Do you have any long-term financial goals that motivate you? Anything that gets you out of bed each morning and into your corporate cubicle?
I’ve found that when I ask this question in real life, I’m often met with one of two answers.
- A blank stare
- “I’m saving for retirement”
A blank stare is understandable. Many individuals and couples haven’t ever thought about it, or discussed it. They are living life how they have been taught, one work filled day at a time, while trying to carve out their own little piece of the American dream.
From a young age, most of us are trained to get an education, get a job, and continue along that path for 40+ years until retirement or death. And that is the classical life cycle in America. After all, peak earning years come late, and Social Security isn’t available until you reach your 60s.
But there is a real problem with this line of thinking. It assumes we should all follow the same linear path from elementary school until death. It implies that we should spend the majority of lives at work, trying to climb the ladder, to get a raise, to buy a bigger house, to fill it with more stuff that wasn’t necessary to begin with. Only after you get old and retire do you have any freedom to make life decisions, or travel, or spend time with your family.
I can’t speak for you or anyone else, but I find that entire scenario repulsive. I’d like to have the ability to change careers, take some time off, or do whatever I want. It’s not about what I choose to do, it’s about the freedom to choose.
Welcome to Financial Freedom
What I’m describing is financial freedom, or the ability to make life decisions without worrying about financial constraints. It’s the ability to quit the job you despise without worrying about your next paycheck. Financial freedom is synonymous with financial independence or early retirement, all of which seem to be used interchangeably these days.
It may simply be a matter of semantics (or framing), but I prefer not to think of financial freedom as “retirement.” The term retirement has been soured because of the implications stated earlier in this post. People tend to view retirement as the last stage of life. It implies old age, tired bones, and health complications. It also tends to be viewed as “a long time from now” for working age individuals, which I believe contributes to the lack of savings in America. At age 25, why should I think about retirement? I have 40 years until that event occurs.
Because of these difficulties, I never tell others that I’m saving for retirement (or even early retirement). I tell them that my primary long-term financial goal is financial freedom. A brief explanation further clarifies my statement, and often leads to meaningful conversation on the topic.
The point is this, financial freedom is about the ability to make decisions. It doesn’t require that you stop working, or make any major life changes. But it allows you that opportunity.
Time (not money) is your most valuable asset. But money allows you the freedom to spend your time as you see fit.
Ask Yourself This Question
How would you spend your remaining years if money weren’t an issue?
You should seriously think about your answer, and ask your spouse the same question (if you have one). It’s a difficult question to answer, because it’s wide open.
That question is the entire point of this article. By focusing on achieving financial freedom, your life opens up. You go from sludging through 40 years of dreaded employment, to designing the life that you desire.
You don’t need to wait 40 years to find freedom, you can get there much quicker if you’ll devote your money, time, and energy toward that goal.
How You Can Achieve Financial Freedom
There are no insider secrets here. Financial freedom is most commonly defined as the point at which your assets (stocks, bonds, real estate, etc.) produce enough income to cover your baseline expenses. The rule of thumb in retirement planning is to use a 3-4% withdrawal rate for calculation purposes (Here is empirical evidence). In other words, you can withdraw 3-4% of your portfolio each year (increases are allowed for inflation) without depleting the principal. The goal is to primarily consume the dividends, interest, and appreciation.
Take a look at our scenario. We spent $10,000 in our first year of marriage. To obtain our “financial freedom number” we would multiply our annual expenses by 25 for a 4% withdrawal rate (1/.04 = 25x), or 33 for a 3% withdrawal rate (1/.03 = 33x). That means we need somewhere between $250,000 and $330,000 in saved assets.
Each additional $5,000 that we consume annually requires an additional $125,000 to $165,000 in supporting assets.
In reality, I think we can live comfortably on $20,000 or less per year (in lower cost of living areas). But there are additional unknowns, such as having children in the future, and all of the healthcare changes taking place today. To be safe, my current goal is to accumulate roughly $600,000 in a taxable account, plus any funds inside retirement accounts (IRA, 401k, SEP, etc.). The result is a portfolio that should be able to sustain our living expenses, even if the market plummets.
If you don’t know your monthly/annual expenses, you need to figure it out. The easiest way we have found is using the free Personal Capital tool.
Once you know your expenses, do the simple math required to figure out your own “financial freedom number.”
Next, Increase your savings rate
Your savings rate is a function of income and expenses. It’s best to both increase income and decrease expenses.
Increasing income is easy for some and difficult for others. Obviously more education typically leads to higher wages and more employment opportunities. You can also pick up books on negotiating your salary and benefits (like this one).
Decreasing expenses is equally important. As you can see above, small increases in annual spending require a significant stash of supporting assets. By lowering your annual expenses, and subsequently increasing your annual savings rate, you can get there much quicker.
We are currently close to a 90% savings rate, and while we haven’t achieved full financial freedom, we are progressing.
It has been important for me to figure out the appropriate balance of enjoying life today, while simultaneously staying focused on reaching financial independence. It can be a difficult task. What has helped immensely is being thankful for the progress made. Today at age 25, Vanessa and I are in a great position. Completely debt free, and enough assets to choose our jobs and even our careers without worrying about any temporary loss of income.
People often view financial freedom as an enormous task that requires years of saving and investing. That’s usually true, but it’s much more wise to focus on each victory along the way. For example, most people could pay off all non-mortgage debt, and accumulate enough assets to buy temporary freedom to find another job or career that they enjoy. Those are huge steps in the right direction that should be celebrated.
What do you think? Are you actively pursuing financial freedom?