Regardless of what state your finances are currently in or how your career has been progressing, true financial freedom is something that appeals to all of us. Who wouldn’t want the ability to choose when and where you work rather than being forced to work out of need?
Retirement and financial freedom can seem a million miles away in your 20’s or 30’s, but achieving financial independence at a young age is possible, and many people are actively working toward that goal.
What is Financial Independence?
Financial independence could mean many different things to different people, but for the sake of this article, we’ll be talking about accumulating enough money that you no longer need to work. You may choose to continue working, so retirement and financial independence are not necessarily synonymous.
The Trinity Study found that 4% is a safe withdrawal rate, and the 4% rule has become a cornerstone of the financial independence community. That means that if you can live for a year on 4% of your investment portfolio, you’ve reached financial independence.
For example, if you spend $50,000 per year to live, you would reach financial independence with $1,250,000 (which equals $50,000 x 25 years).
Keep in mind that this is a general definition. The goal of pursuing financial independence or financial freedom is to gain freedom over your life and to feel free from the stress and worry of money. A simple formula alone can’t dictate when you feel true freedom over money. Your goal for achieving financial independence could be higher or lower. For the sake of this article, we’ll be using this standard definition, but feel free to set higher or lower goals for yourself.
Getting Started Toward Financial Independence
Now that we’ve covered what financial independence is, let’s take a look at how to get there.
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Know Your “Why”
First, you need to understand why you want to pursue financial independence. Do you want to get out of a career that you don’t like? Do you want to be able to travel the world? Do you want more time with your family?
There is no right or wrong reason, but you should think about your own motivation because it can have a big impact along the way. Pursuing financial independence will require some sacrifices and it’s much easier to make those sacrifices when you realize why you’re doing it.
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Calculate Your Annual Spending
Before you can know how much money you need to save and accumulate in order to reach financial independence, you’ll first need to know how much you spend each year. This includes ALL of your expenses.
Hopefully, you already know how much money you spend each month or each year, but if not, you can use things like your credit card statements and bank statements to go back through the past year.
It’s also a good idea to start tracking your expenses on a regular basis to make sure you know exactly how much you’re spending. You can use an app like Mint or Every Dollar to help with tracking expenses, use a simple Excel budget spreadsheet, or write it down with pen and paper.
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Calculate Your FI Number
Once you know how much money you spend, you can calculate your FI (financial independence) number. The calculation is simple. Just multiply your annual spending by 25 to get your FI number.
However, you should also consider upcoming changes that may be occurring in your life that could either increase or decrease your spending. For example, if you’re currently married with no kids but you’re planning to have kids in the near future, you should expect that your annual expenses will increase.
If you’re spending $40,000 per year now with no kids, your true FI number is probably higher than $1,000,000 ($40,000 x 25) because of this.
In my case, I hope to be able to do extensive traveling in retirement, so I anticipate that my living expenses will increase and I need to account for that when calculating my FI number.
Maybe you’re not expecting any major changes and your living expenses will likely remain the same. If so, you can simply multiply your current yearly spending by 25 to determine your FI number.
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Increase Your Savings Rate
Your savings rate is the percentage of your income that you have left after paying taxes and all other expenses. If you’re currently making $60,000 and saving $6,000 per year, you have a savings rate of 10%.
Many financial experts recommend that you should have a savings rate somewhere around 15%, but that advice is based on a plan that involves working until you’re roughly 65 years old.
If you want to reach financial independence earlier, you’ll need to increase your savings rate. Many people who are pursuing financial independence are able to reach a savings rate of 40%-50%, or even more.
Don’t be intimidated if you’re nowhere close to that number right now. This is something that you can work on continually improving by finding more ways to cut expenses or by increasing your income (without also increasing your expenses).
→ Cut Monthly Expenses
When you’re looking for ways to increase your savings rate, take some time to evaluate all of your recurring monthly expenses. Reducing these expenses will allow you to save each and every month, and the cumulative impact of a few small changes can be a big increase in your savings rate.
Some recurring expenses like cable TV, expensive wireless or cell phone service, insurance premiums, as well as memberships and subscriptions can usually be reduced if you’re willing to shop around and consider making some sacrifices.
You can also reduce the amount that you spend on groceries, gas, utilities, and entertainment with some small changes and a little discipline.
Another option is to refinance student loans, mortgages, or other debt.
→ Establish Good Spending and Savings Habits
At first, finding ways to save may seem difficult, but you’ll quickly develop some good habits that make it a lot easier going forward.
If you want to make the process more fun, you could take a money saving challenge that gives you some added motivation to save as much as possible. You could do this on your own or find a friend to take the challenge with you to make it competitive.
Once you get into the habit of regularly looking at your expenses, savings, and net worth, you’ll find that saving money is less of a challenge and more a part of your normal life.
→ Increase Your Income
Reducing expenses should be one of your goals if you want to pursue financial independence, but the other way to increase your savings rate is to make more money. Many people in the financial independence community use a side hustle as a way to make extra money so they can save and grow their net worth faster. Riley works a second job as a freelance finance writer.
Another major benefit of a side hustle is that you can continue to do it (if you want to) after you retire from a traditional job. Many early retirees side hustle as a way to earn some income and to do something that they enjoy.
Side hustle income can also help to essentially reduce your FI number. For example, if you need $40,000 per year to live and you’re able to make $15,000 per from a side hustle (and you’re going to continue making that much in the future), you’ll only need an additional $25,000 to cover your living expenses.
That reduces your FI number from $1,000,000 ($40,000 x 25) to $625,000 ($25,000 x 25). So you can see why side hustles are so popular among early retirees. All the more incentive to make money while you sleep, explore a number of passive income apps, and learn why passive income is the best type of income.
Of course, a side hustle isn’t the only option for increasing your income. You may be able to get a raise at your current job by developing some high-income skills, working overtime, getting a promotion, or taking a higher-paying job. These options can allow you to increase your savings rate while you’re working.
Related: 21 Income-Generating Assets to Make Money
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Have an Investment Plan
All of that money that you’re saving will need to be invested. There are a lot of different approaches that you can take when it comes to investing money, but you don’t need to feel overwhelmed or intimidated if you don’t have much investing experience.
Most people who are pursuing financial independence take a very simple approach to investing using investments like the best index funds on apps like Robinhood. There are also a number of free stock trading apps that allow you to open an account and begin investing in individual securities should you wish to do your own research.
While stocks have a long-term focus for your investing horizon, you’ll also want to consider buying the best short term investments for your needs in the near future. This will avoid the need to sell stocks at any specific point in time, and allows you greater flexibility to draw down your investment account balances over time.
You’ll want to start tracking your net worth on a regular basis using some of the best financial apps so you can see where you stand and monitor your progress. Use a free tool like Empower (Personal Capital is now Empower) to make it easy, or simply create a spreadsheet to calculate and track your net worth.
- Empower (formerly Personal Capital) is a free app that makes it easy to track your net worth.
- You can link it to your bank and investing accounts, credit cards and more to see a single view of useful information and data, including your net worth.
- Free net worth, cash flow and investment reporting tools
- Dedicated investment advisor
- Tax optimization retirement account withdrawal strategies
- High minimum for investment management ($100k)
- High investment management fee (0.89% AUM)
You should also keep in mind that not all assets or investments are equal in terms of liquidity. Be sure that you have an emergency fund or some other investments/assets that can be converted into cash quickly if needed. In addition to calculating your net worth, it’s a good idea to pay attention to your liquid net worth, which takes these factors into consideration.
Some common and simple approaches to investing that you could use include:
- Invest in index funds like VTI
- Create a complete portfolio with mutual funds like VTSAX and VFIAX
- Use a robo advisor like M1 Finance
- M1 Finance's Smart Money Management gives you choice and control of how you want to invest automatically, borrow, and spend your money—with available high-yield checking and low borrowing rates.
- Basic account includes an FDIC-insured checking account and an M1 Visa debit card.
- Upgrade to M1 Plus and unlock perks including 1% cash back, 4.50% APY, ATM reimbursements, and 0% international fees.
- Invest in stocks, ETFs, and cryptocurrencies.
- Special Promotion: Open an account and get 3 months free of M1 Plus* ($31.25 value).
- Robo-advisor with self-directed investing capability
- Attractive cash-back and APY opportunities with M1 Plus subscription
- Doesn't support mutual funds
- Doesn't allow trading throughout the trading day (1 trading window for Basic, 2 for M1 Plus)
- High cost for M1 Plus service tier
Don’t Stop Here
Although this covers the basics steps for getting started on your journey toward financial independence, you’ll want to keep learning and improving your financial literacy. This is a long-term journey that requires significant commitment and some changes to your life, but those sacrifices and changes will pay off when you gain control over your life instead of being controlled by money and work.
Author Bio:
Marc is a personal finance blogger at VitalDollar.com, where he writes about topics related to saving money, managing money, and making money. He’s also created a course called Blog Launch Breakthrough that covers all of the steps needed to start and grow a money-making blog.
