Financial Independence: Numbers to know before you walk  

For a long time, it was commonly accepted that financial independence/retirement was the end goal and prize of a 30–40-year career.  However, over the past decade, increased media coverage of the FIRE (Financial Independence Retire Early) movement has made the viability of financial independence by one’s 30s and 40s more mainstream.  There have been numerous profiles of Gen X and Yers who’ve been able to leave corporate America by earning a 6-figure income, living frugally and saving and investing aggressively.  While this unconventional path is not for everyone, there are aspects of the journey that can teach us much about life, work, money and meaning.  For those interested in achieving financial independence, there are a handful of numbers you need to know before you walk.     

1: Net Worth

This is your financial bottom line.  To calculate your net worth, take all your assets and subtract it by all your liabilities.  Looking for a short-cut?  Here are some potential online calculators to use:

      ·       Net worth Calculator – Nerdwallet

        ·      Net worth Calculator – Kiplinger

       If your net worth is positive, you’re heading in the right direction.  If your net worth is negative, then you have room for improvement.  Here are the key ways to increase your net worth:                                                                                                                                                                                                                                       

      ·      Cut your spending and, thereby, increase your saving. 

      ·      Increase your earning.

      ·     Increase your investing.

      ·      Cut your spending; increase your earning, saving and investing.

Of course, the last option will get you quickest to your goal.  However, it all starts with making sure that your spending doesn’t exceed your income so that you can save and invest.  Otherwise, it’ll be difficult, if not impossible, to progress financially.  

2: Annual Living Expenses

Based on my experience, most people have a good sense of their income, but have a tendency to underestimate their expenses.  There are a number of ways to calculate your living expenses.  One way is the “pen and paper” route, which involves listing all your expenses via pen and paper or Excel spreadsheet.  Another way is to leverage financial software, such as YNAB and Mint, by linking your financial accounts into it.  While tracking your expenses via software may be easier, listing them out by hand (initially) may be more impactful as it lets you see how your daily decisions affect your bottom line.  And, perhaps this realization will prompt you to make a deeper commitment to change.    

3: Passive Income 

Here’s the definition that I like for passive income:  The money you receive is (far) greater than the effort you put into making it.  Oftentimes, passive income is a by-product of previous, active work.  Here are typical examples of passive income: savings account interest; investment portfolio dividend; rental income; business or land royalty?  Ideally, you’re positioning your money and efforts so you’re able to develop and generate multiple streams of passive income, foremost being interest and dividend. 

Determining “enough” 

Once you know your net worth, annual living expenses and passive income, then you’re able to gauge where you are with respect to financial independence.  The general rule-of-thumb is if your annual living expenses is 4 percent (or less) of net worth, then you are financially independent.  For example, if your annual living expenses is $40,000 and your net worth is $1 million, then you’re financially independent.  (Another way of calculating financial independence is your net worth is 25 times greater than your annual living expenses.  For those more fiscally conservative, shoot for a net worth that is 30 times greater than annual living expenses.)  This math is based on the Trinity Study (below), which concludes that you can withdraw 4 percent annually from your portfolio and not run out of money if you allocate a certain percent to stocks.   

 Conclusion

For most people, financial independence is the end goal to working, saving and investing.  However, among those who have achieved this holy grail, financial independence is not an end, but rather another beginning.  What would you do if money is no longer an issue?  Interestingly, this question is likely far more difficult to answer than whether or not you’ve achieved financial independence.  For once you’ve reached financial independence, the focus is less about making a living, but rather making a life.