Reaching financial independence may be challenging but not impossible. It also sounds complicated, but in just a straightforward calculation, you can get an estimate of how much money you’ll need to be financially independent.
I define financial independence as having enough income to pay your living expenses indefinitely without the need to work or earn income.
The Financial Independence Number
Let’s calculate your Financial Independence Number, the total amount of money required to give you a sufficient income to cover your living expenses for the rest of your life.
Financial Independence Number = Yearly Spending / Safe Withdrawal Rate
Your FI number will help you with a target amount to achieve financial independence sooner.
Learn how to calculate the years it will take you to reach financial independence.
Step 1: Calculate Your Spending
Know how much you are spending each year. If you’ve done a financial analysis, created a budget, and monitored your cash flow, then you’re ahead.
Take your monthly budget and multiply that amount by 12. Make sure you include periodic expenses such as annual premiums and dues or quarterly bills. Also include continued monthly contributions into accounts like your emergency fund, vacation clubs, car maintenance, etc.
Add all these together to get your Yearly Spending Total.
Keep in mind the lower the spending total, the lower the amount of money you’ll need to become financially independent. Learn how to lower your monthly household expenses and determine the difference between needs and wants.
Step 2: Choose Your Safe Withdrawal Rate
The safe withdrawal rate (also referred to as SWR) is a conservative method that retirees use to determine how much money can be withdrawn from accounts each year without running out of money for the rest of their lives.
The safe withdrawal rate method instructs financially independent people to take out a small percentage between 3-4% of their investment portfolios to mitigate worst-case scenarios. This withdrawal percentage is from the Trinity Study.
The Trinity Study found the 4% rule applies through all market ups and downs. By making sure you do not withdraw more than 4% of your initial investments each year, your assets should last for the rest of your life.
Step 3: Calculate Your Financial Independence Number
Your FI number is your Yearly Spending Total divided by your Safe Withdrawal Rate.
To find the amount of money you’ll need to be financially independent, take your Yearly Spending Total and divide it by your SWR.
- Yearly Spending: $40,000
- Safe Withdrawal Rate: 4%
Financial Independence Number = Yearly Spending / SWR
$40,000 / 0.04 = $1,000,000
Based on this example, you’ll need to accumulate $1,000,000 in your portfolio to reach financial independence. Your portfolio can include retirement accounts, investable assets (brokerages, stocks, etc.), pensions, rental properties, business ownership stake, etc.
Helpful tools: Use the best budgeting apps to help you track your monthly spending.
It’s also good to know there are other financial numbers to know on the journey to FI. Learn more about the best personal finance numbers for better health and wealth.