Today I’d like to go over one of the most vital steps that will begin to propel you towards financial freedom. Financial independence is a term that I toss around a lot and, at its most basic, FI is having enough money stored away or invested so that you now no longer have to do any type of mandatory work. No more 9 to 5, meeting unreasonable deadlines, sitting in traffic, or doing any type of job that you no longer enjoy. I’m willing to argue that this is one of the greatest freedoms we, as human beings, can attain. It allows for so many opportunities to obtain happiness through simple things like getting enough sleep, spending time with family and friends, raising your children, being active, accomplishing goals you previously didn’t have time for, and the list goes on.
Now in order to do this your going to need a lot of money. This is a fact we can’t hide behind. So you may be asking well how much do I need? Fortunately for us, there have been many great minds who have done tons of research on this topic and have found a very safe number for us to determine what our retirement or financial independence date will be.
This is called the 4% rule
The 4% rule indicates that when you retire, if you only withdraw 4% of your networth per year you should be able to live the rest of your life without running out of money. So how does this work? First, you have to determine what your expenses are per year. So, let’s say you’re a pretty frugal person and you’re able to keep your expenses low. You determine you and your family are able to live off of $24,000 per year. This means that you will need to have a net worth of $600,000. Now i like to determine the amount needed per year based off how many hundreds of thousands you have saved. So as I mentioned $600,000 will mean you can withdraw $24,000 safely per year, $700,000 allows you $28,000 per year, $800,000 will get you $32,000 and if we jump to one million dollars, you and your family can live off of $40,000 per year for the rest of your life.
How will I not run out of money?
If you read my past article you may remember that I mentioned how much the stock market earns on average. Although the stock market has averaged close to 10% over the past 100 years, a conservative number I like to use is 7% as it accounts for inflation. So lets say you have $800,000 saved and invested and you feel you are ready to retire. You have now quit your job and you withdraw $32,000 the first year to cover your expenses. You have now depleted your account by $32,000 leaving you with $768,000. But we forgot to add the interest you earned throughout the year averaging at 7%, which would give us an amount of $56,000. This leaves now with an additional $24,000 or $824,000 for that year.
Now this is just a hypothetical situation and it is possible the stock market can perform at under 7% or even much higher than 7%, we are strictly speaking in averages here.
What this illustrates is that you can generally count on your money to continue to grow even after you retire. The simple math is a 4% withdrawal is offset by a 7% stock market gain leaving you with 3% a year on average that your money is still growing.
Another benefit that many people ignore is that when you retire your annual costs often go down. Because you no longer have a mandatory daily commute to work your costs for gas, vehicle maintentance, uniforms, lunches out, tolls, etc.. are generally removed. So you may find that you initially you thought you needed $32,000 per year but it may very well go down to something like $28,000 giving you an even larger safety net in retirement.
I now urge you to figure out what your current expenses are. See if theres some trimming that can be done to lower the amount you need each year to cover your expenses. This will give you a good idea of how much time you will need to reach your finanical independence number.
One great tool I use is a compound interest calculator. You can follow this link https://www.investor.gov/additional-resources/free-financial-planning-tools/compound-interest-calculator and put in the current amount you have saved, how much you plan to save each month, and use an interest rate of 7% to determine how many more years you have to reach your financial freedom number.
Feel free to comment below and let us know how much time you have until you can reach your retirement date.
Stayed tuned for more information on types of investments, retirement funds, and how I have my money allocated.