The answer to this question typically seems to center around hitting some magic number, sometimes with astonishing precision according to those ING commercials. Accumulate a big enough financial nut, and you’ll be able to live off the interest for the rest of your life.
But that’s the problem. It’s easy to fantasize about this, and it’s also very easy to get discouraged. The focus on the number, a figure that is often quite ginormous and several orders of magnitude more than whatever I have today, makes the whole thing seem like a decades-long endeavor at minimum and most likely unattainable. Might as well splurge on something that will offer me a bit of comfort right now.
Where to begin?
I’ve been pretty fascinated by this area for a long time, and fortunately a lot has been written about this already. This is great, as it’s less writing for me, and savings in time are way better than savings in money.
Consider two very awesome and popular blogs on the topic and their takes on the path to the promised land:
- Early Retirement Extreme: Emphasis is on the extreme. If you can cut spending to the bone through extreme frugality and sustain those spartan habits into perpetuity, you can consider retiring within 5 years. It’s a combination of philosophy and lifestyle design optimized for a poverty-level budget. This approach seems pretty accessible, but one that few would likely pursue voluntarily.
- Financial Samurai: In a way, this is the opposite end of the spectrum. For all the faults that holding down a corporate job may have, it is still an incredibly effective way to earn a lot of income quickly. Combine a few years of high earnings with high savings, and you can contemplate leaving those salaryman days behind soon enough. It’s basically the traditional path to retirement, but accelerated and condensed into a decade. This approach is somewhat less accessible than Early Retirement Extreme, as you would need to have the ability and drive to actually be hired into a well-paying corporate position.
Both of these blogs offer viable paths that worked out well for their respective authors. On the other hand, I readily admit that neither of these approaches are a good fit for me. I have to think that many others share a similar opinion. I’m just not sure how practical it is to sustain myself on a diet of oatmeal and lentils, or to get rid of the car and ride a bicycle everywhere. Or to keep a demanding job AND climb the corporate ladder for over a decade in order to score that first million. There might have been a time in my life when I could summon that desire, but that time has long passed.
Don’t get me wrong; these are two of my favorite personal finance blogs. As a source of inspiration and as a source of ideas for what is possible and what to do (here’s the path depicted as a cash flow diagram), these have been invaluable to my own education. These are merely examples, and the beauty is that I can pick and choose among these and many more for what I think works for me. I think the approach outlined in Mr. Money Mustache blog is the closest to my own thinking about how to become financially independent.
What does financial independence even mean?
At the most fundamental level, I think financial independence means not having to worry about money.
This is not quite the same as early retirement, as many resources (blogs, books, etc.) often conflate financial independence with early retirement. The point isn’t to move from full-time wealth accumulation up until financial independence day, and then be dedicated solely to leisure activities thereafter. The point is to be able to live life on your own terms, to be able to say no to requests from bosses that you don’t admire and to tasks that you feel disinclined to pursue, and to be able to bear comfortably whatever financial consequences that might entail.
This also means that I do not think that it’s absolutely necessary to have all anticipated expenses covered by assets or passive income sources. I realize that some may consider this heresy. From a purely mathematical standpoint, the precise point of financial independence is when passive income sources is sufficient to cover all expenses. Much work has been done around retirement calculators and ideal withdrawal rates in this area to determine the right combination that minimizes the risk that you run out of money.
And I would agree that having all your bases covered would be the ideal situation. However, I would also point out that:
1. Expenses can be fluid. Unless you are planning for an absolutely bare-minimum budget, chances are your lifestyle will have sufficient flexibility to accommodate more frugal measures if necessary. That flexibility will be necessary, as planning out your expenses for the rest of your anticipated life with any degree of accuracy seems unrealistic.
2. You may still find yourself engaging in income-generating activities post financial independence. This isn’t meant to be a loophole. It’s one thing to engage in an activity for personal enjoyment that includes income as a side benefit, versus working a job for the primary purpose for making money.
3. If you are actually going to spend your time differently and in a more fulfilling way once you are financially independent, then shifting to those activities earlier may ultimately be more valuable to you than continuing to spend time sub-optimally to simply accumulate a bit more in savings to bolster your passive income.
Of course, this might not apply to everyone. What it means to not worry about money will be different for everyone. Some may prefer the security of a perpetual income stream, while others might be fine having only 20 years covered, or 10 years covered. If you are fortunate enough to have some useful and readily employable skill, whether it is programming or a trade skill or healthcare-related, you may likely never worry about the financial consequences of leaving a current job. Or you may just have picked up an eclectic mix of handy skills over the years, and you can live your life while expending fewer financial resources.
The point is that if something is holding you back from changing your current situation, you probably don’t need as much as you might initially think you need. And whatever amount that is will be a fluid number; it won’t be precise to the dollar. Hopefully, this post, the links provided, and other writings to come will help to clarify that.
A few basic principles
The journey toward financial independence is going to be long and interesting, and one that I am still on. Here are a few thoughts to keep everything in perspective. Nothing too original here, but still worth outlining.
1. One step at a time.
We’re going to be dealing with big numbers and long time frames, and the incremental amounts that will be saved and earned will seem tiny and slow by comparison. It will be easy to lose sight of the long-term goal when it feels like we’re hardly making a dent. But it all adds up. Dividends and other passive income streams will build from $10 to $100 to $1,000, and eventually cover 1 day’s worth of expenses into perpetuity, then a week’s worth, then a month, and then the better part of a year.
2. Not all capital is financial.
Money is just another resource. It’s easy to get obsessed with the financial elements, but spending time picking up other useful skills may yield better returns.
3. Spend less than you earn.
This is the basic formula that it all boils down to. You can achieve this by figuring out how to earn more, or figuring out how to spend less, or a combination of both. The more you save, the faster you get to where you want to go.
4. Focus on net worth, particularly the assets that are working for you.
Whatever scenarios you run regarding savings rate and investment returns, the key takeaway is that the faster you accumulate a big chunk of capital, the closer you are to hitting your target. If that capital is lying idle an unutilized as equity in your primary residence, then it doesn’t really help you.
5. Live your own life.
For whatever reason, there are going to be people that will choose to be the guardians of current societal norms. Norms that include conventional career paths, working unceasingly for decades, leaning in for more responsibility, angling for raises and promotions, and pursuing consumerism. I may have been guilty of that myself, once upon a time. The important thing is to figure out what matters to you, determine how to get there, and then go out and get it done.