Financial independence, financial freedom, and retirement may seem like impossible goals. But like other goals, the best way to ensure you are on the right track is to put together a plan and periodically check to see if you are making progress.
So, if you do not already have your own plan for financial freedom, here is what you need to get started with your own plan for financial independence so you can declare FIndependence!
The Financial Independence Dough (“FIDough”) Basics in two steps
To develop a basic plan for financial independence, you must figure out two things: 1. how much money you will need to become financially independent (your Catching FIDough Number), and 2. how you will reach your Catching FIDough Number. Easy, right?
Step 1 – Determine your Catching FIDough Number by determining the income you want your FIDough to generate
To determine your Catching FIDough Number, you need some idea about how much you want to be able to spend the rest of your life without running out of money. Typically, this figure assumes you will be pursuing your non-paying FI interests and not have wage income. In other words, how much income would you like to live on in retirement? Of course if you have paying FI interests, as many people do, that’s a bonus and should make retirement easier.
Furthermore, if you expect to have other sources of income while retired (like a pension or social security), you only need to worry about generating the additional income you desire from your FIDough.
Your FIDough Income Number is the annual amount of income you would like your FIDough (or “nest egg”) to generate. This number should obviously be enough (when combined with other sources of income) to cover your expected expenses. So tracking your expenses over time becomes important. As explained, here there are many great tools to do this and my favorite is Personal Capital. But this “income” number must do more than merely cover your usual expenses. It must include enough to permit you to “save” for those infrequent big ticket items like cars, new home roofs, etc. You may also want to include a budget amount for travel that is higher than what you currently spend. For these reasons, figuring out your “expenses” in retirement is often more complicated than many think.
Once you have figured out your FIDough Income Number (which you can think of as expenses plus), you can get a rough (or is it ruff) idea of the amount you need to save to retire. In particular, to determine your Catching FIDough Number, a good place to start is by multiplying your FIDough Income Number by twenty five (or thirty). This is known as the “25 times” rule of thumb.
Catching FIDough Number = your FIDough Income Number X 25.
This number, which is the official minimum you need to declare financial independence. This figure, however, is in today’s dollars. Accordingly, it must be inflation adjusted into the future based on the number of years remaining before you want to officially become financially independent.
Although more than 25 times is even better, if your savings is roughly 25 times larger than the amount you will need to withdraw from your retirement portfolio in your first year of retirement, you should be in pretty good shape (especially if you are willing to make spending adjustments late if necessary).
There are of course other complexities and nuances that you can learn about here, but having some rough idea about your Catching FIDough Number is a great place to start with your own FIDough Plan. Another good resources on the topic is this book.
Step 2 – Figure out how to reach your Catching FIDough number
To determine how to reach your Catching FIDough Number (to catch FIDough), you need to determine the number of years remaining before you want to catch FIDough (your target date for Catching FIDough). You must then determine the remaining amount you need to save/invest to get your FI number within your timeframe goal. So, if you want to catch FIDough in 5 years, and you are $100,000 short of your Catching FIDough Number, you must grow your saving an average of $20,000 per year for the next five years.
Here too there are some complexities and nuances due to things like expected investment returns, etc., but you now have the basic framework to begin building your plan to catch FIDough.
An excellent explanation of the impact your savings rate can have on catching FIDough is Mr. Money Mustache’s The Shockingly Simple Math Behind Early Retirement.
Once you have your basic plan in place, the hard work begins. Saving and investing, and otherwise growing your wealth. If you start looking hard, you might be surprised at the number of places you can trim to help increase savings. Here, I have put together a practical plan that actually helps people save more without a traditional budget.
You may also find helpful the tools available in Personal Capital, including its spending tracker (my favorite), the net worth overview, retirement planner, and portfolio tools.
Good luck with your plan!