FI stands for financial independence. No – not the kind of financial independence that simply means Mom and Dad aren’t paying your rent anymore. This kind of financial independence is more akin to financial freedom. You may have seen FI used as a part of a larger acronym FIRE or FI/RE, which stands for Financial Independence Retire Early – we’ll cover FIRE in its entirety in a later post. FI in itself doesn’t necessarily involve early retirement.
In a nutshell, FI is the ability to live the life you want, without being hamstrung by your own finances.
To be financially independent means you’ve saved and invested enough money to be able to cover your expenses and be able to live, work, and enjoy life on your own terms – not beholden to anyone but yourself.
If this sounds like a pipe dream, or something only trust fund babies could achieve, we won’t blame you right off the bat. It seems a little too good to be true that just about anyone could become financially independent. But the real reason that most people won’t achieve FI is for that exact reason – we are our own biggest obstacles. And if we stick our nose up at something without understanding it, then we cut ourselves out the opportunity to figure out how we could actually do it.
FI doesn’t mean being exceedingly rich. It’s not about having so much money you don’t know what to do with it. It’s about achieving your own definition of wealth. FI is about leading a values-based, financially stress-free life. FI means making financial decisions that will allow you to take advantage of what you want in life without waiting for your “golden years”.
Many people associate FI with retirement, but that doesn’t have to be the case. Lots of FI’ers (as they’re affectionately called) may continue to work, but their financial independence allows them to pursue a job that they are passionate about. They aren’t forced to stick with a job purely for the paycheck.
FI takes effort. It means making tough decisions, both big and small, that will ultimately get you closer to your financial goals. Your goals may include the ability to travel at a moment’s notice, spend more time with the people you love, or have the time to pursue projects that bring you joy. In short, FI means that you’ve taken control of your finances so that you can actually focus on the things that bring your life meaning and purpose. Financial independence is developed by prioritizing your future over your present.
Chances are you have probably made a decision using FI principles and haven’t realized it.
Have you ever thought twice about buying something and decided it wasn’t worth it?
Have you ever put money away for retirement even though you would have enjoyed spending that money on something fun?
The internal dialogue you had while making those decisions is based on the same premise that FI is. The point is to cut spending, make strategic investments, and prioritize your future financial situation over the present.
There’s no magic formula
There’s no magic formula to achieve FI, but there are 3 major components to help you get there:
1. Live well below your means
Living below your means entails minimizing your expenses. For example, someone who makes $75,000 a year probably doesn’t have any more necessary expenses than someone who makes $45,000. Notice the italicized necessary. People who make more money, tend to spend more money, but that’s usually due to lifestyle changes that coincide with their salary. Meeting your basic needs costs the same regardless of how much you make. If you’re able to cut down on your lifestyle spending, it allows you to save and invest MUCH more than you would otherwise.
2. Increase the amount you save and invest
This step really goes hand in hand with living well below your means. The less you spend, the more you can save and invest, therefore the earlier you can achieve financial independence.
However, if you’ve cut your expenses as much as you can, and you still aren’t saving and investing as much as you want, it means you’ll need to figure out a way to increase your income. Pursuing a raise, switching careers, starting a side hustle – even starting a blog like The Ambitious Dollar – are ways people have made the tough decisions to use their current blood, sweat, and tears so they can live the life they want earlier than retirement.
3. Make strategic decisions that can help you achieve FI before retirement
These strategic decisions can be both large and small. Sometimes it’s as simple as assessing whether a 401(k) employer-matched account or a Roth IRA account will return you a better yield. Other times it can be a big decision, like deciding to move to a lower cost-of-living area in order to reduce your spending and increase your investment and saving opportunities.
Finding your FI number
Now that we’ve covered what FI is, it’s time to get out your calculator. By now you’re wondering, how much money would I have to have in order to be financially independent? How do I figure that out?
In order to find your FI number, you need to calculate your annual expenses and then multiply that figure by 25.
Part One: FI Number = Annual Expenses x 25
If you’ve already done the work and created a budget, calculating your expenses will be pretty easy. If not, you’ll need to lay the groundwork by combing through your credit card and bank account statements and calculate it all up for the year. Depending on where you’re at in life, it’s smart to consider the fact that your expenses may increase (i.e. if you have young kids and they’ll be dependent on you for the next 20 years) or decrease (i.e. your kids are grown up and won’t require much more financial support) in the foreseeable future.
For a simple example, let’s say you expect your annual expenses to be relatively stable for the foreseeable future and you’ve calculated them to be $50,000. So you take $50,000 x 25 = $1.25 million. That’s your FI number: $1.25 million. It means that you need to save and invest a total of $1.25 million in order to be able to cover your annual expenses. Now, don’t panic! Just keep reading.
Part Two: The 4% rule
Closely linked to the 25x rule, is what’s called the 4% rule. The 4% rule is a rule of thumb considered to be a safe withdrawal amount – meaning that you can, with relative safety, count on being able to withdraw 4% from your investments each year without worrying about running out of money. So if you were to have invested $1.25 million, you’d be able to withdraw 4% of that investment each year to pay your expenses without worrying about depleting your account.
The Trinity study, which founded this 4% rule, was based on 50 years of historical stock and bond data. It found that even in volatile market years, no retirement portfolio account was exhausted in any less than 33 years following that 4% rule. The reason the 4% rule is a rule of thumb, despite its sound research, is because it will depend on a few other factors including inflation rates as well as portfolio allocation.
Backing up to the previous FI number example, 4% of your $1.25 million dollar investment = $50,000. That’s the amount you had calculated as necessary to cover your annual expenses.
Remember, FI doesn’t necessarily mean retiring early
The point of FI is not to say you should be like this 30 year old who retired with $1.25 million. The point is for you to take control of what you can control. Achieving FI before retirement is not a pipe dream. But it’s not for those who aren’t willing to make sacrifices in order to prioritize their future over their present.
The average American household spends at least $51 per month on cable subscriptions, $288 on dining out, and $268 on entertainment. That’s a total of $607 per month. Add that up for the year and that brings you to a nice lump sum of $7,284.
This is not to say that you should quit all that unnecessary spending, have no fun, and be miserable until you achieve FI. That point is to highlight that all of these expenses are choices. FI is about being intentional with your finances and consciously deciding whether or not you want to prioritize the present or the future with any given decision.
The idea is to think rich, not to look rich
Those who are striving for FI focus on what matters and what is necessary. FI is the opposite of feeling the need to “keep up with the Jones’s”. It will require making sacrifices. But that feeling will pale in comparison to the ability to live your life the way you want knowing your expenses are covered.
If you’re mulling this over – thinking, “How cool would it be to be financially free? Maybe it is feasible? No, I can’t possibly do that”. Then the answer is no, you won’t achieve FI. But if you can quit mulling and start doing, you will find a way. Ask yourself what your time is worth. If the decisions you make now give you even one additional year of financial independence before you retire – would it be worth it?
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