Financial independence (FI) is a word that gets thrown around a lot. It means different things to different people. For one person, it may mean being able to live comfortably and stress-free. For another, it may mean being able to leave your job when you feel like it. We all have our definition and understanding of financial independence. But one thing’s for sure, we all want to become financially independent someday.
As nice as it sounds, it’s not easy to become financially independent. If it were, everyone would be financially independent, but that isn’t the case. Usually, it’s because people don’t know where to start their journey to financial independence. This is why we’ll be discussing the formula to achieve financial independence—a literal formula.
If you’re starting an FI journey, you need to have an FI number. This is how much money you’ll need to be able to call yourself financially independent. Calculating your FI number is quite simple. Here’s a step-by-step process:
Step one: Figure out how much you spend every month. That includes expenses such as housing, transportation, food, and miscellaneous expenses. If you don’t have a record of your expenses, try to come up with an estimate. And then start recording your expenses for the upcoming month.
Step two: Multiply your monthly expenses by 12. The result will be your expected required annual spending when you become financially independent. For example, if you spend $3,000 a month, your annual spending requirement is $36,000.
Step three: Divide your annual spending requirement by 4%. This is your safe withdrawal rate. It’s based on the 1988 Trinity study or the 4% rule. If your annual spending requirement is $36,000 and you divide that by 4%, you’ll have $900,000. Thus, $900,000 is your FI number.
Step four: Divide your FI number by the number of years you’ll want to reach financial independence. If you want to become financially independent in 20 years, divide your FI number by 20. In this case, if you divide $900,000 by 20 and you’ll get $45,000. This is how much you’ll need to save annually to become financially independent in 20 years. It’s really up to you how long you want to take to reach your FI number.
Once your net-worth has reached your FI number, you can finally call yourself financially independent. Now that you know what your FI number is (a.k.a. your goal net-worth), all you need to do is find a way to reach that goal. Here are four ways you can do so:
- Focus on paying off your debts.
The earlier you pay off your debts, especially your mortgages, the faster you’ll reach financial independence. Make sure to put away and save up money specifically for your mortgage. You can pay off your mortgage earlier by refinancing your mortgage or paying more than you’re required to. Refinancing allows you to pay off your current mortgage and get another mortgage with a better interest rate.
- Find other streams of income.
The more money you earn, the better. Other than your main job, why not try freelancing? Or try finding a part-time job? You could also sell things that you aren’t using that could still be worth something.
- Build an investment portfolio.
Investing your money is always a good idea if you’re looking to make more money. But you shouldn’t be investing in only one thing. It would help if you built an investment portfolio. The more you diversify your investments, the bigger chance you have to earn more money. Diversification means investing in different industries and companies. That way, if one of your investments isn’t doing so well, you have other investments supporting you. You will still face losses, but it won’t be as bad as if you had invested in just one thing.
- Cut unnecessary expenses.
Create a budget for yourself and cut off any unnecessary expenses. Make smarter spending choices. Ask yourself, do you have to eat out tonight when you have food at home? Do you need a new phone if you’ve got a perfectly functioning one? People are often sucked into what we call lifestyle inflation. People think that just because you’re earning more, you should also be spending more. When in fact, it would be smarter to save that extra income you’re getting instead of spending it.
The only way you’re going to reach financial independence is if you save more and spend less. And as easy as it sounds, we all know it isn’t that easy to do especially if you’re taking care of other people than yourself. Even if it takes you 40 years to reach financial independence, never stop trying. You’ll reach your goal someday as long as you follow these four suggestions.