I will be financially independent in under 10 years, how about you?
Last year, I decided to leave my comfy corporate job to do to missions work overseas. Because this move came with a massive pay cut, I knew I needed to get my arms around our financial situation. In the process, I stumbled across the concept of FI.
There are some things I love, and some things I don’t love about FI, but overall, I have found it to be BY FAR, the most effective method to build a plan for intentionally stewarding my money. However, it can be difficult to know where to start, so I created this simple, step-by-step guide to creating a FI plan.
Step 0 – Determine Your “Why”
While technically not part of the process, before you start on your FI journey, you really need to ask yourself what you plan to do post-FI. Your response could wildly swing how much savings you’ll need for FI.
If you don’t yet know your “why”, that’s ok. What a great opportunity to ask yourself this crucial question.
The Baseline
Step 1 – Determine Your current budget
How much does your current lifestyle cost? If you don’t know, start tracking everything you spend. You need to get a baseline of your expenses. I used to track my expenses with mint. Now I live in a place where credit and debit cards aren’t used, so I track all my expenses with google sheets and google forms. Here’s what my budget looks like:
I need $100,500 a year to maintain my current lifestyle and I’m currently saving $9,000.00 a year towards FI. Note how much you’re saving towards retirement, you’ll need that figure later. Here’s how my budget compares to the average American’s budget (as of 2018). I combined the like-colored rows from my budget to make it easier to compare the two.
This average American’s budget budget is based on an average of 2.5 people per “consumer unit”. At first I was kinda discouraged, because our budget is way higher than average, but we have 5 people in our family, so that explains part of the difference. We also give more, save more and insure more than average.
Step 2 – Determine Current Investable Assets (for FI)
Next, add up how much you have saved for FI/retirement. Odds are, your FI savings are in one or more of these accounts:
- 401k
- 403b
- 457b
- All types of IRAs
- HSA
- Any other brokerage, savings or checking account where you have funds designated for FI or retirement.
Do not lump your 529 or other tax-advantaged education savings plans in here. Those savings are not for FI, and you’ll likely spend them on some purpose other than meeting your post-FI living expenses. Likewise, you shouldn’t count your home equity in here, unless you plan to sell your house once you reach FI, and live in a tent….or van, which is a thing people do.
Finally, if you have rental properties or other income generating investments and plan to keep those income streams post FI, don’t count that just yet. Hang tight, we’ll come back to that. However, like home equity, if you plan to sell these investments once you reach FI, add in the value you’ll net after sale (including taxes, broker commissions, etc).
All clear?
Good, let’s look at a quick example.
Say, I have $225,000 in my 401k, $15,000 in my Roth IRA and $10,000 in my brokerage account. (These aren’t my real numbers but they’re in line with the average retirement savings, as per the 2019 Survey of Consumer Finances). In total, I have $250,000 in current investable assets for FI
Post FI Projections
Step 3 – Project Future Budget
Now that we’ve got our baseline, it’s time to look forward. In order to calculate how much we need for FI we really need to know what our budget will be post-FI. So, we need to spend some time thinking about how our budget might change post-FI.
This goes back to knowing your “why”. For example, if you want to travel 24/7 you’ll increase your travel budget. If you want to stay right where you are and do volunteer or ministry work, your post-FI budget might look pretty similar. Some good questions to ask are:
- Will you live in the same house/apartment?
- Will you want to travel more?
- Will you want to go back to school?
- Will you have (or still have) kids living with you? This will hugely impact categories like education, groceries, entertainment.
- Will you continue to need to save for anything….seems kinda obvious but don’t forget to zero out the retirement savings line if you no longer need to save.
- Will your level of giving change?
- Will your healthcare related costs change? We know health costs just go up as we age. Also, if you’re planning to FI and leave employer-provided healthcare, this is a big one.
Here’s my update budget with some notes so you can see my thought process.
I project I’ll need $83,600.00 a year post-FI. I probably could have lowered the budget even further but I want to err on the conservative side.
Step 4 – Assess Future Income Streams
Now we need to adjust our $83,600.00 for any post-FI income. This could be passive income streams, social security, pensions, side hustles, part-time work, any income you plan on generating after FI. If you plan to FI early in life, it’s pretty unlikely that you won’t have any extra income coming from somewhere.
For example, I have started to invest in rental properties. I like the idea of having passive income post-FI, as well as diversifying away from 100% stocks and bonds. My goal is to generate $41,800.00 a year in passive income which will reduce the amount I need to save significantly.
$83,600 (Annual Income Needed)
-$41,800 (Annual Passive Income)
= $41,800 (New Annual Income Needed)
Again, in the spirit of being conservative, I’m not going to include income from social security (check this out if you want to learn how to estimate social security income).
Choose Your Investments
Step 5 – Choose Asset Allocation
Now, we choose how to invest our FI/retirement funds. There have been volumes upon volumes written on this topic, and I have my own opinion on what, where and how to invest your FI funds. But, for the sake of our FI plan, we really just need to determine the average rate of return of our investments. So, if we assume that our FI fund of $250,000.00 is invested in:
- 80% US Total Stock Market Index Fund
- 10% International Stock Market Index Fund
- 10% Total Bond Market Index Fund
With the following rates of return:
- 10% US Total Stock Market Index Fund
- 7% International Stock Market Index Fund
- 3.4% Total Bond Market Index Fund
Our average rate of return is 9%
Step 6 – Choose SWR
Now, it’s time to select our withdrawal rate. Withdraw rate means what percentage of our FI investments we’re going to withdraw each year. Based on the Trinity Study, we can withdraw 4% a year and be relatively certain that it will last at least 30 years.
People on the more conservative end (yours truly) or those that are looking to FI earlier in life and need their savings to last upwards of 50 years may choose a lower withdrawal rate, such as 3.5%. This killer article from thepoorswiss.com walks through all the details and shows that with our example asset allocation and a 3.5% withdrawal rate, we have a 98% chance of not running out of money, even after 50 years!
Step 7 – Calculate your FI Number and Date
Calculating your FI number is pretty straight forward. In our example, I said that I needed $41,800 a year and I am going to use a withdrawal rate of 3.5%. So, $41,800/3.5% = $1,194,286.00.
I need to save $1,194,248.00 to be financially independent
Now, to figure out how long it will take to get to FI, you use the NPER formula. We have all the variables we need:
- PV – I have $250,000 in current investable assets for FI
- PMT – I am saving and additional $9000.00 a year towards FI
- RATE – My average rate of return is 9%
- FV – I need to save $1,194,248.00
When I plug those into a spreadsheet, or my Time to FI calculator, I come up with 14 years and 8 months.
My time to FI is 14 yeas and 8 months
Now that I have a first-draft FI plan, I can start to play with the variables and figure out how to accelerate my path to FI. A few examples:
- If I change my withdrawal rate to 4%, my time to FI changes to 13 years 3 months. 4% is more than sufficient according to mrmoneymustache.
- Further, if I reduce my grocery, restaurant and entertainment budgets by $55 each month, my time to FI changes to 12 years 4 months. Totally do-able.
- On top of that, I can take advantage of some tax benefits available to expats and rental property owners to reduce my tax bill to zero and now I’m FI in 9 years and 11 months.
So, what’s your time to FI?
