I may write down a goal like “I want to retire at age 50 with 2 million dollars in investments and a mortgage paid off”, but that isn’t the real golden goal. The real golden goal is financial independence.
I’d go straight for financial independence. ;) How much would you need saved for the dividends to equal your living expenses (or alternatively, your current paycheck)?
Even if you don’t meet that goal, it gains you a ton of freedom later when life gives you options you’d never dreamed of.
What does financial independence mean to me? Financial independence means not needing my job to be able to get by – being able to save 100% of the income from my day job and live off of the income from my savings and investments.
In 2011, I saved around 50% of my net salary each month and 100% of the net income from my bonuses, for a total of 61% of my overall net income (salary and bonuses). My housing expenses have gone up this year, so I’m projecting to only save 57% of my overall net income.
I think that yearly living expenses, rather than my current paycheck, is the right figure because of how much of my paycheck is currently being saved. My total monthly budget adds up to $3,600 right now, ignoring travel. If you deduct the mortgage payment from my condo budget, my monthly expenses would be $2,500. On a yearly basis, that translates to $43,200 with a mortgage payment or $30,000 without a mortgage payment and that $13,200 difference actually multiplies out quite a bit. I made a chart showing various rates of return and how much I would need to have in savings/investments to earn enough in dividends and interest to cover my yearly expenses:
There are several points missing here:
- The dividend income required ignores the income taxes I would pay on it.
- The calculations ignore inflation and assume that my expenses level will not go up.
- The monthly/yearly expenses don’t include the money I’m setting aside to replace my car or the money I set aside to spend on travel.
- The 0.5% to 1% return on my savings accounts aren’t going to get me anywhere near financial independence.
- Buying a condo or a house instead of continuing to rent means that when I eventually pay off the future mortgage, my housing expenses will drop by about $1,200 per month, but I would still have to pay property taxes and HOA dues.
- Since I can’t withdraw from my 401(k) easily, I should only count taxable investment account funds towards the amount I have invested for the purpose of living off of the yearly earnings.
I’m going to say that 6% is a fair rate of return to assume, which means that I need to have $500,000 in taxable investment account funds and a paid-off mortgage to be able to live off of the dividends yearly without needing my monthly salary or bonuses.
Wow, $500,000 is a large sum of money. That needs to be acquired without too much sacrifice and doing the following:
- Investing for my needs after age 59.5 using my 401(k) and Roth IRA
- Taking all of the vacation days my employer lets me take and enjoying them
- Buying a 2 bedroom condo and paying off the mortgage early
- Investing my extra funds in taxable investment accounts
- Keeping my car in good condition
I wonder how long it would take me to reach $500,000 in taxable investment accounts. My current forecast is about $10,000 by the end of 2013.
I earned about $10,000 net more in 2011 than I did in 2010 and I’m estimating a similar step in 2012. If that pattern continues, the amount that I can save will grow faster than the amount the IRS will let me save in my 401(k) and my Roth IRA, which means that each year, I will be able to invest more in taxable investment accounts than the previous year.
I’m going to set a goal of having $500,000 in taxable investment accounts by the end of 2020 and enough passive income generated to cover my expenses. That gives me 9 years to save and grow an average of $55,555.56 per year. That sounds a bit crazy at my current income and savings level, but I believe in it!
Readers, have you calculated your crossover point to financial independence? Is it a crazy far-off number like mine is, have you already reached it, or is it in your sights?