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Are you wondering about what financial independence is? Imagine a life without the 9-to-5 grind, alarms or rush-hour traffic. And with the freedom to live on your own terms, travel or spend time with your family, or pursue your passions!
The idea of financial independence and early retirement appeals to many but few achieve that status. This is because it is not a get-rich-quick scheme.
The path to becoming financially independent requires commitment and total dedication toward your goal. But it is totally achievable!
Retirement is not an age, it is simply a savings target! Unfortunately, turning 65 won’t magically fund your account with the money you need to retire. I wish it did! What’s even worse? If you don’t have enough saved, you’ll just have to continue working forever.
So whether your goal is to retire at 35 or at the standard age of 65, you NEED a plan to become financially independent!
What is financial independence?
If the income from your investments, assets or other passive income sources is sufficient to cover your yearly expenses, then you would be considered financially independent.
Ultimately, it means that you don’t have to exchange your time for money and rely on a job to pay for your living expenses.
Let’s talk about how to become financially independent.
1. Define your idea of financial independence
How would you spend your life if you no longer had to work?
Some popular ideas include travelling, spending time with family, picking up a new passion project or hobby like volunteering, sailing, golfing etc.
Some people may choose to continue working because they love their job!
It’s important to identify what your future lifestyle looks like because that would impact your financial independence (FI) goal.
2. Analyze your finances and net worth
Start by calculating your net worth. List out all your assets and subtract your total liabilities from it.
Assets are all things that you own that can be cashed out. Eg: Real estate, stocks, bonds, cars, jewelry and cash.
Liabilities refer to money that you owe. Eg: Credit card debt, car loans, personal loans, student loans and mortgage.
If your net worth is positive, that’s amazing, you can skip this next bit!
Assess your debts
If you have a negative net worth, assess your debts and create a debt payoff plan.
Evaluate which one of your debts has high interest rates and target them first in your payoff plan. This will help you save money on interest fees and you can put those savings to better use.
Credit card debts, personal loans and payday loans would top this list.
Set up an emergency fund
This should be one of the first steps you take to shield yourself from life’s unpredictability. We had lived without emergency savings for 6 months and the constant fear of a financial emergency took a toll on my mental health.
Start with a basic emergency fund that can cover 3 months’ worth of living expenses. This can give you some breathing space in case you face car/house repairs, emergency medical expenses or unemployment.
If it takes months to find a replacement job in your field, ramp up your emergency savings to cover you for that time.
This spending tracker will help you figure out how much you spend in a month.
3. Set your goals
First, let’s figure out how much you need annually to maintain your lifestyle in retirement. Use the values from the spending tracker above to calculate your yearly cost of living.
Target FI amount
Financial planners’ favorite 4% rule says that you can safely withdraw 4% from your retirement portfolio every year without reducing the principal.
Based on the 4% rule, your target retirement amount should be 25 times your yearly expenses. Even though this rule accounts for inflation and historical market trends, some financial advisors support a 3% withdrawal rate to create a more conservative portfolio.
Target time
Now for the million-dollar question! How long will it take you to reach your FI target?
The biggest factor in determining this is your yearly savings rate. It doesn’t matter how much you earn!
Consider two people who spend 50% of their income. Anna earns $40k a year and needs $500k to retire. While Betty earns $120k annually and needs $1.5 million to retire.
With a savings rate of 50%, both will reach their financial independence goal in 15.7 years!(Assuming a 4% withdrawal rate and 6% investment returns after inflation and taxes)
Increasing your savings rate will shave off valuable years from your path to financial independence. I boosted my savings rate to 40% using the Progressive Budget Plan!
This early retirement calculator will help you figure out when you can reach your goal.
Creating milestones for your journey will help you track your accomplishments and will give you greater motivation to keep going! It is said the first $100,000 will be hardest milestone to achieve but your success will keep snowballing from there!
4. Invest your money
Saving for retirement without investing would be an uphill battle. Investing was a big, scary thing for Dhruv and me when we first started out. But once you dip your toes, you realize that it’s really not that risky or scary.
It is certainly not like gambling as we’ve all been raised to believe! And investing is definitely not a middle-aged person’s thing. If you’re in your 20’s and 30’s, NOW is the right time to do this!
Consider this example. Anna is 25 years old and Betty is 35 years old. They both invest a one-time amount of $20,000 and it grows untouched until their 65th birthday. (Let’s assume that both got the same 10% annual return.)
At the end, Anna’s portfolio would be worth $905,000 while Betty’s portfolio would only be worth $349,000. That’s 61% lesser!
Compound interest needs time to work it’s magic and to earn you more money on your earnings. Sure, you would have more savings to invest as you grow older but time is not something you can get back. Time is your most valuable resource right now.
What kind of investments should I be looking at?
If you’re just starting out in your investing journey, start by learning the basics and educate yourself. The Little Book of Common Sense Investing and A Random Walk Down Wall Street are great books to get investment advice!
Some of the popular investment options to consider:
- Robo advisors like Stash and Wealthsimple are an easy way for beginners to get started. They have a zero account minimum too.
- Index funds and ETFs are a popular choice compared to buying individual stocks.
- Example: buying an S&P 500 index fund would be equivalent to investing a bit in each one of the 500 companies that make up that index. In the past decade, it gave an average yearly return of 13.6%.
- One of my personal favorites is the Invesco QQQ ETF which tracks 100 of the largest technology companies like Apple, Microsoft, Amazon and Tesla. It gave an average annual return of 20.4% in the past 10 years.
- Real estate is another crowd-favorite. You could buy residential or commercial properties and make money through rental income or by the property’s value increasing over time.
- With REITs (Real Estate Investment Trusts), you can invest in real estate without the hassle of managing properties. REITs are companies that own commercial real estate. They are publicly traded on the stock exchange and can be purchased like stocks.
Well, what about market crashes?
Market crashes could happen in the future, but the important thing is to not panic. Investors only lose money when they sell during a market dip. The trick is to stay calm, and ride out the storm! Historically, the stock market always rebounded to greater heights as it recovered.
During the Dotcom bubble (2000s) and the Great Recession (2007-2009), the market recovered in about 4-5 years.
Savvy investors use this opportunity to buy stocks at a discount instead of panic selling everything they own and realize their losses. Another way to shield yourself would be to diversify your portfolio so that it doesn’t go down together.
Find an investment style that suits your mindset and your appetite for risk and stick to your plan!
5. Revise your goals
On your journey to financial independence, your plan may undergo many upgrades as your life grows and changes. It’s important to revisit your goals and account for the new priorities in your life.
Be sure to track your investments at least once every month.
Make it a habit to use the spending tracker to track your monthly expenses until your expenses fall within your budget.
Three most important strategies for financial independence
In short, these are three principles that you can use to achieve this.
1. Increase your investments and assets
Research and choose your personal investment strategy. Find the right investments that can maximize your passive income.
Investing your money would literally put your money to work, to keep earning more for you.
If you are worried about how the market might perform, one way to safeguard yourself would be to diversify your investments. For example, you could choose to put money in stocks, real estate, REITs, peer-to-peer lending or bonds.
2. Decrease your spending
As we saw earlier, increasing your savings rate is the best way to shave off YEARS from your retirement timeline. It’s the biggest deciding factor! So create a more conscious budget and work toward cutting back on your expenses.
I was able to go from ZERO savings to $25000 in just 7 months by following the Progressive Budget.
If you find yourself living paycheck to paycheck or if you’re unable to save a good chunk of your income, you could be overspending on your lifestyle. It’s one of the most common money mistakes.
The idea is not to lead a frugal lifestyle, but to just spend less than what you earn! Learn how you can consciously identify and curb lifestyle creep (spending more as you earn more) from hurting your finances.
Lastly, monthly payments are not a good way of life. Before signing on for new debt, evaluate if it’s necessary and if it’s good debt. Will the loan earn you more money than what you’re paying? Examples of good debt may include mortgages, student loans etc.
3. Increase your income
Increasing your income is another effective way to boost your savings.
You could achieve this by stepping up in your career plan. Improve your skillset by taking on certifications or online courses so that you can qualify for advanced roles.
Improved skills can get you a better job with a better salary! I got a 35% pay increase by completing a 4-week certification!
Always be aware of your market value and negotiate for what you’re worth. It’s easy to get caught up in the familiarity and comfort of your current job. Take time to consider if familiarity is more important to you than money or job growth.
According to Forbes, those who switch jobs get a salary boost of about 10-20% on average.
You could also research passive income ideas or turn a hobby into a side gig that earns you extra income. Another option is to participate in the gig economy, work part-time on your own schedule and boost your monthly savings!
Parting words
If you think you need 30 years to retire, it will take you 30 years. If you think you can do it in 15, then you only need 15 years! You just need to map your goals and start on your path.
As we clearly saw, the secret is in your savings rate, not your income! Waiting for a higher income before you start planning for financial independence would be a waste of time and money. You are exactly where you need to be to start your journey!
Would you rather spend only 50% of your paycheck and retire in 15 years or spend 90% of your paycheck and retire in 45 years? Tell me your choice in the comments!
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