Finding Our Financial Independence Number
When starting our journey to financial independence, one of the first things we wanted to do was establish our financial independence (FI) number — or, in other words, how much money we needed to save before we could live off of our assets.
In theory, this is a very easy number to calculate. Based on the 4% rule, you would simply multiple your annual expenses by 25. For example, to provide $100,000 of income per year, you would need $2.5 million in investments.
While the calculation itself is simple, there were a few important things we needed to consider before we could establish an accurate FI number.
Current vs. Future Expenses
Because your FI number is based almost exclusively on on the income you need live on, it is essential to have a clear understanding of your post-FI expenses. While it can seem tempting to use a rough estimate, it’s worth taking the time to come up with a realistic number.
Underestimating this number can lead you to draw down your investments more aggressively in retirement (and potentially run out of money), while over estimating it can keep you working longer than you really need to.
Since we already track our spending meticulously, we used our current expenses as a starting point to create a post-FI budget and then reviewed each category to determine whether our spending would go up or down in retirement.
For example, since we plan to spend a lot more time exploring the world, we know we’ll want to at least double our travel budget. Meanwhile, our living expenses will drop substantially since we’ll be mortgage free.
By taking the time to review our expenses and make thoughtful estimates, we were able to come up with a FI number we feel confident in.
Wants vs Needs
When establishing our post-FI budget, there were times that we struggled with how much money we would really need or want to spend on various things.
For example, while we love the idea of travelling more, we both agreed it would be worth cutting back on to leave a job that was making us miserable. But since our current plan is to continue working after we reach FI — why not put the money aside for travel?
Questions like this led us to create two different FI numbers — a ‘just enough to get by’ number and a ‘room for everything we love’ number.
We used our more conservative budget to calculate the ‘just enough to get by’ number, and included only basic amounts for things like clothing, food and travel. Then we ran the numbers again using more lavish estimates to calculate the ‘room for everything we love’ number.
In the FI community, these are often referred to as Lean FI and Fat FI.
By calculating both numbers, we’ve created a range for our FI number. Once we hit the lower number, we’ll know our basic living expenses can be coverered.
We’ll keep working until we hit the higher number, but only as long as we’re happy doing so. If work become miserable, we’ll look for other work (even if it pays less) or consider retiring all together.
Net Worth vs. Investments
While net worth is an important number, it should not be confused with investments. This is especially true when pursing financial independence, as your FI number is influenced not only by the value of your assets, but by how much income they can produce for you.
Because we hold (and plan to continue holding) assets that are not income producing, it can be a little tricky to get a true senses of our progress towards FI. Namely, these assets include our house and a cottage.
While we currently rent our cottage out part-time, we plan to sell our home and live in the cottage mortgage free within the next 3–4 years (we’ll pay the mortgage off with the proceeds from our home).
Because of this, we won’t be able to utilize any of the value currently tied up in our home or cottage to create income. But certainly they should ‘count’ in some way — shouldn’t they?
After all, if we sold the properties to invest the cash and then utilized the 4% rule, the additional income we could draw would more than cover rent on a comparable property.
To keep things simple, we’ve calculated our post-FI budget to include a rent amount equal to the additional income we could produce by selling the properties and investing the proceeds (since in a way, that is the true cost).
This gives us an easy way to monitor our overall progress towards financial independence. And if we ever do decide to sell, we’re confident the additional funds would be sufficient to cover the cost of rent wherever we end up.
Thanks for reading! To learn more about our journey, visit Financially Free 2033.
