What is Financial Independence?
Financial independence is making sure you no longer need to participate in the rat race in order to sustain yourself. It means you have enough money coming in every year that without a job you are able to foresee in your yearly financial needs.
It does not mean you do not like to work, it just means that you want to have the choice to work or have the choice to enjoy free time when you can.
Financial Freedom is less about Financials and more about FREEDOM –―
How to reach Financial Independence?
Unlike what you might suspect reaching financial independence does not get easier with having a high income. While it will certainly help to earn more, if your expenses are matching your income it will not speed up the time you reach financial independence. What will speed up your path to financial independence is your savings rate.
To reach Financial independence you need to have a yearly return on your investments enough to sustain you for one year. Sounds simple doesn’t it?
Calculating your current path to financial independence in 5 steps
1)List how much you spend in one year
If you do not know how much you spend its impossible to calculate when you can reach Financial independence. A lot of banks like KBC actually have this feature build in in their site. If you have an account at multiple banks you will need to start doing the math. The easiest and most flexible way for your needs is Excel.
2)List how much money you save every year
This is actually easier then the above. You just keep a spreadsheet where at the same day every month calculate how much your net worth is. Simply by doing this you start to list how much money average per month you save.
3)Find out your current net worth
This easier. Figure out how much you currently have in investments and savings. This means bank accounts, stocks but also properties (apart from the place you live in) count towards this.
4)Decide your safe withdrawal rate
This will depend of how much your investments are generating. Its safe to withdraw about 80% of what your investments return is. So if this is 5%, you can withdraw 4% of your investments every year. If you are still in the early stages of Financial independence, you might not think much about this, and you can take the fictional number 4% for now. If you already have a few investments it pays off to take the actual number.
5)Do the math
Now its time to calculate how long it will take you to reach Financial independence.
A common formula you will find online when you search on google is (Yearly Spending / Safe Withdrawal Rate – Amount Already Saved) / Yearly Saving = amounts of years to reach Financial independence
Example Jack is making 25.000 euros a year. He spends 12.500 euro’s yearly, Currently he has no savings. We assume a 4% withdrawal rate. That means (12500/4% – 0) / 12500= 25 years to financial independence
While the amount you need to retire at the end is correct, and the formula does give an indication, the formula actually does not keep into account the interest you get every year from your saved amount.
When we add in the interest rate then we can make an even better picture and we notice that with a 50% savings rate and 5% interest rate on those savings Jack can actually already retire after 17 years. Assuming he can get the right interest rate.
The bellow table shows how far you are from retirement (assuming a 5% interest rate and assuming Jack has no money saved).
|Yearly savings %||Years to Financial Independence|
Or displayed as a graph, you can clearly see how fast the years go down, especially as you just start and increase your savings rate
It becomes especially interesting to see how much just 5% of extra saving percentage can have on reaching Financial independence earlier. So if Jack can save 1250 extra per year, he can reach Financial Independence 2-3 years earlier.
Think about that before you decide to buy that new iPhone.
Speed up your way to Financial Independence
By now it must be clear that there is different ways to speed up your path to FI:
- Increase your income: this will happen over time, but generally it is quite slow
- Increase the return on investments: quite hard to do so, usually you do not have control over this
- Decease your expenses: if you can find a way to decrease your expenses then you will get an instant higher savings percentage. Wage does not matter here, infact the lower the wage the more it makes sense to take action
Five Ways to reduce your expenses right now
- Stop buying lottery tickets: you buy air, and you have more chances to get killed by a furniture in your lifetime then win Euromillions. Yes the chance of you dying by furniture is 100 times bigger then you winning Euromillions.
The odds of winning Euromillions jackpot is 1 to 139.838.160. The odds of you getting killed by falling out of bed or off a chair is 1 in 2 million
- Save restaurant visits for good and carefully planned moments with friends and family. Avoid ending up in a situation where you suddenly are hungry and need to buy an expensive meal to fix it. Avoid paying for bottled water all together, try to always bring some tap water from home on walks.
- Plan what you buy and buy what you plan. Do not buy anything in the moment, as chances are you do not need it.
- Check your recurring utility bills yearly: most countries have websites where you can compare your utilities, internet, phone, TV providers. By doing this yearly you can probably save a few 100s of Euros. For example in Belgium we have the site https://www.aanbieders.be/
- Check your recurring insurances: car insurance, family policy, fire, theft. I don’t mean to take the worst, but the most expensive might not be the best.
- Do you really need that expensive car/phone/… When you think about it, is paying 10.000 euros more for a car worth waiting a few additional years for Financial independence? Keep this in mind at every large purchase
- Check any subscriptions you might have: is there any subscription you pay for that you do not actually use? Perhaps its time to reconsider
- Don’t pay for storage: there is a reason why a lot of storage facilities offer the first month free. Because this temporary solution can often turn into a permanent one. Keep a rule of thumb of you do not use something for X years you get rid of it. Or better: sell it and make some extra money that you can get a return of
- Avoid paying for car parking: that is assuming you have a car, but if you do avoid to pay for parking. Often public transport is cheaper and there is park and rides around big cities. Even cheaper is taking the bike.
- Consider to grow some of your own food: if you have a garden, its quite easy to plant a few baby trees or plants growing fruit. They cost almost nothing when they are small and can grow fast and big.
Who inspired me?
I first read about Financial Independence on a forum called tweakers. I saw some people discussing about FI, and this is when I first started reading about the subject.
There is a few famous authors and bloggers who I would just like to mention that will hopefully give you inspiration as well.
First is Pete Adeny, also known as Mr Money Mustache, he is probably the most famous blogger about this. Pete actually retired when he was thirty, when he reached his goal of 1M on savings.
Go and check out his blog here https://www.mrmoneymustache.com/
Another interesting book is “The millionaire next door” from Thomas J. Stanley. He writes about so called white collars (high income group) living in high class areas might not be as wealthy as you think. And people living in a lower class neighborhood might be a millionaire without anyone knowing because of their low spending rate.
He also keeps a good quality blog, find out more about it here http://www.thomasjstanley.com/
So now you know a little bit more about what Financial Independence means. I will keep this blog updated with tips for you to reach your goals, write about people and their progress, and of course I will write about my own progress as well.
Im interested to hear about you as well. hat is your savings rate currently and how far are you from Financial Independence? Leave a comment bellow and let me know.