The notion of becoming financially independent is described by Wikipedia as:
the state of having sufficient personal wealth to live, without having to work actively for basic necessities.
It is a bit abstract, since basic necessities can vary among people. Therefore, clearly defining these basic necessities, and therefore what this notion means to me is important. It will not only set concise and quantifiable goals, but place a clear finish line at some point in the future. I do not intend on making this a life long journey.
It should be noted that any reference to myself includes my family.
There are assumptions I make throughout this process that I discuss in the last section.
Becoming financially independent means being able to eternally provide for my basic necessities of life without having the need to work: shelter, food, water, clothing, transportation, communication and technology tools. Each basic necessity is considered an expense(s), requiring resources (money).
There are few basic necessities listed because the basic premise for my endeavor rests on minimizing my expenses:
By minimizing my expenses, I will maximize my savings which can be invested. These investments, once grown to a sufficient size, can pay an income either through dividends or by being sold without ever affecting the underlying principal given a sufficient growth rate.
When the income paid from investments equals my expenses for basic necessities, I will be almost financially independent. There's more on this below.
My partner and I spent 2015 carefully analyzing our earnings and expenses.
The average household expenditure(consumption) for a census couple family in Canada is $58,750 ( as of fall 2016), with our own being far less than that. Even though we were very happy with the find, we decided that $50,000 was a fair number to use for our needs ad infinitum.
The assumptions we made to settle on this $50,000 amount are discussed in the last section.
Having my investments pay me income that equals my basic necessities is almost financial freedom. What is missing is a guarantee that the underlying principal in my investments is going to be enough. It harks back to the age-old retirement question: What's your number?
My concern about my underlying principal originates from the simple observation that retiring with a million dollars just before a stock market bubble bursts isn't exactly the same as retiring with a million dollars just after.
In my case, the missing guarantee amounts to the following question: How much do my investments need to be worth to withstand everything that the stock market can throw at it: the Great Depression, wars, etc., and still pay the income that equals my basic necessities?
Common wisdom has it at 25 times my annual spending. For $50,000 in annual spending, that amounts to $1,250,000.
But I like to be more thorough.
Enter FIRECalc: a retirement calculator that factors in historical volatility to see if my investments can take a beating. It takes three variables: the value of my investments upon retirement, my required annual income, and the time period I would like the income to be available for. Then it computes scenarios based on historical stock market data for what would have happened to my investments if I had retired in prior years for the period I want my income to be available for.
It spits out a chart of all the scenarios it ran through and a success rate. A success rate of 100% implies that my investments were always able to provide me with my required annual income for the time period I want it to be available for.
FIREcalc's results of a 100% success rate for investments worth $1,500,000 that pay an annual income of $50,000 and will last for 60 years are shown below. $1,500,000 also happens to be the break-even point to crack the 100% success rate under the constraints described.
Pretty close to the common wisdom.
To be thorough, I also ran cFIREsim, which is a similar to FIRECalc. cFIREsim's results were more optimistic, allowing me a break-even success rate of 100% with my investments valued at $975,000.
It should be noted that these calculators make certain assumptions, which I am comfortable with.
I put in a time period of 60 years assuming I become financially independent at 40 years of age, and live to be a 100. This also allows me a large margin of error in my assumptions for how long I may need to provide for my basic necessities in the long run.
I can conclude that the common wisdom is accurate: I need to accumulate 25 times my annual spending to become financially independent, which amounts to $1,250,000.
The basic premise of my endeavor for financial independence rests on minimizing my expenses. It should be clear now why that is: If I can minimize my expenses even further, my investments need to be worth less to become financially independent.
Alternatively, I can put it in this way: If I can minimize my expenses even further, I can become financially independent faster.
My blog contains my musings over my never-ending quest to minimize expenses.
There are assumptions I have made in defining what financial independence means to me, including the $50,000 that was considered a fair value for my needs ad infinitum. I highlight these below.
I pay a mortgage forever - It allows me a large margin of error in my assumptions for how much my basic necessities will cost long term. It also guarantees me a rented roof over my head if things go south for some reason. I don't intend on paying a mortgage forever.
I make car payments forever - I find it impossible to live in North America and get by without a car, even it's needed very infrequently. This ensures my ability to obtain and finance a car. I don't intend on making making car payments indefinitely. It also allows me an even greater margin of error in my assumptions for how much my basic necessities will cost long term.
The typical household spends 20% more than their income on basic necessities - The fact that the ratio of household debt to disposable income keeps hitting record highs has been reported on for many years now. It's currently at 165.4%. Much of this comes from mortgage debt, which has increased greatly since 2014. This point is much debated by experts, and the widely held view is that this kind of debt is more favorable over consumer credit and non-mortgage loans since it's based off an asset which appreciates in value. Which completely misses the point that the average household spends more than it earns.
The typical person in a household spends 200 hours a month working - I have an average job and consider myself to be an average Joe in this regard, and I also happen to have tracked my hours worked over the last year. I can assure you it's the same for my circle of friends and acquaintances, who happen to be from all walks of life.
I disregard any government and private pensions and value of any physical assets such as land and a house in my plans for financial independence - I happen to live in a country that takes pride in universal healthcare, stable governments and pensions, and it's abundance of natural resources. These are all sources of tremendous pride for me as well. But I have chosen to take responsibility for my own actions and outcomes, and I cannot fully do that if I depend on someone or something else besides for my immediate family. I believe that these pensions and assets whose value I choose to disregard for this endeavor are safety nets, and not to depend on for my basic necessities in everyday life. If and when the time ever comes to cash in on these, I wish to either donate and/or use it for philanthropic purposes. Besides for my time volunteering and mentoring, I believe this is the best way to use my wealth.
Finally, the biggest assumption of them all: my basic necessities will cost $50,000 forever (in today's dollars) - Nothing in life is a guarantee. But the best anyone can do is make good, informed decisions, which I hope I am making. I only have one life, and as I have grown older and (hopefully) wiser I have realized that this world doesn't give you infinite opportunities. Youth is fleeting, and along with it your chances at having a fulfilling, happy life. I find it hard to believe that there is something else beyond this life, and that's why I have chosen to create my heaven for myself here in this world. I don't believe I, or anyone else for that matter, can do that without resources.
Time is not what you think. Dying? Not the end of everything. We think it is. But what happens on earth is only the beginning. I figure it's like in the Bible, the Adam and Eve deal? Adam's first night on earth? When he lays down to sleep? He thinks it's all over, right? He doesn't know what sleep is. His eyes are closing and he thinks he's leaving this world, right?
Only he isn't. He wakes up the next morning and he has a fresh new world to work with but he has something else too. He has his yesterday. That's the way I see it, that's what we're getting here, soldier. That's what heaven is. You get to make sense of yesterdays. - Captain to Eddie, The Five People You Meet In Heaven