In this article, we show you How To FI:
Reaching financial independence is a goal that everyone should strive towards. Financial independence, also known as FI, means finally having the freedom to live life on your terms.
Here, you can learn about your FI number, the 4% rule, and how to develop a long-term FI plan.
What Is FI?
Being FI or Financially Independent means that you can live entirely off of your savings. This means different things to different people.
However, all those who have reached FI have enough money from savings or passive investments that they no longer need to work to support themselves.
Achieving FI does not have to occur at the traditional retirement age. Instead, you will learn how to FI years before this through the strategies discussed in this article.
Many people who achieve Financial Independence do so at a younger age. Instead of retiring fully, these people often devote their time to passion projects or starting a business.
Sounds fantastic, right?
To begin, you’ll need to calculate your FI number.
What Is a FI Number?
Your FI number is the amount of money you will need to live the rest of your life. This money is the money you have saved and invested.
Calculating this number will allow you to know exactly how much money and assets you need to FI.
This number will look very different for everyone, but it is a crucial part of the process for anyone wondering how to FI.
Before calculating this number, you should know some important terms and facts.
Things to Consider First
Before you learn the necessary equations to calculate your FI number, you first need to consider all possible future scenarios.
Consider how much of a cushion you’d like to have in the event of unforeseen emergencies.
Even with good insurance, unplanned medical expenses can derail your journey to FI.
When learning how to FI, you must also consider how long you plan to live off your savings. It is better to assume that you will live for a very long time and plan accordingly than vice versa.
You should also ask yourself if you want to spend all your money by the time of your passing or if you want to leave a legacy for your descendants.
Learn more about building generational wealth.
Before calculating your FI number, you first need to calculate your yearly expenses. Looking back on old budgets is an excellent tool for this.
Tracking your expenses is easier than you think. I use Personal Capital to help track my expenses.
It’s been an invaluable tool on my journey to financial independence.
However, keep in mind that you are also calculating for any unforeseen future expenditures.
The first step is to list any current and future monthly expenses. Be sure to include every expense ranging from car payments to grocery budgets.
Consider things like future investments, which may not perform as well as you once believed.
If you do not already have a detailed budget plan, now would be the time to start one.
Keep in mind the differences between fixed expenses and variable expenses. Variable costs might change depending on your financial security — these include things like money spent on food and vacations.
Fixed expenses are items like mortgages, which will probably stay the same unless you move.
Remember that expenses will change as you get older. Therefore your FI number will likely change.
When you have reached FI, will you still wish to spend the same amount of money as you do now?
You will undoubtedly have more medical expenses as you get older. Therefore, it is best to plan on the higher side for any medical or other expenses.
I recommend Personal Capital to help you track your expenses. (Get a $20 Amazon Gift Card With This Link)
I first started my FI Journey by using Personal Capital to calculate my annual expenses.
This made it easy for me to see that I spend about $35,000 a year.
One thing that people often overlook when considering how to FI is their income growth rate. Assuming that you currently have a stable job with ample growth opportunities, your income will likely increase as you age.
A generally accepted annual income growth is around 1-2% per year.
The 4% Rule
Once you have gathered these numbers, you are almost ready to calculate your FI number. But, there is one more term you must first familiarize yourself with: the 4% rule.
The “4% rule” refers to a famous study known as the Trinity Study. In this study, researchers determined the amount that you can safely withdraw from your FI number each year without running out of money.
For example, if your total savings and investments were $10 million, you would be able to withdraw $400,000 each year without risking your portfolio going to zero.
4% is the assumed annual withdrawal rate used to calculate your FI number in the Financial Independence community.
However, not everyone believes this to still be the best idea.
The Trinity study was compiled using data from over 30 years ago.
Today, some people believe that a withdrawal rate of 3% is safer. Therefore, before calculating your FI number, you will need to develop your safe withdrawal rate.
How To Calculate Your FI Number
Now that you have come up with your yearly annual expenses and safe withdrawal rate, you are finally ready to calculate your FI number.
For the best experience, use the free FIRE Calculator.
However, if you wish to learn how to reach Financial Independence entirely on your own, here are the calculations you will need.
Calculate Your FI Number With My Free FIRE Calculator
FI Number Math
To secure your FI number, you need to do the following equation:
FI Number = Annual Spending/Safe Withdrawal Rate
So, if your annual household spending was $1,000 and your safe withdrawal rate was 4%, you would calculate 1,000/.04 and come up with $25,000 as your FI number!
Using 4% as your withdrawal rate, you can also multiply your annual spending by 25 (1,000 x 25 = 25,000).
Keep in mind if you use a different withdrawal rate, such as 3%, you will have to adjust the number by which you multiply your annual spending. This would turn into 33 for a 3% withdrawal rate.
Thus, it is easier to use the first equation.
Example Of Calculating Your FI Number
The FI calculator gives you several key pieces of information:
- FI Number
- FI Date
- Account Balances
This is an example of planning for financial independence and knowing that your yearly expenses are $35,000/ year.
You can calculate your FI number: ($35,000) x 25 = $875,000
This is based on a withdrawal rate of 4% ($875,000 x 0.04) = $35,000
This calculator will also estimate a FI date by showing you how long it will take your portfolio to grow to this amount.
This is how it looks:
You can see we reach our FI Number of $875,000 in Year 10.
Based on the 4% rule, that gives us $35,000 a year to cover our expenses.
The spreadsheet also gives you a breakdown of how much is in each account.
You can later strategize on accessing those funds efficiently, paying the fewest taxes possible.
Money in your 401k or 403b will be available once you are age 59 ½ or earlier using the Roth Conversion Ladder.
This example gives you a more accurate and responsible picture of your FI journey.
Tax planning allows you to be confident in your early retirement and avoid penalties from the IRS.
As mentioned earlier, I highly recommend using my FIRE Calculator to keep track of each account in real-time.
Calculating Years To FI
Once you’ve calculated your FI number, you are probably wondering how many years it will take you to FI. This is a vital step for anyone wondering how to FI.
To calculate years to FI, subtract your current savings and investments from your FI number, and divide this value by your annual savings.
In other words: Years To FI = (FI Number – Amount Saved)/Annual Savings
As a practical example, if your FI number is $1 million and you’ve saved $400,000 with an annual savings rate of $50,000, you would plug in 1,000,000 – 400,000 (600,000) and then divide by 50,000 to receive 12 years.
Now, you know your FI number and how many years it will take you to reach FI at your current savings rate.
Depending on how aggressively you save your money, this can seem like a daunting task.
If you are curious about how to FI much faster than at your current rate, consider the following strategies.
How To FI As Quickly As Possible
With the following strategies, you can learn how to achieve Financial Independence as quickly as possible. There are three main ways to do this:
- Pay Off Your Debts
- Add Extra Income
- Reduce Expenses
Pay Off Debts
One of the most effective strategies you can employ when wondering how to FI faster is paying off debts.
Debts have the power to constantly eat into your savings and significantly extend your years to FI. In addition, because you have to pay interest on debts such as credit card bills, they can completely derail your journey to FI.
You cannot achieve FI with any outstanding debts.
It is worth the extra effort to invest a higher percentage of your income into paying off debts for a few years until you are debt-free.
Although this may require short-term sacrifices, it will greatly benefit your journey to FI in the long run.
Adding Extra Income
Adding extra income is an excellent idea for those wanting to know how to achieve Financial Independence as quickly as possible.
Adding income is essential for those wondering how to FI because it allows you to invest and save more.
This drives down your years to FI.
This can mean taking on a side job or working longer hours slightly for some. Some people can also invest heavily to build passive income, but this is more of a long-term strategy.
Others have enjoyed great success renting out extra items that you do not always use.
Some services will help you rent out almost any item in today’s world. These can range from an extra bedroom to a vehicle such as a boat.
The final and best way to reduce your years to FI is by lowering your expenses. Although this will require sacrifices, your future FI self will thank you.
Living on a smaller budget opens up more room for annual savings, which directly impacts your years to FI.
Easy ways to reduce expenses include eating out less or switching to a slightly older car model.
Even small items like streaming services that you do not regularly use can make a difference. You can even replace older lightbulbs with cost-saving LEDs, saving lots of money in the long run.
Remember that the bigger an expense you can eliminate, the shorter it will take you to achieve FI.
Many people find that by cutting out excess luxury items now, they can enjoy them more in the future once FI has been achieved.
How To FI Conclusion
Figuring out how to achieve FI does not have to be a long and challenging process. You can get your FI number by simply calculating your expenses and annual withdrawal rate.
After a few more calculations, you will know precisely how long this will take to achieve.
Once you have done these things, recalculate your FI number whenever you increase your savings rate or decrease your annual spending.
With these simple steps, you will know how to achieve financial independence.
The Inspire To Fire Podcast offers insights from industry experts and regular individuals on their journey to financial independence through real estate and other financial and early-retirement resources.
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This information is my opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.