a 60k gross average income together throughout their careers, they will be crossing the retirement level when they’re 48 years old. So much for “The new dark ages where only the wealthy can retire“.
Come on Guardian, you can do better than that.
Instead of sympathizing with people and blame “quantitative easing” and Google for not paying enough taxes, let’s focus on things we can change. Show me solutions, not problems. Stop looking at how the economic doom is upon us and start making changes that are in our control. Like cutting our mobile plan bill from £60 to £18 per month or switching to cheaper and greener gas & electricity. Making small steps like that can bring our retirement age years earlier.
Even if you’ve never saved a penny in your life, it’s never too late to start planning for financial independence. Especially those who earn a higher than average income.
Sure I had it easy, maybe lucky. I worked hard in my 20s to earn a high salary in my 30s and have now adopted a frugal mindset with a long term goal. I’m glad I found a wife that shares the same goals and values. But it’s only a couple of years ago that we realised: “Damn, if I and my wife start saving and investing then the financial independence dream is not that far!”. 7 years to be exact.
You need to invest
If you are to maintain and increase your wealth you need to have your money generate money for you. This is a basic requirement to early retirement.
The middle class works for money, whereas the rich have their money work for them.
Compound interest is the 8th wonder of the world. Albert Einstein.
Compounding is a very powerful force. It’s thanks to compounding that savings start generating some earnings which are reinvested and generate more earnings. At some point, this unstoppable snowball will be able to cover your lifestyle expenses.
It’s not impossible, it’s, in fact, inevitable! I won’t hide that I wanted to name this blog inevitablyrich.com (I had even registered the domain!) because of that powerful compounding force. But it takes time, and this is why the more years you add up those savings the stronger it becomes.
Just to show you the power of small contributions over time:
£200 invested every month will return £14,409 in 5 years but £34,857 in 10 years!
In 20 years, the number is not £70,000….. It’s an astonishing £105,046!
I used the standard 7% average return of the stock market and did not account for inflation just to show you the power of compounding interest over time. Imagine the impact if you can save and invest more than £200 per month…
But I don’t know how to invest
Sure neither did I. But I read a couple of books that are considered the bibles of investing such as The Four Pillars of Investing and the Intelligent Investor as well as blogs of people that have achieved financial independence through the last crisis. I also followed people that have spent more than 40 years in the financial industry such as the legendary John Bogle, founder of Vanguard.
The answer to all of us who have no idea how to invest in the stock market is to not try to become experts in it. Many people (including fool me*) have tried to beat the market by picking individual stocks that can do better than the economy as a whole. Most of them fail dramatically to consistently beat it over the years.
Right now, there are thousands of financial experts trying to do the same. Unfortunately, it’s a zero-sum game. This means for you to buy low and sell high, someone else needs to lose. There are equal numbers of winners and losers.
Many companies specialize in this type of activity (hedge funds). Can you, as an individual investor, compete with them? You have as much chance to consistently beat these folks as you have of beating Roger Federer in a match of tennis.
You could potentially give your money to a talented fund manager that can beat the market. That, though, will cost you much higher because he needs to get paid for it. So if you add in our lack of expertise and costs, you know which category we’re more likely to fall into.
What if instead, we invest very little in every single company in the world? What if we invest in the economy itself that occasionally bumps but always grows over time thanks to innovation and technological advances?
This is called index-fund investing. This is the manifesto, the whole ideology of a company which started back in 1975 and today has grown to $4 trillion in assets.
Vanguard, in a nutshell, said: “We will own the best 500 companies in the United States and you can invest with us almost for free! We commit to never put any of our expertise into trying to buy or sell at specific times or pick any growing companies we think are better than others. Plus the more people join our fund the lower the fees will become.”
This is considered passive-investing in low-cost index funds.
It tries to follow the economy, both in good and in bad times. It builds on the idea that the financial world is hard to predict, prone to human errors and human psychology, and therefore it’s better to trust the economy which performs well in the long term.
Since then, many companies have followed offering passively managed funds.
Here are a few popular low-cost index funds:
- Vanguard Lifestrategy 80% equity fund (0.22% annual fee)
- Vanguard Global Balanced Fund (0.6% annual fee, which I consider expensive)
- Blackrock US equity tracker fund (Blackrock, 0.08% annual fee)
The first two are actually a blend of global indexes as well as fixed-income (bonds). Bonds make the investment journey smoother so that the short-term bumps are not as big as the 100% equity ones.
So there. I don’t know how to invest, but I don’t need to learn either. If I keep reading about investing and economics it’s because I like it as a hobby and not an actual skill I will use.
Plus stocks & shares investing is not the only way to go. You can definitely invest some of your wealth in property (which is an all-time favourite here in the UK) as well as peer-to-peer lending such as Zopa and Ratesetter. I’m actually investing in peer-to-peer lending; here’s my Zopa Review.
Finally, if you’re afraid of moving your money away from your savings account safety, let me tell you this.
You’are already investing. Your pension does not go into a government savings account. It goes to the stock market all over the world, to property and other institutional investing funds. The reason the pension managers can keep up with inflation and keep their promise (hmm…) is because they have invested your cash for 40 years until it’s yours. So don’t be afraid of investing, you’re already doing it 🙂
The 4% magic number – How much do I need for retirement?
In the FIRE maths world (Financial Independence Retire Early), there is a rule-of-thumb that says you’re allowed to withdraw 4% of your total wealth every year without ever running out of money.
This famous study (aka Trinity study) has shown that the 4% rule ensures we will never have to worry about our living expenses eating up all of our investments and dropping our net worth to 0. It takes into account financial crashes, stock market free falls etc.
What about inflation? Won’t I need to spend more as goods become more and more expensive over time??? The 4% rule assumes that our spending will increase to keep pace with the cost of living.
In other words, the 4% number means we need to have 25x our annual living expenses in order to retire safely. So are your annual expenses expected to be around 30k? You need 750k in invested assets to make sure you never have to worry or work again.
What about taxes? You may have noticed I haven’t discussed this topic because I believe is not important. There. I said it. It’s not important because when you’re retired the amount of taxes you pay is very small. If I and my spouse can currently get 22k tax-free (11k capital gains allowance) when selling shares plus 5k each from dividends, that’s 32k in total. Not to mention that most of your wealth will usually be in a tax-free wrapper (stocks & shares, pension etc).
Some awesome people made this FIRE calculator that shows what the chances of your portfolio failing are. In other words, how likely is that I will make it if I stop working in X years? Adjust the numbers on different tabs according to your situation (it’s all in US dollars but the principles remain the same for other currencies too).
All the above assumptions play it safe. The retirement maths assume we will NEVER EVER earn a penny when retired, never inherit any property or money, or find new ways of earning passive money doing our hobby – similar to what I’m doing right now with this blog.
They also assume you will stay at the same place after retirement, instead of moving to a better and cheaper destination (hello Greece!) that will increase your safety margin.
There has never been a better time to start thinking about financial independence. The choice of going to work because we want to, not because we have to.
Having the option to focus on things that make us happy, not on things that better pay the bills. And this needs careful planning. More mental than numerical planning.
Retirement responsibility is moving from a single company to us! Company pensions, Self-invested Personal pension (SIPP), buy-to-let investments, state pension, stocks & shares ISA, GIAs, peer-to-peer lending… Whether we like it or not, it’s now up to us to take the risk of provisioning for retirement.
If you have a frugal mindset and the attitude to change a few things in your life you can do much better than the average 68-year-old retired person. You can escape the 9-5 routine and achieve financial independence much earlier than expected like I plan to do.
According to my calculations, we need 5-7 years to financial independence depending on how safe we want to play it 🙂
What will I do if I’m retired? I don’t know! I may start creating videos to help people get out of debt, solve real-world problems with technology, or go fishing with my father, or whatever! Whatever makes me happy.
What about you? Are you planning for financial independence? How much of your monthly income have you managed to save? Are you afraid of taking the money out of your savings account and invest?
I guess my own advice can be summarised as follows:
Keep increasing your savings rate
Keep investing those savings wisely
Keep using all your tax allowances
Keep the investment fees down
If you follow the above you will become financial independent much quicker.
Would you prefer to earn more or save more?
Let me know in the comments!
* I actually made a return higher than the market for a year, trying to follow value-investing strategies that I had just learned, which was obviously pure luck smiling at me, not investing skills.