Achieving Financial Independence
Achieving financial independence (FI) is a goal or dream for most people. However, we find that, in general, most people do not know how much they need to be financially independent, or they have some abstract number that seems reasonable, but was pulled out of thin air. Achieving FI is no different than any other goal; it has to be SMART (Specific, Measurable, Achievable, Realistic, and Time-Bound).
In this post, we will illustrate in detail how to calculate how much is required to achieve FI and how a financial professional can be a very valuable resource in achieving financial independence.
First, Make Your Goal Specific
To make your FI goal specific, you must create a detailed cash flow plan of expected expenses if you did not work. This is not just routine monthly expenses, but plan for the once-every-few-years expenses; these are often forgotten and can wreak havoc on the best-laid plans. Examples of these expenses include car replacement and repairs, home improvement and repairs, vacations, special occasion gifts, etc.
If you feel you are close to financial independence, we strongly suggest you spend a few months, even a year, living on this projected budget to determine if you would be satisfied with your projected level of spending once you leave work.
Measurable
Now that you have calculated the annual expenses that will need to be met when you are financially independent, you will need to figure out where you attain income to meet your planned expenses. To begin, what guaranteed income will you have? Social Security, pensions, or annuities all fit into this category. If your planned expenses are covered by any of these guaranteed incomes, you can consider yourself financially independent with no need to work. However, for most, they will have an income gap to fill and this will need to be done by utilizing savings.
So how much in savings do I need to create the income needed to fill the gap? A rough guide is to utilize the 4% rule. Simply put, the 4% rule states that if you have your investments in a 60% stock/40% bond allocation, you can take 4% of your portfolio in the first year of retirement and not run out of money for 30 years.
Now to bring this all together with a simple example. You have determined that you need $100,000 a year in order to live comfortably. Social Security between you and your spouse equals $50,000 annually, you will receive a $30,000 pension, which will leave you with a $20,000 shortfall or gap that will need to be filled from your savings. Using the 4% rule you determine that you will need $500,000 to cover the $20,000 income shortfall.
Achievable
When and can I achieve the goal of financial independence? Calculating your pension and social security amounts is pretty straightforward. The annual amounts are available via annual statements from the federal government or your employer. However, accumulating the assets needed to fill the gap is completely up to you. Lets get to it! After determining the income gap that you need to fill to live the life you desire, you need to calculate if it is actually achievable. Without access to advanced software that we have at our disposal for our clients at Incline Financial Planning, we have created a straightforward spreadsheet so that you can calculate your savings and required portfolio balance so that you can decide if your goal is achievable.
Realistic
By utilizing our simple spreadsheet, you can begin to realize what is possible. This exercise is generally eye-opening to our younger clients. To see the unimaginable results that can occur with a little foresight and planning is extremely rewarding. Clients who are closest to financial independence have found value in our sophisticated software where we are able to illustrate the effects of charitable donations, planned inheritances, large purchases, varying market scenarios, and eventual medical needs just to list a few and their effects on their overall financial plan and well-being. This detailed planning for all of our clients provides what we believe is the best outcome for them, peace of mind…
Time-Bound
Becoming financially independent is not a guarantee for anyone, but a mere goal that needs to be calculated. To give your goal a time frame, again visit our spreadsheet. Calculate for yourself the tradeoffs of saving more today to achieve FI at a younger age or the costs of wanting to live more today to achieve FI at a later age, either way, the decision is yours.
Given that markets are volatile, rates of returns change, and your goals mature, we recommend that at least annually you revisit your plan to achieve FI and run the numbers that are personal to you.
Ultimately, if you have a goal it has to be a SMART!
How a Financial Planner Can Help
We outlined a fairly straightforward way to calculate firm numbers in determining if you are or how to become financially independent. However, the simple calculation is unable to capture questions or scenarios that are common and that you may or may not have considered. Such as:
- What if I want to retire before I can receive Social Security or my pension? Do I have to live on less by withdrawing just 4% until I receive those payments?
- What if my portfolio allocation has a larger stock allocation or is tilted more towards bonds? Does that affect the 4% withdrawal rule? If so, by how much?
- How will a one-time large expense or inheritance affect my future financial independence?
- What if my spouse passes away? How will this not only affect my income but expenses, and quality of life?
- How do market declines or increases affect the amount I can take from my portfolio?
- How do I factor in large unexpected medical expenses including the possibility of needing long term care?
This is a small sampling of factors that you may have not considered or have a hard time optimally calculating. Soliciting professional help will not only help optimize your resources for your situation but may also cover the expense of hiring such help in the first place.
We firmly believe at Incline Financial Planning that most people would be well-served with a professional in their corner. If for no other reason than to offer a second opinion or assessment of your current plan. The reason we provide a complimentary financial plan is to provide you with a risk free second opinion. We believe it is only reasonable to extend an offer to serve you as a client if we believe we can add value. Please contact us for your complimentary plan today.
