What is Financial Independence?
The Financial Independence Retire Early (FIRE) movement has been getting a fair amount of press lately, but I think most of it has been misleading. The words retire and early were chosen to make a catchy phrase, but the movement does not really demand that you spend the rest of your life in a hammock somewhere. The movement is really about achieving financial independence so that you can do whatever you want without having to worry about money.
For practical purposes, the hardest part of this goal is achieving financial independence. In fact, even the meaning of financial independence is not really agreed upon. Most people think of some number, such as $1 million (or if one listens to Suze Orman, $5 million). This idea of saving up some large amount of money is a good start. It can reinforce the need to save and can spur you to make spending cuts. But to really make this work, a number is not enough.
Financial independence is really about replacing active income with passive income. Take a good assessment of the lifestyle you want to live. Be reasonable. A good starting point would be your current lifestyle. Be accurate and comprehensive about everything you are spending now. Be sure to include things that are only paid a few times a year (insurance, property tax, etc.). Then average that out to come up with a monthly spending rate. The following is a list of spending categories to help get you started:
Housing Association Fees PropTax/Insurance Home Maintenance Electric/Gas Water Garbage Internet TV Phone Cell Phones House Cleaning/Yard Maintenance Movies Concerts Clothes Drug Store Items Food Dining out Health Insurance Subscription Medicines Dental Insurance Vision Insurance Long Term Care Insurance Auto Fuel Auto Insurance Travel Discretionary
A very important thing to remember is that this monthly spending rate is made up of after tax dollars. You would then have to divide this number by (1 - effective tax rate) in order to calculate the total required income to support this lifestyle. The higher your monthly income, the higher your effective tax rate will be. On the other hand, this income will not be coming from a job, so one can eliminate Social Security (6.2% for employees up to $132,900 of gross income) and Medicare (1.45%) taxes from the effective tax rate estimate.
This final number is the monthly income that you will have to generate in order to be financially independent. The good news is that if you are currently saving money, this number should be less than your current income.