What is financial independence and why so many feel it's important
Financial independence is a concept where you don't need to work to support your lifestyle. It simply means you can retire.
With low job security these days, financial independence means less stress on paying off your bills .
Maybe that's freedom and flexibility to live and work on your own terms.
And it certainly sounds nice!
But I wouldn't suggest that you buy into this concept of financial independence because you hate your job. Work fulfilment is still a large part of happiness and not everybody who is retired is happy!
The equation of financial independence is having a large enough passive income to cover your expenses.
Most analysis seem to suggest a dividend income source and I've a collection of ideas below for you on it.
Why is financial independence hard to achieve?
Most people want to become financially independent but not everybody gets there.
Cars are not cheap and housing is so expensive!
One of the secrets to attaining financial independence is accepting it doesn’t usually “just happen”.
It requires a detailed plan and a willingness to commit to that plan.
Sacrifices must be made today to set aside a few thousand dollars each month to build up savings.
The widely used 4% withdrawal rule for financial independence and formula to calculate how much you need
Financial advisor William Bengen conducted an exhaustive study of historical returns in 1994 and concluded that no historical case existed in which a 4% annual withdrawal exhausted a retirement portfolio in less than 33 years. The retirement portfolio was made up of 50% bonds and equities.
What this means in retirement planning is if you have $1m and you withdraw $40,000 a year for your expenses in retirement, you would be fine.
You can flip the 4% rule and calculate how much you need to be financially independent. That is to use your annual expenses now and x25 to it!
To illustrate it, if your expenses is $50,000 per year, you would need $1,250,000 ($50,000x25) to become financial independent based on this 4% rule.
From William Bengen's rule, once you have $1,250,000 invested in 50% stocks and bonds, you can retire for at least 33years.
Ever heard of the 5% withdrawal rule? Plus research on pure equity portfolios for retirement
In an article by Eric Kong (Aggregate Asset Management), he stated a 5% withdrawal rule is possible. More from article here.
If his 5% withdrawal rule is true, it means that if your expenses are $50,000 per year, you would need ONLY $1m invested to retire instead of $1.25m.
A key component of his approach is to invest entirely into a basket of value stocks. No cash or bonds are owned unlike what is constructed in the 4% withdrawal rule's portfolio.
A contrary recommendation can be found by my colleague Wilfred. His article "The risk of using investments for retirement are often underestimated" states that volatility in equity markets can severely disrupt retirement planning. Follow more here.
He calculated that if you would to invest $922k entirely into the MSCI Singapore and withdraw $5000 per month, you end up running out of money 23 years later as shown below!
If this finding is true, then indeed, retirement relying on investment income can be risky.
Hence, I'd personally still prefer a diversified portfolio of stocks-bonds and always have some work even in "retirement".
What is FIRE or the FIRE movement?
FIRE is Financial Independence Retire Early.
At the heart of FIRE is to be frugal and have a huge savings rate (perhaps 50%-75%) to reach retirement early.
How early? Possibly before the age of 40.
I actually don't quite get the hype on retiring so early....
From polls, some believe that FIRE allows them to enjoy retirement.
Some want to be financially stable and have freedom to pursue artistic hobbies. Kind of like ending "required" work to make ends meet.
FatFIRE takes the concept of FIRE a step further.
There is less emphasis to retire exceptionally early and more emphasis to build assets.
A big portfolio of assets is needed to generate a generous passive income stream.
It is the key to affording the better things in life when you eventually retire.
If there is a chance to do space travel for $10,000 you can afford it. If it's a $10,000 Alaska cruise, you can do it.
Image from https://www.cruisecritic.com/articles.cfm?ID=2002
3 powerful charts on "How to achieve FatFIRE"!
Graph 1 by Financialsamurai.com
In his post, he calculated how much is needed for FatFIRE.
From the chart below, to live the FatFIRE lifestyle, you'd need to build at least $3m worth of net worth by age40 to get a $100,000 gross income rate.
This is still fairly modest.
He further calculated that if you want to live the FatFIRE life raising a family, you need at LEAST $5 million generating $200,000 a year or more.
In his calculations, you probably need to work until closer to age of 50 instead.
Graph 2 by campfirefinance.com
For FatFIRE with a $100,000 to $200,000 per year on expenses, this graph states how much money needs to be invested. The amount of money needed to be invested runs from $2.5m to $5m.
In his post, he described between LeanFIRE, FIRE and FatFIRE.
He believes that if you pursue Lean FIRE (which is to retire with less than $1m), you may be without enough room for error should an unexpected financial or health emergency show up.
On the other hand, FIRE and FatFIRE will both have more room for adjustments. However, they can be achieved only with a longer number of working years.
Graph 3 by minafi.com
From his chart, $1,000,000 seems like the most common goal for financial independence.
Only 10% of people are aiming at FatFIRE
In his post, he is concerned that most people retiring on $40,000 a year may have under-estimated their increasing spending in retirement years.
I personally think it is true. If you think of medical cost, it is an example of a potentially escalating cost when you age in retirement.
To achieve FIRE, you'd ONLY need to focus on saving hard and investing well.
But to get to FatFIRE, saving hard and investing well is not enough.
How would you get to at least $2.5m?
Find out 7 money habits that can keep you poor, watch video below!
Let's use Elon Musks as an example.
He could have retired a multi-millionaire after selling PayPal and lead a FatFIRE life.
However, he chose to solve other problems in the world and start new companies instead of fully retiring.
It's a habit or a winners mindset. Going for the Alaska Cruise everyday was not his motivation.
We can use this as the template. Achieving FatFIRE requires you to
1) Have a deep ambition and passion in your work
That is why people who dislike their work, wish to retire early but can't get there. On the other hand, motivated people develop habits to get to FatFIRE easily but don't actually retire.
Even Steve Jobs mentions about having passion in your work to really excel.
2) Provide superior value to the market place
It can be a career or a business. Providing more value eventually impacts how much you earn. Making $50,000 per year is NOT going to be the ticket to building a $2.5 million portfolio for FatFIRE.
FatFIRE is NOT about focusing on financial independence or the $2.5m mark.
When the $2.5m mark is achieved, it is a consequence of doing the above 2 factors well.
While it all seems logical, I'd leave you with this.
Developing these deep passion in your work and providing more value is not easy, are you willing to pay the price on it to achieve FatFIRE?
To hear more on retirement savings and calculations, watch video below!
Last updated on December 25th, 2020 at 03:53 pm