“We become what we think about.”Earl Nightingale
What do you want? Out of work? Out of life? What goals do you have? What dreams do you have? Do you plan to stay in your current job forever? Do you want to work forever? What would your ideal work-life balance be? What is your happy?
Think about the things making you happy, pull out a pen and paper, and write them down. If you have a partner or a family, then make a list together. Jot down 15 to 20 goals or dreams… then rank them.
If you could do those things and not have to worry about money, would you? My list included things like building custom woodworking pieces in my garage… sipping margaritas on the sand while reading a book at my beach house… lounging in a cozy chair with coffee while I write the next epic fantasy series.
I contemplate these goals on a daily basis, fueling my desire for financial independence. When the days devolve to a struggle and the urge to splurge on something extreme takes over, these goals reinvigorate my grit.
Type them up, print a copy, and post it on your refrigerator. Reread them periodically… update them periodically. And have them in mind as you work toward financial independence.
Side note: Before I even achieve financial independence, I might have already written the next great epic fantasy series (one of the reasons why I am writing this weblog... to practice). So please do not write your goals down and then set them aside until you achieve financial independence. Use them to drive you as you work during and outside of your "nine to five." They could potentially lead you to financial independence earlier... maybe as a side hustle. Or maybe it could turn into your main hustle and be the best of both worlds.
With your goals on the fridge and on your mind, now it is time to calculate your financial independence number (FIN), or the amount of money you need to save and invest to be financially independent. This number could offer you more safety and control in your current career (think about the stress released if you worked at a place without reliance on the paycheck)… or it could allow you to switch careers to something you love but might not pay as much… or let you pursue a dream… or even retire altogether and enjoy that beach or mountain life.
Your FIN is easy to calculate, but I want to put a big asterisk on the first one we put together here. It will change. There are a lot of variables that go into identifying your number, the biggest of which are your expenses and your levels of risk and consumption. But we need a starting point. As we hone in on your true expenses, your acceptable level of risk, and identify your consumption habits, then we will get closer to your true FIN.
In 1994, William Bengen famously researched and tested the appropriate percentage of money to extract from your retirement accounts each year if you invested in a 50/50 split of stocks and bonds. His study came up with 4% in the first year and then each year thereafter adjusted for inflation (generally speaking inflation is an increase in the cost of goods you buy from year to year and is a term I will delve into more in future posts). In 99% of the cases Bengen researched, when individuals lived off of 4% from their retirement accounts each year, then those retirement funds would last more than 33 years… even through the worst economic downturns in US history.
For example, if Fictional David (my character to help highlight an example of the math) has $1mil in his retirement accounts, then he can safely pull out and spend 4% or $40K each year, allowing his retirement accounts to last 33 years or more (again those accounts need to be invested in a 50/50 split of stocks and bonds, something which will be debated more in future posts).
The FIN thus requires the ability to pull out 4% each year from retirement accounts to live and cover all expenses for the rest of your life. To make sure this happens longer than just Bengen’s 33 years, there are four safety nets included in the FIN and future discussions to create a better margin of safety:
- (1) no adjustment for inflation will occur in the calculation when reaching financial independence so it will always be 4% a year, unlike the study and leading to a longer lasting retirement fund.
- (2) numerous multipliers are built in to enjoyably live off of the passive income generated by your retirement accounts so you do not have to worry about potential economic downturns or health challenges.
- (3) retiring early gives you a better chance to jump back into the workforce versus retiring at 70 and/or makes it easier to stay at your current job for another couple years if an economic downturn occurs.
- (4) when calculating expenses, they will be calculated at their greatest height, so cutting expenses and living leaner could be an option if necessary.
The 4% rule constitutes the core of our FIN, but a few other items need consideration. Take a moment to answer the next three questions to the best of your ability and remember them for the FIN Formula:
- (1) What are your monthly expenses?
- Total them up and don’t forget to include everything that you would have to pay in a month to make sure bill collectors will not knock at your door.
|Housing Costs (Rent/Mort., Taxes, Ins., Maint., Utilities)||$XXX.XX|
|Transportation Costs (Loan, Ins., Gas, Maint.)||$XXX.XX|
|Health Insurance Costs||$XXX.XX|
|Income Tax Expenses||$XXX.XX|
|Total Monthly Expenses||$XXX.XX|
- (2) Would you say you are a low, moderate, or high consumer of goods and services?
- Think about your spending habits. When the newest gadget debuts or you experience that moment after work without energy and you do not want to cook, would you spend the money or not?
|Consumption Multiplier||Multiplier #|
|Low level of consumption||1.1|
|Moderate level of consumption||1.2|
|High Level of Consumption||1.3|
- (3) Are you risky, moderate, or conservative?
- This is in terms of your financial willingness to take risks by investing your retirement funds, not your political affiliation.
|FI Risk Multiplier||Multiplier #|
|High level of risk||25|
|Moderate level of risk||30|
|Conservative level of risk||35|
Take your numbers from above and use the accompanying formula below:
FIN Formula -> Monthly Expenses * 12 * Consumption Multiplier * FI Risk Multiplier
Fictional David identifies his family’s total expenses to be $4.5K per month. His family is also a low consumer of goods and can tolerate a moderate level of risk in their investments. Plugging that into the formula equates to:
FIN = $4,500.00 * 12 * 1.1 * 30 FIN = $54,000.00 * 1.1 * 30 FIN = $59,400.00 * 30 FIN = $1,782,000.00
At these levels, Fictional David’s FIN would be $1.782mil. If his expenses are $4.5K per month, then Fictional David’s FIN could also range from $1.485mil to $2.457mil depending on his family’s level of consumption and risk.
As you can see, what type of person you are, or will become, and your mentality play a huge role in determining your FIN. Are you willing to take risks? Are you a spender or a saver? Honestly answering those types of questions will determine your FIN with a solid margin of safety.
Let the shock of the number wear off. It will be high. Probably more than you expected, but remember your FIN has to create enough passive income to support your lifestyle’s expenses and give you a safety net for your level of risk and consumption.
Now you have a choice… with that FIN in mind, you can take two routes. You can either play the victim and say, I am never going to get there so why even try. Or you can play the role of the creator and figure out the quickest route to get there. Be the creator. I promise you, as daunting as it might seem, there are so many tools to use to get you there quicker and I will cover a lot of them.
Your FIN is the key to financial independence… to choice. Take this moment to accept it. Reread your goals. And start contemplating how you can get yourself there.
Up Next: Bonus post out tomorrow! I will walk through Fictional David’s basic retirement withdrawals to show you how the FIN works. And then next week I will breakdown how net worth plays a role in your FIN.