When you consider the idea of financial independence, you may wonder exactly what the concept entails. If you want to achieve financial independence, it is important to understand what it is and how to reach that goal.
We will take a closer look at the concept of financial independence and how to make this a possibility in your life.
What does Financial Independence mean?
Financial independence is often referred to as FI. You reach FI status when you’ve amassed a net worth that can sustain your living expenses for the remainder of your life without the need to work ever again. Essentially, when you’ve reached financial independence, you can leave behind the working world for good.
What is FIRE?
Now that you have a better understanding of financial independence, let’s talk about FIRE. The popular acronym of FIRE stands for “Financial Independence Retire Early.”
Once you’ve reached financial independence, you are put in a place that allows you to say no to jobs you don’t enjoy. Instead of spending your time in a position that doesn’t add joy to your life, you can choose to do things you enjoy.
In some cases, this permanent independence from a paycheck means that you can choose to retire early. Although you don’t necessarily have to retire early, many choose to retire from paid work completely or shift careers to pursue their passions. With careful financial preparations for a lengthy retirement, you have the option to leave the workforce.
How do you get financial independence?
The pillars of any plan to achieve financial independence include earning more, spending less, and investing along the way. You can use any combination of those three principles to work towards your financial independence goals.
As you use the strategies above to increase your net worth, it is good to have a FI number in mind. Many consider themselves financially independent when they’ve reached a net worth of 25x their annual examples.
For example, let’s say you spend $40,000 per year. With the benchmark number of 25x your annual expenses, you’ll need to reach a net worth of $1,000,000 to be considered FI.
It is important to point out that your exact FI number will vary based on your spending patterns, risk tolerance, and investment strategy. Although many consider that 25x annual expenses would allow you to be financially independent, you should factor in your own risk tolerance and investment strategies into this number.
Why is financial independence important?
Financial independence gives you the ability to say no to unfulfilling work. That benefit alone is enough for many to pursue this lofty goal.
Without the need for paid work, you can live life on your own terms. You might choose to continue working at the job you love, switch into a completely different career, or retire early.
Even if you love your current job and never plan to retire, achieving financial independence is still an important goal. Unfortunately, you might be forced into early retirement due to a layoff or injury.
No one wants to be reliant on paid work forever. Without financial independence, you will be subject to the whims of your employer. Most do not want to be dependent on paid employment as they continue their journey through life.
Is financial independence possible?
The idea of financial independence can seem like a lofty goal. It absolutely is a big goal, but it is possible for many. You can find numerous success stories of those who have reached FI. However, you’ll also find many that doubt financial independence is a possibility for anyone.
Luckily, there are a few prominent examples of those who have successfully reached their FI number. You can take inspiration from those who have achieved this impressive milestone. As you read stories of financial independence, consider incorporating different strategies into your own FI journey.
How can I be financially independent in 5 years?
If you want to reach financial independence quickly, it can be possible. However, the amount of time required to reach FI will depend on your unique money situation.
For example, if you already have a substantial net worth, you may be closer to FI than you think. But if you are starting with a large debt burden, it will likely take longer to reach your FI goals.
If you are interested in reaching financial independence, then take a closer look at the strategy below.
Determine your FI number
The first step on the path to financial independence is to determine your FI number. As we mentioned above, you can quickly calculate this number by multiplying your annual expenses by 25.
The logic behind this math formula is based on a study conducted by Trinity. The goal of the study was to determine a sustainable withdrawal rate from your retirement portfolio. After analyzing portfolios in different time periods of the market, a withdrawal rate of 4% was deemed a safe choice. With that, you can multiply your annual income by 25 to reach this safe withdrawal mark.
Of course, you can choose to adjust your withdrawal rate higher or lower based on your risk tolerance. For example, you could settle on a 3% withdrawal rate and adjust your FI number accordingly. Take some time to learn more about the risks associated with early retirement to ensure that you are comfortable before settling on your FI number.
Assess your savings plan
Once you have a FI number in mind, it is time to look at your current financial situation. Take some time to look at your debt, savings, investments, and other assets. You can view your net worth as a starting point towards your FI number.
After you determine where you are starting from, take a close look at your income and spending patterns. If you want to reach financial independence in 5 years, then you might need to consider massive spending cuts or increased income opportunities.
Determine a reasonable timeline
Laying out your net worth, income, and spending in black and white can be a wake-up call. You should look at the numbers and consider a variety of possibilities. You may want to reach FI in five years, but the numbers of your personal finances may force you to push back that goal.
Although it might be possible to reach FI in five years, it will take longer in many cases. Set up a timeline that allows you to reach FI within a timeline that suits your life. You can create a balance between spending and saving, which allows you to enjoy your life now while saving for your future financial freedom.
It is good to set income and spending goals to propel you on your path to FI. With a financial plan in place, it is easier to say yes to opportunities that help you reach those spending goals. Don’t cut too much enjoyment out of your life simply to reach FI as soon as possible. Otherwise, you can miss out on what life has to offer along the way.
Follow through on your plan
Once you have a plan in place, it is time to get down to business. As you build your income and reduce your spending, you’ll find that you have more money available to invest. Take advantage of the investment opportunities that you come your way.
You will find interesting investment opportunities throughout your journey. Although it might require learning something new, a flexible attitude will help you maximize your investment potential and move towards your FI goals. For example, you may decide to incorporate real estate investing into your financial independence strategy at some point. Don’t be afraid to adjust your investment plans as you learn more on your journey.
The bottom line
Financial independence is an achievable goal. Although it may take some delayed gratification and flexible mindset, you can reap the benefits of financial independence in your own life.
Building a strong financial foundation is the best place to start your journey. Take action today!