We celebrate independence day because every human alive wants to be free. There are many types of freedom, and financial freedom is elusive to most. Imagine not being dependent on a job. Imagine being able to wake up knowing that you could do nothing and your finances would be just fine. How powerful would that feel? It’s a feeling I strive and plan for. I’ve made it an inevitability. We all have our own financial independence day. When will yours be?
Do you know what your numbers are? How much would you need to consider yourself independent? How did you come up with that number? It may be much easier than you think. See if any of these apply to your situation.
Define financial independence for you
You can be financially independent with $100,000, $1,000,000, or $10,000,000. It all depends on what your lifestyle is and what expenses you deem mandatory. The average income in the United States today is $56,000. So assuming you are an American, there are millions of people who get by making that much money each year. You probably can too. That income is currently in the 25% tax bracket if it comes from wage income. If you were to adopt that lifestyle, this comes out to $42,000 a year, or $3,500 a month in post tax dollars.
If you could make 5% returns on your investments safely, you would need $840,000 invested to earn $3,500 a month. Capital gains tax is only 15% assuming you are married filling jointly, so you would actually need $988,235 earning 5% to cover your expenses after tax. If you’re single, that’s 25%. Makes that ring look like a good deal doesn’t it? There are lots of ways to mitigate your tax burden, but I’m going to assume a 15% capital gains tax rate for demonstration purposes.
$988,235 is a lot of money, but that’s what it would take to live a median life in the United States without a job with assets generating a 5% return and not sacrificing your principal. If you are willing to move to another country or a low cost area in the US, that number could drop dramatically. Living in a cheaper economy is a raise by default. If you can do your work remotely, you start to get some great options if you’re willing to move.
Make the bar low
We all have different standards. It comes down to what you value. I value time above all else. It is the one resource we can’t get more of. I can’t get it out of the ground. No one can pay me in more time, expect maybe healthy eating and exercise. If you need a certain size house in a certain location and have high standards for cars, clothing, and stuff, you are going to need a lot more money to be independent. Maybe those things are important to you. That’s fine if they are, just be prepared to pay for them with your life. Ask yourself if the nicer car is worth the extra year of life you will have to spend working to pay for it. What could you do with that time? Make sure the ego boost from the car is worth it.
When you make the bar for independence low, you buy yourself more life. You also make it easier to grow your wealth. Mr Money Mustache is my favorite site for learning how to be a lean fiscal mother *$#@#$. When you value your time and relationships, the stuff can go away and those resources can buy more of what counts, time with those we love.
Grow while you’re free
Growing your wealth becomes easier once you have reached financial independence. It becomes automatic. Time you spend working accelerates it, but you don’t have to. A magic turning point occurs when you’ve hit your number. Once you amass enough dollars to work for you, they do all the work while you sleep.
You can increase your standard of living for every thing you grow over 5% in our previous example. The big assumption here is that you make 5% a year. That isn’t necessarily automatic which is why when you become financially independent you absolutely must become an investor.
Protect your downside
Learning to invest will become critical to keeping your time freedom. So many investors chase yield and want to pick the next big stock or inside deal, but that is a fool’s errand. Follow Warren Buffet’s two rules.
- Don’t lose money
- Don’t forget rule number 1
You don’t have to beat the market or even meet it. All you have to do is grow a little each year and never lose money. Let me say that again.
Never lose money.
If the S&P does 12% and you do 7% because you have a more conservative portfolio, you still win. Once you cross the independence line, it doesn’t have to be about the fastest growth. It becomes about keeping your freedom. The extra net worth is great, but I’d much rather keep my freedom than risk it for a gain that I may not get. I will gladly take a lower return if it keeps me out of a job.
Ask yourself what you are optimizing for, and most importantly what you are risking for that. If you are optimizing for growth, you’re probably taking on a lot of risk. If you’re optimizing for freedom, you minimize risk and are not emotionally rattled by the stock market. Don’t let FOMO mess with you. Assume the worst can happen. Plan your finances so if it does, you keep your freedom.