Financial Independence is having enough income or wealth to pay for your living expenses for the rest of your life without having to be employed. Having a net worth of 25 x your annual living expenses is commonly referred to as being financially independent.
Budgeting and financial planning are critical tools to accomplish financial independence. They allow a clear view of income and expenses and the progress towards achieving financial goals (e.g. the holy grail of financial independence).
Reducing expenses, increasing income, and accumulating a mix of revenue-generating assets such as dividend stocks, real estate, and bonds, are all important steps towards accomplishing financial independence.
Retirement is not an age but the ability to pay for all future expenses. You can retire at any age as long as you have the income to do so.
The standard industry formula (Rule of 25) is a good starting point but may not be enough for early retirement as the Rule of 25 assumes a 30-year retirement starting at age 65. Early retirees need to save at least 30 x of their annual expenses.
Unknown input factors (e.g. medical expenses, lower investment returns, and future inflation) make perfect planning difficult, but establishing a foundation via the rule of 25 certainly goes a long way for many. A more conservative approach some researchers advocate for is to instead divide annual expenses by 0.03. A person with $50,000 of annual expenses would therefore need between $1.25MM (50,000 x 25) and $1.67 MM (50,000/0.03) in net worth to be considered financially independent.
Fun Fact: The Rule of 25 is related to the 4% initial withdrawal rate rule commonly used for retirement planning (4% of $1.25MM is $50,000).
Online retirement calculators often use 70% of your income rather than living expenses, resulting in higher estimated retirement funds amounts for high income earners. This is done to approximate current standard of living in retirement.
Examples for revenue-generating assets are dividend stocks, real estate, and bonds. The 2022 annual limit for 401(k) contributions is $20,500 (plus an additional $6,500 for those age 50 and up), so make sure to get the employer matching and maximize pre-tax retirement savings. Additional retirement savings can be done via Individual Retirement Accounts (IRAs). Also review your Social Security account via www.ssa.gov/myaccount.
What is your financial independence day?
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