financial independnce

Financial Independence – A Simple Formula

As you start to get used to reading the Fire Fellow posts, you might get the sense that I’m a math guy, and you’re right. Math was my major in college and the simplicity of it (yes, I said simple in a tongue-in-cheek way) is what makes my journey to financial independence so clear.

When I speak with my friends and colleagues, they are often baffled by the concept of financial independence.  Even those in the top 1% have trouble grasping the idea.  Society has ingrained in them that the normal course of one’s life is to go to school, get a job, get married, work till retirement age, retire, and die.  Well, the Fire Fellow for one, refuses to believe that one must work till retirement age. Heck, Freedom 55 is even too much, while Freedom 45 is more palatable.

Being financial independent does not mean that you stop working.  It just means you have the freedom to choose whether to continue working, or perhaps spend time with your family, or pursue your hobbies, all without having to worry about getting that next paycheck.

To my mathematical mind, financial independence can be summed up with the following formula:

FI = (Savings + Discipline) x Time

Savings and Discipline goes hand in hand. If you are disciplined enough to save over 50% of your savings, you are on an accelerated path to financial independence.  After that, it is just a function of time.  Be patient and save/budget until you reach that FI target number.  Your number could be $500,000, $1,000,000, or $10,000,000.  Whatever it is, a 50% savings rate will get you there much quicker than a 25% savings rate.

How important is a savings rate?  VERY!  I will likely write an in-depth post on it but for now, here is a quick example:

Let’s say Bob has $50,000 in his investment account and expects it to grow at 7% per year.  Bob makes $60,000 and saves 50% of this of $30,000.  (Let’s forget about taxes for now). If Bob maintains this level of savings, he will reach financial independence in 13.3 years with a nest egg of ~$750,000 assuming a 4% withdrawal rate.

On the other hand, if Bob only managed to save 25% of his salary, or $15,000 per year, it would take him a full 24 years!  This is because not only is he not saving as much, he is spending more ($45,000 per year) and that means his nest egg needs to be over $1,000,000.

What is your savings rate?  Feel free to discuss below.

As usual, if you have any questions, Ask the Fellow!

 

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