Regardless of the current state of your finances or how your career has progressed, true financial independence is something that draws us all. Who would not want the ability to choose when and where to work instead of being forced to work out of necessity?
Retirement and financial independence may seem a million miles away in your 20s or 30s, but achieving financial independence, or FI, at an early age is possible, and many people are actively working toward that goal.
What is financial independence?
Financial independence could mean many different things, but here, we will talk about accumulating enough money so that you no longer need to work. You can choose to continue working, so retirement and financial independence are not necessarily synonymous.
The Trinity Study found 4% to be a safe withdrawal rate, and this has become a cornerstone of the FI community. That means that if you can live 4% of your investment portfolio for a year, you will have achieved financial independence. For example, if you spend $ 50,000 a year, you would achieve financial independence with $ 1,250,000 ($ 50,000 x 25 years).
Please note this is a general definition. The goal of pursuing financial independence is to gain freedom in your life and to feel free from the stress and worry of money. A simple formula alone cannot dictate when you feel true freedom over money. Your goal for financial independence could be higher or lower.
Starting towards financial independence
Now that we’ve covered what financial independence is, let’s take a look at how to get there.
Know your “why”
First, you must understand why you want to seek financial independence. Do you want to get out of a career you don’t like? Do you want to be able to travel the world? Do you want more time with your family?
There is no right or wrong reason, but you must think about your own motivation because it can have a big impact down the road. Chasing FI will require some sacrifices, and it’s much easier to make those sacrifices when you realize why you’re doing it.
Calculate your annual spending
Before you can know how much money you need to save to achieve financial independence, you must first know how much you spend each year. If you don’t know how much you spend each year, you can use things like your credit card and bank statements from last year.
It’s also a good idea to start tracking your expenses on a regular basis to make sure you know exactly how much you’re spending.
Calculate your FI number
Once you know how much money you are spending, you can calculate your “FI number”. The calculation is simple. Just multiply your annual spending by 25 to get your FI number.
However, you should also consider the next changes that could affect your expenses. For example, if you plan to have children in the future, you should expect your expenses to increase. If you are spending $ 40,000 a year now, your true FI number is over $ 1 million ($ 40,000 x 25) because of this.
Increase your savings rate
Your savings rate is the percentage of your income you have left after paying taxes and all other expenses. If you currently earn $ 60,000 and save $ 6,000 a year, you have a 10% savings rate.
Many financial experts recommend that you have a savings rate of around 15%, but that advice is based on a plan that involves working until age 65. If you want to get to FI earlier, you will need to increase your savings rate. Many people looking for FI can achieve a savings rate of 40% to 50%, or even more.
Don’t be intimidated if you’re not near that number right now. This is something you can continually work on looking for more ways to cut expenses or increase your income.
→ Cut monthly expenses
When looking for ways to increase your savings rate, take time to evaluate all of your recurring monthly expenses. Reducing these expenses will save you every month, and the cumulative impact of a few small changes can be a big increase in your savings rate.
Some recurring expenses like cable, expensive wireless service, insurance premiums, as well as memberships and subscriptions can generally be reduced if you are willing to shop around and consider making some sacrifices.
→ Establish good spending and saving habits.
Finding ways to save may seem difficult at first, but you will quickly develop some good habits that will make it much easier in the future.
If you want the process to be more fun, you can take on a money-saving challenge that gives you additional motivation to save as much as possible. Once you get into the habit of checking your finances regularly, you will find that saving money is easier and part of your normal life.
→ Increase your income
Reducing expenses should be one of your goals, but the other way to increase your savings rate is to earn more money. Many people in the FI community use a secondary job, or a second job, as a way to earn extra money.
Another important benefit of a side hustle is that you can continue to do so (if you wish) after retiring from a traditional job. Many early retirees use this as a way to earn some income and do something they enjoy.
This additional income can also help reduce your FI number essentially. For example, if you need $ 40,000 a year to live and can earn $ 15,000 a year with additional work (and will continue to do so much in the future), you will only need an additional $ 25,000 to cover your living expenses. That reduces your FI number from $ 1 million ($ 40,000 x 25) to $ 625,000 ($ 25,000 x 25).
Of course, that is not the only option to increase your income. You may be able to get a raise in your current job by developing some high-income skills, getting a promotion, or taking a higher-paying job. Additionally, you can invest in various income-generating assets to increase your savings rate.
Have an investment plan
All that money you are saving must be invested. There are many different approaches that you can take. Most FI seekers take a simplified approach using investments like index funds, which are some of the best investments for young adults and others for their low costs and diversification.
From here, you’ll want to start tracking your net worth on a regular basis so you can see your position and monitor your progress.
Don’t stop here
Although this covers the basic steps to begin your journey to FI, you will want to continue learning and improving your financial education. This is a long-term journey that requires significant commitment, but those sacrifices will pay off when you gain control of your life rather than being controlled by money and work.
A version of this column was originally published on the Young and the Invest blog. It was edited and published with permission.
Riley Adams, CPA, is a senior financial analyst at Google and writes for Young and the Invest, a site dedicated to helping young adults invest, manage and plan their money with confidence..
Marc Andre is a personal finance blogger at VitalDollar.com, where he writes on topics related to saving money, managing money, and making money..