Remember Fictional David from yesterday’s post on setting goals and calculating your financial independence number or FIN (if not then check out the post here). Well, let us see what Fictional David and his family could potentially experience once he reaches financial independence.
He identified his family’s total expenses to be $4,500.00 per month with a low level of consumption and a moderate tolerance for risk. Plugging that into the formula equates to:
FIN Formula: Monthly Expenses x 12 x Consumption Multiplier x FI Risk Multiplier
FIN = $4.5K x 12 x 1.1 x 30 FIN = $54,000.00 x 1.1 x 30 FIN = $59,400.00 x 30 FIN = $1,782,000.00
Side note: If you need all of the questions, charts, and the FIN Formula laid out for you, check out the newest tool page under the toolbox here.
With $1,782,000.00 in mind, Fictional David works hard, saves his money every year, invests it smartly, and chooses to retire at 45 when he hits his number. Since he has a moderate tolerance for risk, he makes sure his retirement accounts are split between 65% index funds and 35% fixed income funds returning 2% each year.
On January 1st, Fictional David takes his first 4% out of his retirement accounts, equating to $71,280.00. This number is actually $17,280.00 more than he identified he needed for his expenses ($4,500.00 x 12 months = $54,000.00). Let us say for this basic example that the government taxes the extra $17,000.00+ at 30%. So Fictional David has the $54,000.00 that he needed to pay for his lifestyle, and another $12,096.00 to save for a rainy day or maybe take an extra trip.
After Fictional David takes out the 4%, his retirement accounts drop to $1,710,720.00, and then his 65/35 split goes to work again for the year. 35% of the $1,710,720.00 or $598,752.00 increases to $610,727.04 by December 31st of that year ($598,752.00 + 2% growth).
The other 65%, or $1,111,968.00, increases or decreases by the amount of the stock market. If the stock market increases 14.24% in year one, then Fictional David sees that portion of his retirement accounts grow from $1,111,968.00 to $1,270,311.93.
If you add the two sides together, then his retirement accounts grew to $1,881,038.97. Fictional David can then take out $75,241.56 the next year, when he would only need $55,080.60 (I added 2% inflation to his expenses because prices rise over time). This comes to a $17,000.00+ difference again, which he can set aside or use throughout the course of the year. Hopefully you are starting to get the idea.
I have mapped out a chart for you below so you can see how his account in a simple form changes over time. Check it out:
The 4% rule plus the built in cushion allows Fictional David to pay for all of his expenses and gives him a small safety net each year if another cost comes along like a new car, or college expenses, or a family vacation. Also, this basic journey doesn’t take into account a few things that could maximize profits in the portfolio, minimize taxes, and even other potential sources of revenue like a part time job or investing the extra funds.
Next week, I will calculate net worth and work to better understand what goes into the FIN. Once we have that solid base put together, then we will start laying out the framework and identify the tools you can use to achieve financial independence sooner than you ever thought possible.