Hello! New to Financial Independence, A.K.A. FI? Welcome, we're happy you're here.
This guide will walk you through the basics of financial independence but if something doesn't fit for your life that's ok. This is your journey and your life. Use the tips you find helpful and toss the rest. We know as a group we can get a little extreme (ok, a lot extreme), but our community is full of diverse and wonderful people. There is no one way to reach financial independence.
A Quick Summary Of Financial Independence
Simply put, the goal of the FI movement is to save 25 times your annual expenses. It is thought that once you have this amount saved you can begin withdrawing enough from your investment accounts to cover your expenses. At this point you would be considered “financially independent” and no longer need to work for money. Your time is your own.
The FI community puts a lot of emphasis on “savings rate”. This is the percentage of your income you are saving or investing. As a rule, we aim for a savings rate 40-50%. That probably sounds like a lot–and it is! Traditional personal finance usually aims for a 15% savings rate. But then it can take 40+ years to reach FI. We don't want to work at a job we don't love for 40 years. The FI community thinks differently. We are striving to reach FI as quickly as possible!
Aiming for a 50% savings rate is one reason the FI community is so unique. We all work together to share tips and encouragement to live this lifestyle. This is support and information you won't find at your neighborhood barbecue.
If you want to join the community you can join the ChooseFI Facebook group here.
Lower your living expenses
Lowering your living expenses is a major focus for the FI community. Having lower expenses allows you to reach financial independence more quickly for two reasons. First, it allows for a higher savings rate. Every dollar you don't spend is a dollar you can invest. Secondly, lower annual expenses means less needed in your nest egg. For example, if your annual expenses are $100,000 you would need $2.5 million saved. But if your annual expenses are $30,000 you would only need $750,000.
Keep this in mind, for every $100 per month you spend that's $30,000 you need to have saved. Yikes!
You can see how having lower living expenses can have a double impact! It allows you to save more while you are working, and at the same time need less. You will reach financial independence years or even decades earlier.
Housing is likely your largest expense. Getting this for free or very cheap goes a long way towards increasing your savings rate. House hacking is when you find a way to eliminate or greatly reduce your housing costs. Typically, this means renting out a portion of your home. This may mean buying a duplex and living in one side while renting the other. Or simply renting the spare bedroom in your home.
It may also mean more creative ways of living, such as living in a modified van or living with an elderly person and trading rent for services around the house.
If you choose to house hack by renting a portion of your home this allows you to both reduce your housing costs and invest in real estate. For example, say you purchase a three bedroom home and have a $1,500 per month mortgage payment. If you rent out two bedrooms for $700 each, your monthly housing cost is now $100 per month!
Remember when I mentioned that not everything in the FI community will apply to you, and that you'll likely pick and choose. We realize not everyone can “house hack”. But we can all be mindful of our housing expense. If you ever find yourself in the market for a new home, perhaps downsizing will be right for you.
The path to financial independence is not about living a life of deprivation. You can travel more than you realize for free or very cheaply using travel rewards. This is an easy way to reduce a large expense in your annual budget! The general idea is that you use credit card rewards (earned through sign-up bonuses) to cover your travel expenses.
There are two outcomes here if you take travel rewards seriously. Either you’ll go on the same amount of vacations for a dramatically reduced cost, or you’ll travel even more with the same (or maybe less!) costs.
While the FI community may not be as anti debt as the Dave Ramsey Community (leverage through real estate is common). We prioritize paying down consumer debt like credit card balances, and student loans. The sooner you pay off your consumer debt the sooner your financial freedom clock begins. We look for ways to radically decrease our structural expenses. Paying interest and making payments to finance your life will slow down your path to financial independence.
If you currently have credit card debt, consider doing a balance transfer over to a card with a 0% intro rate and pay it off as quickly as possible. Here are our recommended balance transfer cards.
If you have student loan debt, look into Credible to see if refinancing it would save you money. The less interest you pay the more you can save for financial independence.
Easy ways to reduce other expenses
Obviously, we all have more expenses than just housing and travel. Here are some common ways to reduce the other expenses in your life.
- Cutting the cord–Nowadays it is easier than ever to get all the entertainment you want without having an expensive cable bill. If you have a good internet connection, you can connect to some of the following services and probably still be able to watch the same content you were watching earlier!
- Netflix, Hulu, HBOGo, Amazon Prime etc
- SlingTV, etc
- Learning to cook–With the vast amount of recipes online, it is easy to get started cooking your own meals. There are benefits beyond cutting your restaurant expenses, including healthier food, entertainment and family bonding. We typically aim for a cost of $2 per person per meal. Follow us on Pinterest for recipe ideas.
- Check your insurance costs–When you first got your various insurance policies you probably didn't shop around too much, or at least haven't shopped for them in years or maybe even decades. Policygenius can help you compare prices for all your insurance needs. Even if the savings per policy term are small, just imagine the recurring savings or decreased compounding interest.
- Cell phone–Services like Republic Wireless offer great cell service at a much lower rate than the major carriers. This is an easy way to save money without affecting your lifestyle.
- Lower your utility bills–Bills like your electric bill, water bill, and others can be lowered by changing some habits. This doesn't have to be extreme, sometimes it's just a matter of being more intentional.
- Car expenses–Biking to work can save big bucks on car expenses. Not only do you not have to pay for gas, you will also save money on your car insurance by driving fewer miles. Of course, this will also extend the life of your car. Here's how to get started biking to work. But even if you bike to work, you'll likely still own a car. Here are some tips to get the most mileage out of your car.
The main focus of investing for the FI community is broad based low cost index funds. We talk a lot about Vanguard's Total Stock Market Index Fund, VTSAX as marker/ticker for this type of fund but Fidelity and Schwab have equally good if not better funds with even more competitive/lower fees.
There are a multitude of studies that show that on average, actively managed mutual funds struggle to match and often underperform their relative indexes in large part due to the headwind of the higher fees that are associated with actively managed funds as compared to index funds.
An actively managed fund that charges 2% per year would need to outperform the index by 2% just to match what you could earn in the index. This is extremely difficult to do over longer periods of time.
A total stock market fund will track the stock market as a whole. Your returns will match the returns of the market. If you would like to include bonds in your portfolio the same can be said for a total bond market fund, such as Vanguard's Total Bond Market Fund.
One popular tool is used by the FI community is Personal Capital. It will pull in the information from all your investment accounts into one dashboard. This allows you to see all your investments in one place, including your overall allocations. It's extremely handy, and free! Check out our review of Personal Capital here.
As much as we love index funds, your first investment will likely be with your employer's retirement account (401K/403B/457). You will want to take advantage of any match, even while you are paying off debt. While there will be exceptions to this (payday loans, credit card debt emergency, with 20% interest) the pre tax match is incredibly valuable and acts like an instant raise.
What is great about contributions to employer accounts is that they are tax deductible. Any contributions will reduce your tax liability this year. While you will pay taxes on your withdrawals you will likely come out ahead. The logic being that you will likely be withdrawing this money after you leave your job and be in a lower marginal tax bracket.
Traditional IRAs offer the same tax advantages as employer retirement accounts except you have much more control of your investments.
Roth IRAs differ in one way. Contributions to Roth IRAs are not deductible but are tax free upon withdrawal. They also offer several benefits for the FI lifestyle. Contributions to the Roth IRA can be withdrawn tax & penalty free which make it a compelling saving vehicle when you are in a lower tax rate. it Also makes it easier to implement one of the more advanced tax strategies like the Roth Conversion Ladder.
Generally, you'll want to contribute the maximum amounts to both your employer retirement accounts and an IRA.
Rental properties are loved by the FI community because for a small down payment there is the potential to immediately generate cashflow and many people in our community have beaten the game using this strategy. This strategy is put into overdrive when you stack with a concept like house hacking that we discussed earlier.
Side hustles are a perfect fit for those pursuing financial independence. Anything you do to make money outside of your regular job counts as a side hustle.
Before you reach FI side hustles increase your income, which you can use to increase your savings rate. Then if you plan on continuing your side hustle after you reach FI it reduces the expenses your nest egg needs to cover, which allows you to need less, therefore reaching financial independence sooner.
For example, lets say you are earning $60,000 and living on $30,000. To have 25x your expenses you would need to save $750,000 to reach FI. This would take just under 13 years to accumulate (assuming a 10% return). However, if you start a fun little side hustle that earns $1,000 per month your numbers will change dramatically.
If you don't plan on continuing your side hustle after FI you will still need the full $750,000. But that extra $1,000 a month into savings would take two years off your FI journey. However, if you truly enjoy your side hustle and plan to continue it after FI, this reduces the expenses you need to cover to $18,000 per year. Which means you only need to save $450,000, and you will be able to reach FI in just over seven years.
In this example, a side hustle cut the Financial Independence journey almost in half!
If you'd like to learn more about starting a side hustle check out this podcast episode. If starting a blog is something you've been thinking about (it can be a great side hustle!) check out this episode.
The 4% Rule “of Thumb?”
We keep talking about having 25x times expenses, why? Where did this number come from? This is largely based on a 1998 study called the Trinity study which looked at what percentage of investments a retiree could reliably draw throughout all investing timelines without running out of money. The study concluded that 4% was a safe withdrawal rate with a 95% + rate of success. This study is not without some well founded criticism, in particular it has been questioned whether the data from this study could be extrapolated from the regular retiree with a 30+ year retirement to the early retiree with a 60+ year retirement timeline. But while the 4% rule may not be perfect, it gives us a great place to start.
The stock market has had an internal rate of return of 7-8% since 1950, and so if the market returns on average even 7% then you should be able to withdraw 4% in inflation adjusted dollars year over year without drawing down on the principal. Congratulations you have likely created a perpetual money making machine.
Using some mathematical gymnastics we can calculate how we need in our investments by multiplying our annual expenses by 25. Note that it is not based on your income it's based on your expenses. This is incredibly powerful. Most retirement calculators on the internet are designed to calculate how much you need to have saved to replace your income. This is a fundamentally flawed approach that could have you working decades longer than necessary.
Whether or not you choose to RE (Retire Early) is a personal choice likely based on whether you get value from your job but is no longer needed to fund your lifestyle.
Get 1% better
If you are just discovering these concepts for the first time you may feel a little overwhelmed. I know I did! You might have thought you were killing it with your 20% savings rate and now you feel behind. That's normal. You don't need to eat the whole elephant today, or even this year. Just focus on what you can do this week to get 1% closer to your end goal. We call this the Aggregation of Marginal Gains. In the future, when someone asks you how you reached FI you can say “I packed my lunch and brought it with me to work each day.” While that may seem silly and insufficient, it isn't that far off from the truth. There's not one thing that you can do, it's a layering of all of these life optimization strategies that will propel you to financial independence.
Just start optimizing your life 1% at a time and you will reach your goal faster than you ever thought possible.
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