Last Updated on August 11, 2024 by Arurhose
Achieving financial independence is a common aspiration for many people. The prospect of sustaining yourself solely through personal income, without dependence on employment or external monetary assistance, is appealing. However, the challenge lies in identifying the specific figure that will enable your level of freedom. This is where the concept of the Financial Independence Number, often referred to as the FI Number, comes in. Let’s go through defining an FI Number, factors to consider when calculating yours, and establishing objectives based on your figure.
What Is Your Financial Independence Number?
Economic freedom and the financial independence numbers are more than just a figure; the numbers represent something more profound. It means the life you want to live, which could be how much you work, how often you work, and where your kids go to school. If you work, do you even need to work? Are you working because you enjoy what you do, or are you working because you need to? A financial independence number is different for everyone. For some people, the number is extensive. Of course, that is relative to who you are. If you’ve never asked yourself what your number represents, now is a good time.
Before continuing down this route, it’s important to mention that understanding your number is very personal. Your number will be specific to you and those around you, even beyond you, to the Legacy you leave behind. Your FI number is more than a numeral on an Excel sheet; it is who you will be. Who you are going to be is very different from who you are today. Understand that becoming that person will require sacrifices and difficult life choices; you can’t have it all, and some things in life are not in the cards for you.
What do I mean? You’re probably not going to have 20 kids, you’re probably not going to get the Ferrari you’ve always wanted, and you might not get the house you want. There will be many compromises such as: schools or the area you want to live in. You are going to make difficult choices and actively decide to remove certain things from your life. That is going to be a painful, honest, and yet beautiful. You’ll be living intentionally.
Where Are You Now?
Like most things in life, you start where you are, and that’s important. Where are you now versus where do you want to be? It’s essential to have an authentic and transparent assessment of where you are, like looking in the mirror. In addition, you might already be close to your goal without even knowing. A good example is when I found out I was worth a million. One day, I sat down with my wife, assessing our earnings, assets, debts, etc, and we were shocked to find out what we were worth.
So understanding where you are is essential – what do you enjoy? What is missing? If you finish the month in debt or the positive, tally up everything you have going on every month. Tall up costs from your rent, transport, food, everything necessary and unnecessary. Put everything in there and then get a number (I advise using Excel workbooks). This is how much you spend and what is important to you. This is your number. Now, let’s see where you want to be.
Understanding Your Financial Independence Number?
Establishing your financial independence number is an essential component of comprehending your financial aspirations and strategizing for the future. This process begins with a thorough evaluation of your current expenditures, which encompass housing, utilities, transportation, healthcare, and various other living expenses. Additionally, it is important to factor in elements such as inflation and the possibility of unforeseen emergencies when calculating your desired financial target.
After gaining a comprehensive understanding of your expenses, you can begin to estimate the amount of money required to sustain those costs on an annual basis. A widely accepted guideline suggests that retirees can withdraw approximately 4% of their total savings each year, commonly referred to as the 4% rule. For instance, if your yearly expenses amount to £50,000, your financial independence number would be calculated at £1.25 million (£50,000 divided by 0.04). However, alternative strategies may also be considered, which can be explored in future discussions.
Knowing your financial independence number is crucial, as it establishes a clear objective for your savings and investment efforts. This figure serves as a concrete target, enabling you to assess your progress toward achieving financial independence. By being aware of this number, you can make educated financial choices and implement necessary adjustments to your savings or spending patterns, ultimately empowering you to reach your financial goals more efficiently.
Where You Want To Be?
Understanding our desired future is closely linked to recognising our current situation. It’s the difference between the lifestyle we aspire to lead and our present. Try to envision who you will become in a decade. Consider various aspects of life, such as the possibility of marriage, raising children, and caring for ageing parents. By vividly imagining these scenarios, you can better understand the experiences you wish to pursue and be responsible for. Then, quantify these experiences into financial implications or numbers and write them down in an Excel sheet for simplicity.
In my first effort to calculate my Financial Independence Number, I did not fully appreciate the impact of my children’s future ages on my financial planning. I only looked a decade ahead, not realising my children would still be in their teenage years, which constrained my overall strategy. While I did take into account certain factors like travel—planning for two significant vacations each year along with several shorter getaways—I overlooked the broader implications of my children’s growth and the associated costs that would arise as they transitioned into adulthood.
Additionally, my initial considerations included my newfound enjoyment of dining out and staying in hotels, as well as accounting for all my regular bills and potential medical expenses (insurance). However, a more comprehensive approach would have involved projecting further into the future, allowing for a more accurate assessment of my financial needs as my family dynamics evolved. By expanding my vision and incorporating these elements into my financial planning, I could create a more robust strategy that aligns with my current lifestyle and long-term aspirations. What I’m trying to say here is where you want to be, and your FI number needs regular reviewing as your life evolves.
Factors Influencing Your Financial Independence Number
Determining your financial independence number can be a soul-searching process, depending on various honest factors. Here are some key points that can influence your financial independence number.
Firstly, your current lifestyle (and the future lifestyle you want) plays a significant role in determining your financial independence number. The more extravagant your lifestyle, the higher your number will be. This includes factors such as housing expenses, transportation costs, and monthly living expenses. It’s important to evaluate your current spending habits and make necessary adjustments to ensure financial freedom in the long run. Remember, the biggest and most important step towards FI is directly tied to your needs; when you reduce your needs, you directly reduce your FI Number.
The second most crucial factor to consider is your desired retirement age. The earlier you plan to retire, the higher your financial independence number will be. This is because you will need to accumulate enough savings to sustain yourself for longer. It’s not just important; it’s urgent to start saving and investing early to reach your financial independence number by your desired retirement age. Retiring at fifty-five, fifty-seven, even sixty is a win in my book.
Another critical point is that your investment returns will significantly impact your financial independence. A higher investment return means you will require a smaller nest egg to achieve financial freedom. However, investing comes with its risks, and it’s crucial to have a diversified portfolio to ensure a stable income stream. I’ll discuss my approach in a future post.
Evaluating your current lifestyle, investment returns, and desired retirement age are not just crucial steps, they are your responsibility. Understanding these key factors is a proactive step towards your FI goal.
Setting Achievable Goals Towards Financial Independence
Establishing realistic objectives is a crucial step on your journey to achieving financial independence. Identifying specific, measurable, attainable, relevant, and time-bound (SMART) goals that align with your personal financial aspirations is essential. By breaking down larger financial ambitions into smaller, manageable targets, you can create a clear roadmap that guides your decision-making and prioritizes your financial activities. My wife and I started with 5-year plans; now we have moved into 10-year plans (made of two 5-year or some 3-year goals). This structured approach enhances your motivation and fosters a sense of accomplishment as you reach each milestone.
Setting your financial goals should always begin with thoroughly assessing your current financial situation. As mentioned above, this includes a detailed review of your income, expenses, debts, and savings. Understanding where you stand financially is the key to identifying areas that require improvement and strategic choices. Additionally, it is beneficial to consider both short-term and long-term goals, as having a dual focus can provide a balanced perspective on immediate needs while also paving the way for future stability and growth. In the short term, I have plans to buy a property a year for the next four years; this is a 4-year goal within an overall 10-year plan.
Furthermore, it is crucial to remain flexible and adaptable in the pursuit of financial independence. Life circumstances will change, and unexpected challenges will arise, forcing adjustments to your goals and strategies. This adaptability is a key component of successful financial planning, ensuring you are prepared for any situation.
Regularly reviewing and revising financial objectives ensures that your plans remain relevant and achievable, allowing you to stay on track despite any obstacles. By maintaining a proactive, resilient and intentional mindset, you can navigate the complexities of personal finance that work towards your FI Number.
Conclusion
In conclusion, your financial independence number should be under regular review and evolve. Things don’t always go according to plan, which can work against you sometimes; however, that can also work for you in many significant ways you can’t even imagine. When I met my wife, I only had a bicycle and a computer, and my flatmate had a car. For context, my bike was more expensive than my flatmate’s car. Anyway, in less than seven years of marriage, my wife and I acquired a lot of wealth. That not something I could have imagined for myself in so short a time. Life’s unpredictability can swing both ways.
So now you know where you want to be, you’ve looked at the numbers and you see what they represent. You understand what financial independence means for you. You have decided what you need to keep and what you need to cut out. Also, you have a clearer understanding of how long it’s going to take you in terms of years. You can start building yearly goals in the right direction, with clear conviction. remember that financial independence is about lifestyle, not money or numbers. Finance will always be a means to an end, so let’s be honest about what we want, how we want to get there, and make the tough, intentional choices to live a life worth living.