The term “financial independence” is widely discarded in articles about persooMarmaduke Rugglesijke finances and blogs, and not everyone uses it in the same way. For some, financial independence simply means earning enough to pay your bills, so you don’t have to depend on help from your family or the government. For others, it means that you have no debts, so you don’t have to rely on credit to make ends meet.
However, if you see the term in capital letters – such as “Financial Independence” or “FI” – it usually has a very specific meaning: having saved enough money to support you for the rest of your life. This type of financial independence – also known as independent wealth or having “running away from money” – means that you are not dependent on a salary. Once you have achieved Financial Independence, you no longer have to work for a living.
Although most people expect Financial Independence to retire, the two do not have to be connected. Reaching FI does not mean that you have to stop working, it just means that you no longer have to worry about how much you earn. So, if you’ve always wanted to give up your marketing job and become a diving instructor, FI makes it possible to pursue that dream. Even if you don’t make money with your new job, you can still live off your savings or investments while doing what you love.
The financial independence formula
Achieving financial independence is an ambitious goal, but it is not a complicated goal. In fact, with a few simple calculations, you can make a rough estimate of the number of years you need to take to get there, based on your current spending percentage and saving.
In short, the Financial Independence Formula consists of two parts. The first part calculates your FI number – the total amount needed to give you a sufficient income for life:
- FI number = annual spending / safe payout percentage
The second part of the formula uses your FI number to calculate how many years you should reach FI:
- Years to FI = (FI number – amount already saved) / Annual saving
This is only a rough approximation, but it is good enough to give you an idea of how far you are from FI right now. Once you know that, you can take the following steps to achieve faster financial independence.
Calculate your expenses
To calculate your own Financial Independence Formula, the first thing you need to know is exactly how much you currently spend per year. If you already have a detailed household budget, this step is easy. Just look at your total monthly expenses and multiply that number by 12.
If you don’t have one, your first step on the road to FI is to make a budget. Sit down with a budget app, a spreadsheet or just a pen and paper and list all your normal expenses – from your rent or mortgage payment to your daily cup of coffee or bottle of water. Don’t forget to include expenses that only occasionally pop up, such as a quarterly property tax or an annual insurance premium. Also make sure that you leave some stuff in the budget for possible emergency costs, such as car repairs or medical bills.
Add it all together and you have your first key number: your total annual expenses. The lower the amount, the easier it is to reach Financial Independence.
Search for your FI number
Once you know how much income you need each year, you can calculate your FI number: the total amount needed to give you that level of income for life. Your FI number depends on two things: your current expenses and your safe retirement percentage (SWR). Your SWR is the percentage of your savings that you can safely withdraw without running out during your lifetime.
The amount of income that you can reliably receive from your investments is the total amount that you have saved multiplied by the SWR. So to find out how large the amount is that you need to achieve the desired income – in other words, to find your FI number – simply take your current expenses and distribute them through your SWR. For example, if your current spending is $ 30,000 a year and your SWR is 4%, you divide $ 30,000 by 0.04, resulting in an FI number of $ 750,000.
Many financial experts say that 4% is in fact a reasonable SWR for most people. This guideline, known as the 4% rule, is based on a 1998 study published in the Journal of the American Association of Individual Investors, usually called the Trinity Study. The survey found that retirees who have invested at least half of their nest egg in shares can safely reclaim 4% of their starting money each year – adjust for inflation annually – and have more left over at the end of 30 years than they used to have started.
In the long term, the Trinity Study calculated, the 4% rule works through all sorts of ups and downs in the market. As long as you do not withdraw more than 4% of your original money per year, your investments should lead you for the rest of your life.
Some financial experts claim that the 4% rule is no longer valid in the current economy, with its low interest rates. A 2015 study by PricewaterhouseCoopers (PwC), however, concludes that the rule is still reasonable for households with “regardMadaduke Rugglesijke prosperity”, in other words, that are financially independent. So even if the 4% rule is not perfect, it is still a good guideline for planning your way to FI.
Determine years of financial independence
The last part of your Financial Independence Formula is how much money you save each year. Once you determine your annual expenses, calculating your annual savings is easy: just subtract the amount you spend from the amount you earn.
Now you have everything you need to find out how far you are from Financial Independence. You know how much you have to save and you know how much you save per year. So if you divide the first number per second, it indicates how many years it will take to reach FI. For example, if your FI number is $ 750,000 and you can save $ 25,000 a year, it will take 30 years before FI is reached.
However, this assumes that you start from zero. If you already have some money in your savings, the picture will look brighter. For example, if your FI number is $ 750,000, but you already have $ 250,000 in your retirement accounts, you only have to save $ 500,000 to reach FI. So at a rate of $ 25,000 a year, it will take you 20 years to get there.
On the other hand, if your savings rate is lower, your time for FI becomes longer. For example, if you only save $ 10,000 a year, it will take 50 years to save the $ 500,000 you need to reach FI. And if you don’t save anything at all, achieving FI will become impossible – your savings will never grow and FI will never get closer.
All this is of course too much of a simplification, because it assumes that the money that you save per year does not generate interest. If you only keep your money in a savings account, that is not far from the truth, because the interest rates are now barely above zero. However, if you have invested your nest egg in a sensible mix of shares and bonds, the return on those investments must be added to your savings each year, shortening the time it takes to reach FI.
In essence, the Financial Independence Formula eMarmaduke Rugglesijk is just a starting point. It tells you the longest possible time it could take to reach FI, but healthy investments can shave years off that total. If you want a more precise calculation that reflects the factors in your investment returns, you can use a Financial Independence calculator as offered by Networthify.
Save for financial independence
Your Financial Independence Formula shows how long it can take to reach FI based on your current spending and savings ratio. However, you do not have to settle for that. If you can find ways to reduce your annual spending or increase your savings – or better yet, both – you can reach FI much faster.
Financial experts disagree on exactly how much you should save. Financial writer Jonathan Chevreau, author of the book ‘Findependence Day’, says in an interview with Forbes that people who strive for financial independence should try to save 20% of their gross income. Chevreau sees this as an ambitious goal that is “impossible” for some people – yet many financial bloggers say they manage to save 50% of their income or even more, and encourage their readers to do the same.
While experts have different views on what your actual savings goal should be, they generally agree on how to achieve it. In general, three strategies are recommended: pay your debts, maximize your income and lower your expenses.
Pay off debts
According to a report from The Pew Charitable Trusts, 80% of all Americans have some sort of debt. About 44% have mortgages at home, 39% have a credit card debt, 37% have car loans and 21% have excellent student loans. All in all, a typical household is about $ 68,000 in the hole.
The bulk of this debt is just deadweight in your budget. Month after month you have to pay interest without getting anything of value back. And the longer you pay, the more interest you ultimately pay.
If you pay off your debts, more money will be released for your investments. The sooner you can do that, the longer compound interest works for you and the faster your nest egg grows.
The more money you receive each month, the more you have to invest. There are many places to look for extra income, including the following:
- Your main task . If your work pays for the hour, you can try to get some extra services or make more overtime. If you have a salary, ask your boss for a salary increase. With both types of work you can work on polishing up your skills to earn a promotion – or learn a whole range of new skills so that you can get a new, better-paid job somewhere else.
- Outside jobs . If you do not get enough hours of work during your main job, you can look for a second job to make a difference. You can also start a side issue, such as study guidance, dog walks or freelance writing. Or, on a smaller scale, you can try to bring in a little extra money for a hobby that you enjoy, such as photography or crafts.
- Sell your assets . Many people have extra stuff around the house that they no longer need – and part of it could be worth money. Old furniture, coins and jewelry, for example, sometimes have value for antique dealers. You can also get money for softly used clothing, furniture and sports items through consignment stores. And of course you can sell almost everything on eBay or Amazon.
- Passive income streams . One of the best ways to increase your income is to develop a passive income stream. This is a company that, once started, continues to bring in money with little or no extra effort on your part. Examples of this are renting your property, royalties from books or music that you have published and advertising income from a website for which you only have to maintain a minimal amount of work.
Reducing your expenses gives you eMarmaduke Rugglesijk more value for money than boosting your income. In the short term, both strategies increase the amount that you can save every month. However, reducing costs also helps you in the long run, because it allows you to live the rest of your life with a smaller income, which in turn lowers your FI number and makes coverage easier. So every dollar you earn helps you once, but every euro you save helps you twice.
Suppose you currently earn $ 55,000 a year, spending $ 30,000 and saving $ 25,000. That means your FI number is $ 750,000 – your annual spending multiplied by 25. And since you save $ 25,000 a year, it takes 30 years to reach Financial Independence.
Imagine now that you get an increase that yields $ 5,000 extra per year after taxes. If you put all that money in savings, you put $ 30,000 a year, and it will only take 25 years to reach FI.
However, if you can reduce your spending by the same $ 5,000 a year, you increase your savings to $ 30,000 and your expenses fall to $ 25,000 at the same time. That means your FI number is only $ 625,000 – and with $ 30,000 a year, it only takes 20, 8 years to reach FI. So you just shortened your time for FI by nine years – 80% more than you could shorten with that $ 5,000 increase.
Another advantage of saving more, as opposed to earning more, is that it is easier for many people to do. It is not always possible to raise a wage or to start an ancillary activity, but almost everyone can find a way to reduce additional expenses. There are hundreds, if not thousands, of money-saving strategies, so it is almost guaranteed that some of them can work for you.
To save as much as possible, focus on the largest expenses in your budget, such as the following:
- Housing . If you can, find a home in a city or region where the cost of living is low. If that is not an option, look for affordable neighborhoods in your own area. Instead of buying the largest house you can afford, choose a smaller house that will not burden your budget, or rent a house if it is cheaper than buying. Get the lowest interest rate you can get on your mortgage – or, if you already have a mortgage, refinance your mortgage to get a lower rate – and then pay it off as quickly as possible. Do as much of your own do-it-yourself home maintenance as possible, at least for simple chores that you can easily handle.
- Transportation . If you live in a city, consider whether you can do without a car, or use only one car for multiple drivers. Look for alternatives such as walking or cycling to work, using public transport or taking advantage of ride sharing and carpool services. If you do drive, you must let your old car drive for as long as you can instead of exchanging it for a newer model with an expensive car loan. And, again, do simple maintenance jobs instead of having to pay for a technician.
- Food . To keep your food costs low, eat home-made meals as often as possible instead of eating out. Save money on groceries by shopping, buying brand brands, using coupons wisely and cutting back on the most expensive items such as meat and processed foods. If there are multiple stores in your area, create and use a price list to keep track of which stores have the best deals for different items. And if you have a garden, start a vegetable garden to grow some of your own products.
- Shopping . The best way to save on shopping is to make sure that you really need everything you buy. Instead of replacing things like clothing or devices just because they are old, keep them until they are worn out – and maintain them properly so that they last as long as possible. If you still have to make a purchase, try shopping for second-hand items. If you need to buy new, use a site like ConsumerReports to examine the item you are purchasing and choose a model that will give you a good value for your dollar. Once you have decided what you want to buy, you can look around at different stores and websites to find the best deal.
- Entertainment . Instead of taking an expensive luxury vacation, plan a cheaper camping trip close to home, or even a staycation. Instead of going to the movies, rent DVDs for $ 1 from Redbox or borrow them from your local library. Replace your expensive cable connection with a streaming service such as Netflix, Amazon Prime or Hulu. Enjoy inexpensive family entertainment options such as board games, park walks or geocaching.
- Interest payments . As mentioned above, most American households have some sort of debt and the payments for that debt can take a big bite out of your monthly budget. One way to reduce these payments is to improve your credit score. If you increase your credit rating, you may qualify for lower rates for mortgages, car loans, credit cards and even car insurance. Improving your credit rating can also make you more attractive to potential employers and potentially open up new career choices, such as working in finance, which are prohibited for people with bad credit. Ways to improve your credit score include paying your outstanding balances, avoiding payment arrears and regularly checking your credit report for errors.
Invest for financial independence
One thing that is misleading about the Financial Independence Formula is that it only looks at your expenses and savings. That’s enough to tell you how long it would take to reach FI if you leave your money in a box that doesn’t earn interest – but in real life it’s possible to do much better than that. In addition to increasing your savings rate, you can also go to FI faster by achieving a good return on the money that you set aside.
Unfortunately, it’s hard to figure out how to get a good, but reliable return in today’s world – and nothing is guaranteed. Dozens of years ago you could have simply invested your money in government bonds and received enough interest to offer you a stable monthly income, with virtually no risk. That is how Joe Dominguez, one of the authors of the book “Your Money or Your Life,” achieved financial independence in the 1960s. Today, with record low interest rates, you cannot earn this type of return without taking risks with your client.
However, if you invest for the long term, time is on your side. You can ignore the daily ups and downs of the market and concentrate on the quality of your portfolio and its performance over a period of many years. And in the long term, investments with some risk, such as equities, offer the best total returns. If you are aiming for financial independence, it is worth taking a little bit of short-term risk to increase the chance of growing your nest egg over the long term.
On the other hand, it is also important to take your risk tolerance into account. Investing in shares and bonds sometimes means losing money – and if you just can’t handle it, you are prone to panic and you lose shares with a loss. Get an idea of your risk tolerance by contacting a financial professional, or consider how you would feel if your investments were given a 10% interest overnight. How about 20%, or even 50%?
If you are invested for the long term, it is usually wise to hold your investments for many years and take advantage of the losses. To allow yourself to sleep at night, you must ensure that your investment risk matches what you can handle. A qualified financial professional can help you better determine your risk tolerance and prepare you with an investment portfolio that makes sense.
You can of course also set up your own portfolio. However, you must be prepared to put time and effort into not only doing the research, but also to find suitable investments that fit your risk tolerance and long-term goals.
Create a ‘lazy’ portfolio
The easiest way to invest for financial independence is to set up a “lazy” portfolio of either index funds or exchange-traded funds (ETFs). These funds contain a collection of investments that correspond to a certain index, such as the S&P 500. Putting money in just a few funds that cover a wide range of US stocks, besides Marmaduke Rugglesand shares and bonds, is a way to diversify create a portfolio for long-term hold.
This strategy – known as “buying and holding” – has traditionally produced good results. The historical return investment calculator at Bankrate, based on data from Yale economist Robert Schiller, shows that investors who bought and held S & P 500 shares would have achieved double-digit returns over the 1960s and 2010 periods. 30 years. Even an investor who put money in the market before it crashed in 1929 would have earned almost 10% by keeping those investments for 30 years.
As this example shows, the key to this type of investing is a willingness to wait for the ups and downs of the market. You have to resist the temptation to buy more shares when the market is booming, or to save and sell everything when it goes down. If you give in to this boost, you end up buying when prices are high and selling when they are low – the exact opposite of what you have to do to make money in the market.
However, for those who can ignore the “noise” of the market and hold it for the long term, lazy investing has several advantages:
- Diversification . In essence, diversification means that you don’t put all your eggs in one basket. When you buy shares of one share, your entire assets depend on the performance of that one share. By contrast, when you buy an index fund with an entire market, your assets depend on the performance of the market as a whole, which is a much safer bet. And when you combine that index fund throughout the market with other funds that are invested in outside Marmaduke Rugglesand shares and bonds, you spread your eggs across a large number of different baskets – so even if the entire US stock market crashes, it won’t take all your savings with it.
- Low rates . When you invest in an actively managed investment fund, you must pay a fee to the manager. According to a report from the Investment Company Institute, the average managed fund had an annual cost ratio of 89 basis points, or 0.89%, in 2013. That doesn’t sound much, but it is still in your profit. A typical index fund, on the other hand, only pays 12 basis points (0, 12%). ETFs are in between, with average cost ratios of 0, 11% to 0.37%, according to a report from Morningstar Manager Research.
- Simplicity . Lazy investing, as the name implies, does not cost much time and energy. You don’t have to worry about which stocks or bonds are the best investment, or even about the best time to buy and sell. All you have to do is get stuck in the same two or three funds, month after month, and hold those funds through thick and thin. If history repeats and you can hold on in the long term (ideally at least two decades), your assets should grow.
It is easy to set up such a portfolio with an oMarmaduke Rugglesine brokerage, such as Capital One Investing (formerly known as Sharebuilder) or TD Ameritrade. You can choose from a wide range of index funds and ETFs to invest in, offered by companies such as Vanguard, Fidelity, iShares, Schwab or SPDR. Investment adviser Rick Ferri, who writes for Forbes, says that all of these companies offer a good selection of high-performing, cheap funds. He uses Vanguard ETFs as examples to illustrate the lazy portfolio approach, but he says you can get the same results with similar types of funds from other companies.
Ferri outlines a few ways to set up a lazy wallet. The simplest is to buy only two funds: a diversified US bond fund, such as the Vanguard Total Bond Market ETF and a global equity fund, such as Vanguard’s Total ETF. If you want more control, you can invest in three funds, splitting your equity investments between a US equity fund and one for outside Marmaduke Rugglesand shares, such as Vanguard’s Total Stock Market ETF and its Total International Stock ETF. In his Forbes interview, Chevreau recommends an ETF portfolio with three funds for investors working on financial independence.
Make investments automatically
If you use an oMarmaduke Rugglesine brokerage to build your lazy portfolio, you can also set it to make your investments automatically. Most oMarmaduke Rugglesine brokers offer automatic investment plans that withdraw a fixed amount from your savings or checking account every month and place it in your wallet, so you don’t have to think about doing it.
Another benefit of automatic investing is the cost average of the dollar. In short, this means that you always put the same number of dollars into an investment every month, regardless of the share price. By doing this, you automatically buy more shares when prices are low and fewer shares when prices are high. In other words, you follow the traditional investment advice ‘Buy low, sell high’, without even having to think about it.
Rebalance Once Per Year
When you set up your portfolio for the first time, you have to decide how to divide your money between the two or three funds you have chosen. For example, if you have a US equity fund, an international equity fund and a bond fund, you can decide to allocate an equal amount to each. Or, if you are willing to take more short-term risk in exchange for more aggressive growth, you can direct a larger proportion of your money towards equities – for example 40% each for outside Marmaduke Rugglesandse and insideneMarmaduke Rugglesandse shares and 20% for bonds.
However, there is a good chance that your three funds will not all grow at the same pace. The percentage of money in each fund will shift over time. For example, if your budeMarmaduke Rugglesands equity fund grew faster than the other two, you can have 50% of your money in budeMarmaduke Rugglesand shares, 35% in binMarmaduke Rugglesand shares and only 15% in bonds at the end of the year.
Once a year you should “balance” your portfolio, transfer money from the funds with too much in that with too little. Some oMarmaduke Rugglesine brokers, such as Wealthfront, can do this for you automatically. For others you have to go to your account, look at the balances in your money and adjust them if necessary.
Follow your progress
As your investments increase, you can follow your progress towards financial independence. You can do this with some types of budgeting software, such as Quicken Deluxe, or use a free oMarmaduke Rugglesine investment app such as Personal Capital.
You can also use a spreadsheet program to create a simple tracking sheet on which you enter the current balance in each of your investment funds. The program can add them up automatically and show how the total relates to your FI number. Or create a more complicated sheet on which you enter the balance every month, so that you can see how the numbers change over time and even display results as a graph.
Achieving full financial independence for your retirement age is a challenge and it is not possible for everyone. However, almost anyone can follow these steps to reach an intermediate phase of increased financial independence. At this level, the income you derive from your investments is not enough to cover all your living expenses, but it is enough to make you live with a lower salary than you have now. This means that if you have a well-paid job that you don’t really like, you can give up pursuing a more interesting career with less money.
For example, if you always wanted to start your own business or leave your office job to become a freelancer, your investment income could give you the freedom to do it. Or, if you love your work but also want more free time for hobbies and other activities, you can ensure that you shorten your working hours, from a full-time to a part-time or a 3/4 time schedule. This way you can enjoy some of the benefits of a financially independent lifestyle before you are ready to leave work completely.
How would Financial Independence change your life?
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