Are you tired of working long hours and feeling like your life is sleeping away from you? Or perhaps you’re sick of the nine to five grind and would like to spend your time doing something you find more fulfilling? Do you know how to FI?
If you’re looking to achieve financial independence to take back your time, know that you’re not alone. In fact, the idea of reaching financial independence to retire early became popular with the best-selling book “Your Money or Your Life” published in 1992 by Vicky Robi and Joe Dominguez. The idea was to combine a frugal lifestyle and income from various investments to achieve retirement early.
Fast forward three decades and the concept is more popular than ever, especially among millennials and GenZ who are looking to achieve a better work-life harmony. The FIRE movement (Financial Independence, Retire Early), consists of hundreds of thousands of members, and blogs that have millions of unique page views every month.
So, to help you reach your goals and fulfill your dreams, here’s everything you need to know about achieving financial independence in this guide.
What is Financial Independence?
“Financial independence is about having more choices.”
– Robert Kiyosaki
Financial independence is the idea that you’re earning enough money from your investments not to have to rely on someone else for money ever again. The goal is to be able to break the chains of financial dependency and live the life you always envisioned for yourself and your family.
Now, although the FIRE movement is usually all about retiring early, it’s not always the case. Instead, it can be about taking back control of your time and choosing how you want to spend it.
Therefore, reaching financial independence is about having the option to retire early if you want to or being able to choose your career and life path without financial constraints.
What Are the Advantages of Early FI?
There are many pros to becoming financially independent early, and we’ve listed the main ones below:
- Enjoy flexibility: did you know that one-third of our lives is spent at work? One of the main advantages of retiring early is having the flexibility to choose to work if you want to and when you want to. Being financially independent allows you to allocate your time how it suits you and live your life the way you want to. No more commuting for hours, spending your days in a cubicle looking at your watch, and missing out on your kids’ soccer games because you couldn’t leave early!
- Live a meaningful life: financial independence allows you to make decisions based on what makes you happy and not on what you need to do to pay the bills. This means that you can allocate your time to pursuing your hobbies and passions and fulfilling your dreams, giving your life more purpose. Too often do we find ourselves doing a job we don’t find meaningful because of financial constraints, affecting our happiness and wasting time.
- Reduce your stress: 52% of all US workers feel burnt out, and this number is unfortunately on the rise year on year. Pressure from management, staff shortages, or lack of feedback are some reasons why most people feel stressed and exhausted in the workplace. Not having to worry about money means that you get to either work in a role you genuinely enjoy or allocate your time to doing the things you love, relieving any work-related stress.
How To FI?
Knowing how to start your journey into financial independence can be overwhelming and even daunting. That’s why we’ve drafted for you a step-by-step approach to reaching financial freedom and finally taking back control of your time and your life.
STEP 1: Calculate Your FI Number
The first step in achieving financial independence is to find your FI number (also called the FIRE number).
But what’s an FI number exactly?
Your financial independence number refers to the amount of money you need to accumulate to cover your living expenses for the rest of your life. As discussed before, knowing this number is important because it tells you when you can retire or at least not have to rely on work to fund your living expenses anymore.
To calculate your FI number, you need to consider the following factors:
- Monthly Income
- Savings Rate
- Investments Performance
- Total Monthly Spend
- Safe Withdrawal Rate (SWR)
Create a spreadsheet tracking all of your spendings and multiply the total by 12. Also, don’t forget periodic expenses such as car servicing or quarterly bills. You can also use budget apps to monitor your spending. Not only will this make it easy for you to calculate your monthly expenses, but it will also allow you to quickly identify spending patterns and see where you can save at a glance. Naturally, the less you spend, the less money you’ll need to reach financial independence.
The safe withdrawal rate (also referred to as the 4% rule) is one of the most important factors to consider when trying to reach financial independence.
Based on Investopedia’s definition, the safe withdrawal rate is the amount of money a retiree or financially independent person can withdraw before the end of their life without running out of.
Now, according to the Trinity Study, financially independent people can safely withdraw 4% of their savings every year without the risk of running out of money for at least 30 years. Note that if the inflation rate is higher than 4% they should adjust that rate based on inflation.
How To Calculate Your FI Number?
The formula to find your FI number is:
Yearly Spending Total / Safe Withdrawal Rate
Let’s assume your yearly spending total is $40,000, and your safe withdrawal rate is 4%. Then, based on the formula, your portfolio will need to be worth $1,000,000 for you to reach financial freedom.
$40,000/0.04% = $1,000,000
Note that this is just an example, and you’ll need to adjust this to your personal situation.
Also, if you want to know how many years until you can be financially independent, use the formula below:
FI number – Total Savings/ Annual Savings
Use a FI calculator
And to make it even easier for you to find your FI number, you can use a FI calculator like the one below. This is an easy-to-use tool that allows you to input critical information such as your age, your annual household spending, and your monthly savings and calculate how many years it’ll take you to reach FI.
STEP 2: Pay Off Debts and Create an Emergency Fund
Now that you know your FI number, and before starting to look into investing your money and maximizing your investments, you should always establish an emergency fund and pay off your debt.
Approximately 80% of Americans carry consumer debt with an average of $68,000 per household, not including mortgage debt. The issue with consumer debt is that the significant interest rate you have to pay back each month can quickly add up and prevent you from reaching your financial independence goals. The longer you carry debt, the less money you’ll be able to save. So, paying off your card balances and any outstanding consumer debt is critical.
What’s more, before investing your money, you’ll first need to create an emergency fund so that if something happens, you will have a buffer and won’t be put under tremendous financial pressure. Experts generally recommend having at least six months’ worth of expenses in your emergency fund.
STEP 3: Reduce Your Expenses
One of the main pillars of the FIRE approach is to live frugally, so the proceeds you earn from your investments are enough to cover your living expenses.
Therefore, if you want to reach FI, you need to start cutting back on current expenses to increase your savings and limit the amount you need to achieve financial freedom.
Here are a few tips on how to reduce your monthly spending:
- Track your spending
- Reassess your subscriptions
- Limit your water and electricity use
- Cook homemade food and avoid going out for meals
- Reduce your insurance premiums
STEP 4: Boost Your Income
Last but not least, one of the quickest and most efficient ways to reach financial freedom is to increase your income. That way, you can save and invest more every month and boost your ROI.
- Your main job: you might be able to do overtime and get paid for this. Or perhaps you could develop your skillset and ask for a promotion or change company to get better pay. Regardless of your personal situation, explore the different avenues you could pursue to boost your primary income.
- Side hustles: why not use some of your free time to start an e-commerce shop, provide freelancing services in your area of expertise or even deliver food on the weekend to earn some extra cash?
- Your investments: investing your money in the stock market or real estate is an excellent way to beat inflation, boost your income, and fast track your way to financial independence. For instance, the average return on investment of S&P 500 was 13.6% between 2010 and 2020, significantly outperforming savings account interest rates and beating inflation.
3 Best Ways To Invest For Financial Independence
The idea of investing money is to create passive income streams that will generate cash flow once you’ve reached financial freedom.
1. Maximize Your 401(k) Match
One of the best ways to save for retirement is by contributing to a 401(k) retirement plan. This employer-sponsored plan offers many benefits for employees and will fast-track your way to FI.
With 401(k) plans, the government allows companies to offer retirement savings accounts that employees can contribute to with specific tax advantages. The goal is to incentivize people to save for retirement. Depending on your plan, your contributions to your retirement savings might be matched by your employer.
But how does that work exactly?
If your plan offers this option, your employer will contribute to your retirement savings to a certain percentage of your own contributions and up to a certain amount. The most common employer contribution is 50% of what you contribute and 6% of your salary. However, make sure to review the terms of your employer’s 401 (k) plan and discuss this with them.
2. Open a Roth IRA
A Roth IRA or individual retirement account is a tax-advantaged account you can use to save money and invest for retirement. This type of account has garnered much interest over the last few years due to its tax-free growth and tax-free withdrawal benefits.
Indeed, traditionally, any profit you earn through your investment account is taxed annually, inevitably slowing the growth of your account. Now, the great thing about Roth IRAs is that your earnings aren’t taxed while they’re on the account. This, in turn, will help you grow your earnings through the power of compounding. What’s more, any withdrawal you’ll make during retirement is also tax-free.
You’ll find more information on Roth IRAs in this updated guide.
3. Diversify Your Portfolio
Whether it be in the stock market or real estate, investing your money can be risky. And one of the best ways to mitigate the risks is to diversify your portfolio.
Ever heard of the expression never put all your eggs in the same basket? This is exactly the mantra you should adopt when it comes to your investment basket!
Say you invest all of your money into real estate. After all, real estate is expensive, right? So, you might be tempted to put it all in on a rental property. After a few years, you decide to buy a second property. While this sounds like smart reasoning, investing every penny you have in real estate is also risky. What if the market turns and you’re left with empty properties or worse, properties that have lost value?
Diversifying your investments is one of the best strategies to reach financial freedom.
So, make sure your investment portfolio is a healthy mix of bonds, ETFs, individual stocks, and real estate to mitigate the risks, maximize your investments and reach financial independence quicker.
Is FI Really Possible?
Sure, the internet brims with articles and YouTube or TikTok channels featuring successful GenZ or millennials who have reached financial independence early.
But you might be wondering whether that’s a dream or whether it’s really achievable. And that’s a legitimate question. After all, some of them have been monetizing their knowledge by selling courses and growing their audience which can raise the question as to whether their claims of becoming financially independent early are true.
The good news is that FIRE is not just a buzzword, and it’s possible if you start early, follow a strict approach, do your due diligence, and remain patient. Beware of get-rich-quick schemes. Becoming financially independent requires planning, hard work, dedication, and time! Also, remember that early retirement will most likely involve having a frugal lifestyle rather than living a lavish life, as some YouTubers might be depicting.
As with everything in life, there are pros and cons to reaching financial independence. Make sure to familiarize yourself with these so that you can make an informed decision when it comes to starting your journey to financial freedom.
Theresa is a personal finance blogger. She writes content for busy professional women to take control of their money and investments. She enjoys reading, traveling, cooking, and writing. Her work has been featured on GoBanking Rates, Your Money Geek, Savoteur, the Corporate Quitter, Thirty Eight Investing, and more.