# The Real Golden Goal: Financial Independence

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.

On my post “How Blogging is Helping Me”, nicoleandmaggie left the following comment:

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:

1. The dividend income required ignores the income taxes I would pay on it.
2. The calculations ignore inflation and assume that my expenses level will not go up.
3. 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.
So these numbers are clearly somewhat off, but I think they are a good starting point. I can learn the following from the above numbers:
1. The 0.5% to 1% return on my savings accounts aren’t going to get me anywhere near financial independence.
2. 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.
3. 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:

1. Investing for my needs after age 59.5 using my 401(k) and Roth IRA
2. Taking all of the vacation days my employer lets me take and enjoying them
3. Buying a 2 bedroom condo and paying off the mortgage early
4. Investing my extra funds in taxable investment accounts
5. 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?

## 26 thoughts on “The Real Golden Goal: Financial Independence”

1. Ours is 2 million. One million of that goes straight to buy a house with cash in Mountain View, CA. If we retire early, it has to be someplace with lots of stuff to do and good weather, and we have to have enough money to be able to enjoy food etc. and to pay for our kids’ college. The second million would also allow us to continue saving, which feels like a cushion.

We’re saving a ton in tax-advantaged accounts because if we do quit our jobs because of financial independence, the only ones remaining for us would be IRAs, and we’re hoping to live a long time.

Financial independence for both of us isn’t going to happen any time soon. But, striving for it has allowed us a lot of freedom in our jobs. DH was able to take a year off without pay when I was on sabbatical to work on a start-up (and we were able to live in paradise for that year, and not have to worry about how long it took us to rent out our house). We’ll be able to take our time deciding what to do with our next career changes (more on that tomorrow).

• Striving for it is really a mini-version of financial independence. Because I’m saving 50% of my paychecks each month and 100% of my bonuses, I have a ton of flexibility in what I do with my discretionary income. For example, I realized recently that I have enough discretionary income to be able to pay cash for a three-year part-time Master’s degree while owning a condo, traveling, and mostly maintaining my current standard of living.

Right now since I have funds set aside for a down payment rather than tied up in equity in a condo or a house, I actually have cash savings that would allow me to maintain my current standard of living for 26 months. Instead of buying a condo, I could take my cash savings and travel the world or go to grad school and have a decent standard of living instead of living like a student.

One of my goals is to be well on my way to financial independence if I am not already financially independent when I want to have kids (if I do). That just gives so many more options and also makes it easier to save for their college educations.

2. The Stoic Investor says:

I’m looking at 300k as my FI amount. That is bare bones and assumes I will keep my life much the same as it is now. That is a big assumption. So many things can change, but it at least gives me a number to work towards. I’m guessing at my current rate of savings and with what I have saved I could hit that amount in about three years. Most likely I will continue doing what I’m doing now, but it will be nice knowing I could take some time off if I wanted to or just work part-time. Freedom…

• At this point, I see the \$500,000 goal mostly as a far off goal, some goal to motivate me to keep saving and investing. I will keep re-evaluating how things look as I get closer and closer to that goal.

I like the freedom of knowing that I can quit my job at any time and I would not be in dire straits. That feeling is amazing.

3. One of my financial goals will be hitting FI, but based on my situation right now, it is definitely far away! :) This is definitely on my mind as I contemplate my work situation (or lack of) for the year.

FI in less than 10 years?? That’s awesome!

• FI in less than 10 years may be a bit of a stretch, but I’m going for it! My current forecasts show \$7,300 in taxable investment accounts by the end of 2012 and an additional \$8,600 added in 2013. That’s only \$15,900 invested with 7 more years to go, so we’ll see!

• TJ says:

I am targeting \$500k too – I think 8 years is too soon, but it’s an awesome goal,

I may also be more risk averse with my investments and I also might not make as much \$\$. :)

• Too soon to hit the mark or too soon age-wise? I’m a huge fan of setting goals high – gives me more to work towards ;)

4. Wow! The difference between your salary and living expenses is very impressive! 9 years – that’s really not too long! And once you get there you’ll have even better data to re-calculate if you’re independent already or if you need to save more.

What kinds of investments would you have to get 6% (really 9%ish to include inflation, right?)/why do you think that rate is reasonable? It seems a bit high to me – not while you’re growing your accounts but for if/when you actually need to live off them. Of course that’s based on my reading about retirement, not early retirement.

Unfortunately we don’t have enough information to calculate our path to financial independence, either on the salary or living expenses side. Maybe when we’re done having kids and are on career paths we can make some estimates. I love these exercises though so I can’t wait to get there!

• That’s what happens when you give a saver a high salary and bonuses :)

I will probably compare my total expenses each year to the amount of dividend and interest income I earned, as well as the value of my investments and how far I am from the \$500,000 goal.

I mostly just made up the 6% number. I didn’t want to assume anything higher, but I didn’t want to go too much lower than that. 6% without a mortgage resulted in the beautiful round number of \$500,000, which is probably why I picked it… Since at this point, it’s just a far-off goal, I’m not concerned about how precise it is. One of the tricks with early retirement is that you can’t use your 401(k) or IRA accounts very easily, so that’s why my \$500,000 number ignores those accounts.

It sounds like you and Kyle are of the right mind set to plan financial independence out well once you are in a position to be able to calculate your path to financial independence :) In the mean time, you will probably be able to do similar exercises for your future kids’ college education funds!

• TJ says:

For me, I just don’t think it’s enough time for my investments to grow in conjunction with my rate of savings.

I’m shooting for \$500k by 40, I’ll definitely revisit it when income streams change, and if I hit that number sooner, I’ll just make some other goal. :)

• I love hitting goals and then making new ones :)

5. I’ve been really focused on the idea of FI and a crossover point lately. The professional freedom FI allows sounds amazing.

I saved as much as you when I was younger. It allowed me to pay for almost all of my MBA with cash. I ended up getting a small amount of loans so that I would not graduate penniless.

Now that we have kids, we still save a high % of our income, but it’s not 50%. Childcare costs are through the roof. That said, I feel so lucky be in my 30s with no student loan debt and a really healthy 401k balance since I saved so much earlier.

Great post. Thanks for the motivation to revisit our numbers!

• Thanks! I’m definitely curious to see the professional freedom that FI affords. The mini-version I have now with such a large difference between my expenses and my income is pretty interesting as well.

Childcare costs will go down once your kids are in school, right? But then I suppose you might want to funnel some of that money into education savings accounts instead.

Don’t pass it all off to luck – you also put in a lot of hard work to get where you are!

6. Con-Man says:

Generally speaking, one can assume a 4% withdraw rate for a 3o year period with very small probability of failure (depending on AA, market performance etc). It is important to note where this 4% is based from. A fella named Bengen in the early 90’s first came out with this number using ROLLING historical returns. It was later updated by some guys at Trinity college, and sometimes carries the name of the “Trinity Study.” This is a REAL 4%, so after inflation. Becoming financially independent early on/retiring early carries much more risks because of the obvious time one needs to support themselves from their portfolio. Wade Pfau is doing some excellent work in this area and on a recent blog post of his, I noted a 1.9% real withdraw rate for 40 years using with a 1% chance of failure (using year over year returns, discounted 2 basis points in a stochastic model, e.g. not rolling).

So, if you believe all this, it means you can look at all of this differently. If 4% is the number you like, you can multiply your current annual expenses by 25 and it will get you the number you need for FI/ER (or FIRE as some people like to call it). If you believe the 2% number, multiply your annual expenses by 50 to get your FIRE number. This is opposed to what you did above (which, admittedly, I don’t fully understand).

I don’t have the answer for which withdraw rate to use, but there are other considerations (which help to justify why 1.9% is EXTREMELY conservative, besides the fact he discounted the return by 2%). First, could you cut things out of your budget if you had to (like travel and eating out)? Second, these numbers don’t account for anything like social security or for the fortunate 20 somethings (which I used to be one until I recently changed jobs) with some type of future annuitized distribution (e.g. a pension).

We are a single income family with one child and our expenses are somewhat similar to yours (with mortgage). I’m serving my final year as a 20 something, but I calculate I need around \$1.5MM to be FI (which suggest ~3% WR). I am a little under 1/3 of the way there, but the important thing, is to A) enjoy life and B) save as much money as you can while young.

Thanks for the blog, I enjoy reading it.

• What I am calculating here is my crossover point (http://wheresmytrustfund.com/2011/01/19/the-crossover-point/) or the point at which the earnings on my investments outpace my expenses. I’m pretty sure that the rate of return that I used in my calculations is totally off, but at this point, I want a number that actually feels attainable to strive for. Thanks for the data on the withdrawal rates. My current plan is to definitely be financially independent by age 50 and with the life span of my relatives, I would guess I could live 25-45 years past that point, maybe even to 100! I also want the flexibility to have a mortgage paid off so that I have the choice of taking a job in an industry that pays less than my current position.

Wow, I wish I had some sort of pension! I just have a 401(k) with a very small employer match, which I guess is better than no match at all like some employers are doing or no 401(k) period.

I am definitely striving for a certain level of balance between enjoying life and saving as much money as I can while I’m in my twenties. I’m a saver at heart, not a spender, so spending money to enjoy life more has taken a lot of work and is something that I’m still working on.

Good job on being almost 1/3 of the way to your FI number! The later parts will only get easier due to compounding returns, right?

Thanks for stopping by, Con-Man!

• Con-Man says:

I think I understand now…and what I am calling withdraw rate is the same as your rate of return. My point is, you don’t need to guess what rate of return/withdraw rate to use, as it is an age old question that has been heavily studied.

Either way, we all get to choose for ourselves….

• True, I probably should have gone with 2-4% as you say. I will for sure re-evaluate when I get to \$500,000 and on my way there though to make sure that I’m actually going to hit FI, not just The Number.

7. […] Related:  Leight PF talks about calculating her financial cross-over point. […]

8. TJ says:

“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.”

With condos, I think it really all depends on where you live now, where you want to retire, and if you want to hang on to that real estate investment indefinitely as a long distance landlord. With condos, they tend to be in apartment complexes these days as many condo conversions didn’t complete during the bubble – and these maybe aren’t the best investments if you plan on selling them in the near future, but I feel like I would never need to sell.

I grew up in Southern California where rent in a nice area near the beach for a tiny 600 sq ft is roughly the same price as a place twice as large in a less than desirable area. What I did was buy a nice 2 bedroom condo in one of the more desirable portions of a less desirable area, and my mortgage (on a 15 year loan) is 1/2 the price of what renting would be for the equivalent unit in the same complex Then there are tax deductions. and I rent out the spare room since I am single and don’t need it….so my housing costs turn out to be much smaller than if I was renting the same exact unit and splitting the costs 50/50. I’d have to do the math on the breakeven point with the down payment, but I don’t worry about that because the equity is the equity and I bought at a historically low time.

When you add in HOA, taxes and utilities, it may be the same payment NOW, but once that mortgage is paid off, there should always be a nice profit in the condo. Also, as I continue to save at a high rate, the condo will be even less of my total net worth…..

I also plan to move to a much cheaper area, where even if I pay a management company 10% to manage it – hopefully this investment could pay for the costs of this place as well as most of my renting costs somewhere else.

In addition, if I ever did want to come back to California someday, by having equity in a SoCal real estate investment, I will have the choice. So many we know downsized to somewhere like Kansas and they will never be able to come back to California.
.

So for me, because of where I live, how long I wanted to live here initially, and the fact that I may want to return some day, and perhaps most important- the down payment didn’t totally kill my savings- a condo made total sense. for others, it may not.

With regards to income and expenses,

I kind of stopped keeping tracking of this, but last year I was saving 33% of my net salary and 100% of my bonus. I would guess that my mortgage would be around 25% of my net (before deductions),

I am 26 and I expect to EASILY be financially independent in 15-20 years, assuming that I maintain solid employment and don’t end up marrying someone who is solely dependent on my income.

One of the reasons I do save so much now while I can IS the uncertainty of a possible marriage/family etc, to me, this is more of a motivation to save than obtaining complete financial independence ( though I would imagine my ideal spouse would share the same goals of financial independence early in life….;) )

• Right now, I would say that I would love to retire here. I’m within driving distance of my family and there are plenty of activities around here to keep me occupied while not working. I’m in a city and not in the middle of nowhere, like Kansas, which helps too. But I’m in my twenties, so I do I know where I would want to retire?

If I buy a house later, I would consider keeping the condo and rent it out instead of selling it. My plan after purchasing a condo is put my discretionary savings (which are 100% going to my down payment fund right now) equally three ways towards: house down payment fund (cash savings), condo mortgage pre-payment, and taxable investments (retirement). If I decide to buy a house and keep the condo, I can keep direct the monthly/bonus mortgage pre-payment third towards cash savings instead or if I decide I don’t want to buy a house, I can dump the down payment cash fund at the mortgage and pre-pay the mortgage more.

If I could afford to keep the condo around for years, that would be great. My grandparents moved into a 2 bedroom condo a while after the kids had all moved out, so a person could always stop renting the condo and down-size back there in later years.

I’ve contemplated renting out the 2nd bedroom since I plan on buying a 2 bedroom/2 bathroom condo. I really like my space, so I’m not sure that I will, but I will obviously re-evaluate that once I’ve bought a place and moved in.

I also expect to easily be financially independent in 15-20 years, with the same assumptions as you. I see marriage/possible family pretty far off and don’t really think about saving a lot before then. It would be pretty cool if the person I end up marrying has saved a lot just like I have though :) I’m not really sure why I save so much now. Probably a combination of not needing the money, enjoying watching my account balances grow, and that compound growth is amazing!

9. TJ says:

Yeah, I have no interest in somewhere like Kansas either. I have been in surburbs my whole life – and I want to try a city, not a small town. Haha. But in a city, I feel like I’d almost have to change my lifestyle completely to maintain high saving rate. (I have not used my kitchen one time in the two years I’ve had my condo….)

I found that living in a 2 bed 2 bath by myself was just lonely. I did it for two months and decided I might as well defray some of the costs – I live with somebody fun for way less than market rate- I don’t care, I’m not doing it for the money….but it all adds up.

If you’ve lived in multi-bedroom apartments alone – you probably wouldn’t have any issues.

With mortgage rates so low, I stopped prepaying very shortly after I started, but when I see the the market go up like it’s done recently – I wonder if I should take some \$\$ off the table and pay down my loan. Haven’t yet. :)

• I use my kitchen often enough to remember that it’s there. With a busy lifestyle, microwaving leftovers is far, far easier than going out for dinner.

I lived in an almost 1,000 sqft 1 bedroom apartment for my first few years here by myself and absolutely loved it. I love space and I could probably see myself living in a 2 bed 2 bath by myself quite easily. It would also be nice to have that spare bedroom when I have friends or family visit.

I don’t want to pre-pay too quickly with how low rates are, but I don’t want to not pre-pay and have the mortgage for 30 years either. So by partially investing more, partially pre-paying, and partially keeping more cash savings around, I’ll be doing a bit of all of them instead of trying to say that any one option is definitely better than any other.

10. TJ says:

I think splitting between the 3 is definitely a wise choice. I guess I ended up choosing none of the above in the end because I’m the guy who instead of deciding to pay down loans, keep in cash or invest, decides to take a crazy extensive vacation!!! :)

I re-fied my condo loan from 30 years to 15 years after not even 2 years into the original loan because I can afford the higher payment and I think 30 years is just too long. It’s a lot more interest spent, but if you pay off a 30 in 15 I’m not sure it’s that much more than just getting a 15 yr loan. The re-fi was literally no costs. From a 30 year 5.25% to a 15 year 3.625% the monthly payment increased by not even \$200.

Also, I got rid of that pesky escrowed property taxes that the old bank made me do, which gives me more freedom as to when I should pay the county. :)

• I thought about the 15 year fixed loan, but I think the payments are a bit too high for my base pay. Having the 30 year fixed is easy to pre-pay with bonuses, but stick with if the bonuses don’t come through, whereas with the 15 year fixed, it would be more difficult to make the payments if my bonuses don’t come through.

I’m not a huge fan of escrowing either. My parents didn’t understand the concept at all as I tried to explain it to them – “Why would you give money to the bank to pay the property taxes when you can just pay the county…?” :P

• TJ says:

I don’t really care about the escrowing but I do like the freedom – it allowed me to make 3 property tax payments in 2011 instead of just letting the bank decide when to pay.

Generally they’ll give you a better rate if you escrow – but for the refinance – that bank didnt care.