Reaching financial independence may be challenging but not impossible. It sounds complicated but in just one simple calculation you can get an estimate of how much money you’ll need to be financially independent.
The Financial Independence Number
Let’s calculate your Financial Independence Number which is 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.
Step 1: Calculate Your Spending
Know how much you are spending each year. If you’ve done a financial analysis and use a budget, then you’re ahead. Take your monthly budget and multiply that amount by 12. Make sure you include periodic expenses that may not be reflected on a monthly budget 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.
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withdrawal rate (also referred to as SWR) is a conservative method that retirees use to determine how much money can be withdrawn from accounts each year without running out of money for the rest of their lives.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 indepedent people to take out a small percentage between 3-4% of their investment portfolios to mitigate for worse case scenarios. This withdrawal percentage is based on 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 investments should last for the rest of your life.
Step 3: Calculate Your Financial Independence Number
Your FI number is calculated using your Yearly Spending divided by your Safe Withdrawal Rate.
To find the amount of money you’ll need to be financially independent, take your Yearly Spending and divide by your SWR.
- Yearly Spending: $40,000
- Safe Withdrawal Rate: 4%
Financial Independence Number = Yearly Spending / SWR
$40,000 / 0.04 = $1,000,000
This means 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.