What Is Financial Independence?
If you’re here, you probably already know that financial independence (“FI”) is achieved when your passive income (e.g. income from stocks, bonds, or real estate) can pay for your spending. You no longer have to rely on an active source of income, like a job, to pay for your expenses.
The more important question is, how soon can we get there?
The number one thing that affects how long it takes you to get to financial independence is your savings rate, calculated as the percentage of your take home pay that you save. Here’s a graph of how many years it will take you to become FI at different levels of savings:
There are some real life caveats that I discuss in Building Wealth and Being Happy, but this graph is a great starting point because it’s so simple to interpret. If you save 10% of your income, you’ll be financially independent in 42 years. Save 50% of your income? FI in 15 years.
After writing the one thing everyone’s missing about the latte factor, I got a lot of e-mails about how small things like coffees and lunches out don’t really make a big impact on your financial health. The chart above disagrees.
For example, let’s imagine you make $50,000/year after tax and spend $10 every work day (250 days a year) on coffee and smashed avocado toast with feta, or whatever. That $2,500 a year is 5% of your income. If you already save 10% of your income a year, saving another 5% would decrease your time to FI from 42 years to 34 years.
That means you’d achieve FI 8 years sooner. Yes, 8 more years of being able to do whatever you want. Whether that’s playing video games and eating Cheetos, becoming a chef and coming up with your own avocado recipes, or even continuing to work at a job you enjoy, the choice is up to you.
So no, $2,500 a year doesn’t sound like nothing to me. In fact, it sounds pretty significant. Maybe you know that and still want the avocado toast, and that’s fine too – As long as you understand and accept the outcome. But to overlook those daily purchases as something that won’t make a difference is silly. Sure, they won’t make as much of a difference as your salary or rent, but they still matter.
Increasing Your Savings Rate
A lot of people get fixated on the income side of the savings rate equation. I won’t discuss increasing your income too much on this blog, for a few reasons:
- I don’t know who you are. I don’t know what your marketable skills are or what you could be doing to better utilize them.
- I assume you’re already trying to maximize your income to a certain extent. Me telling you to “get a job” isn’t going to help.
- There’s a limit to increasing your income. It can’t go up forever. If you’re already making a fair amount then it’ll be easier to increase your savings rate by decreasing your spending.
Decreasing your spending is incredibly powerful. In Building Wealth And Being Happy, I gave the example of someone who spends $200 a month at a hair salon and is trying to spend less. By going to a less expensive salon that costs $50 a month, they save $150 every month. Simple, right?
But there’s also a secondary effect. By decreasing your expenses now, you’re not only increasing your current savings, but you’re decreasing your future spending. In other words, the amount of money this person needs to become FI just got smaller because they won’t have to pay for the expensive salon in the future and they’ll have extra cash in their pocket every month to help them get there.