Over the past decade, the FIRE movement (Financial Independence, Retire Early) has spread like—you guessed it—wildfire. Who hasn’t dreamed of retiring early to pursue their dreams beyond a traditional career?
But early retirement is just one aspect of the movement. The other part—gaining financial independence—is equally, if not more, important. Focusing on financial independence can offer radical benefits to your lifestyle here and now—whether you retire when you’re 35 or the more traditional age of 65.
What exactly does financial independence mean? And how can you calculate the amount you’ll need to satisfy your monthly budget?
Financial Independence Isn’t Retirement
Retirement, traditionally, is the end of your career. It’s a point when you no longer want or need to work to sustain your lifestyle. The FIRE movement is notorious for celebrating extremely early retirement ages, sometimes as young as 30.
Retiring this young clearly isn’t possible for everyone, especially those who don’t earn six-figure salaries in their early careers. Financial independence, on the other hand, is a more attainable goal. The key is that “independence” can mean different things to different people.
For some, it may mean saving to the point that you can quit your full-time job and supplement your savings with freelance or consulting work. For others, it may mean building a passive income stream to supplement your savings. And for others, it may mean practicing extreme austerity, which is cutting out every unnecessary expense.
Simply put, financial independence just means that you have enough income to stop depending on others for money. You can still work full- or part-time—or you can choose not to.
Financial Independence Depends on Your Budget
The first step to achieving financial independence is understanding that having long-term wealth is not the same as having a high income. Making more money will only help you if you are spending less than you are making.
This means that making more money is not the only path to financial independence: Spending less is another route. You don’t necessarily have to become a software engineer or a doctor to be financially independent. You just need to prioritize long-term saving and investing over short-term spending.
This is a balancing act, but figuring out what could work for you in the long term is what allows for financial independence. Many in the FIRE movement have achieved their goals by living frugally. Others might see this as a lifestyle downgrade and choose to focus on investments that can cover their budgets. Meanwhile, others might choose to make some spending sacrifices while supplementing their income by doing part-time work.
Discover what you’re comfortable with and create a budget—and a savings and investment plan—that works for your lifestyle.
How Can I Calculate the Amount I’ll Need to Be Financially Independent?
Finding the magic number you need to be financially independent isn’t difficult. If you have your budget in place and know the amount you need to spend each month, you’re almost there. The general formula for your “FI,” or financial independence, number is:
Yearly spending/Safe withdrawal rate
The safe withdrawal rate (SWR) is the amount of your savings you can withdraw each year without running out of money in the long term. Financial experts suggest that 4% is a good SWR for most people. So if you have $20,000 in expenses each year, you would need $500,000 saved and invested to be financially independent, roughly assuming a 6% annual return on investments.
This number might sound daunting, but a big part of the FIRE movement involves getting your yearly spending number down. And remember that financial independence means different things to different people—so for many people, a financially independent lifestyle might involve supplemental income, which can offset many of those expenses.
Don’t Forget Taxes
You’ve heard it before, but taxes are inevitable. In order to perfect your calculations and confirm your financial independence, you’ll need to consider the ways taxation will affect your income and investments.
To start with, if you have active income—from a part-time job or side work—you will have to pay taxes on those earnings. If you’re new to self-employment, be aware that your tax bill will most likely be higher than you were used to with your traditional full-time job, and you’ll probably need to pay quarterly estimated taxes.
Passive income, such as money earned from renting out a property, is also taxable. Other forms of income, such as dividends withdrawn from an investment portfolio, are likewise taxable, so keep this in mind when you’re doing your calculations.
Many FIRE proponents look forward to the day when they own a home outright. Even then, though, you also need to account for the property taxes you’ll continue to pay. Other forms of income, such as dividends withdrawn from an investment portfolio, are likewise taxable, so keep this in mind when you’re doing your calculations.
Financial Independence and Your Family
If you have a family to support, getting your spouse on board is essential, and it may take convincing and some serious conversations. Remember that it’s not just your lifestyle that will be affected by your plans for financial independence. Your spouse and children will also have to make spending sacrifices, so you should understand their wants and needs. Ultimately, you may have to make concessions, particularly when it comes to reducing expenses.
When it comes time to talk to your partner, take things slow, and don’t expect to put a radical plan in place overnight. You may be excited about starting on the path to financial independence, but give your family time to consider what this will mean in terms of practical living. You should also account for college savings for your children, if needed—will cutting your budget impact your contributions to a 529 account or high yield savings account for their education?
Next, do some dreaming together. Figure out what shared life goals you have, and discuss how financial independence will allow you to achieve these goals together. If you can come up with a shared vision for how you’ll spend your increased free time, your partner is more apt to come on board with your program of cutting spending.
What Steps Can I Take to Become Financially Independent?
If you’re ready to start a plan leading to financial independence, here are six simple steps to remember:
1. Start early. The earlier you stop spending and start saving, the more time you’ll have to reach your goals.
2. Make a budget. To start saving, you have to know how much you’re spending vs. how much you’re bringing in.
3. Stop spending, start saving. Now the real work begins: Cut down on your expenses to the extent that you’re comfortable, and stash that money away.
4. Invest. Generating passive income can contribute to financial independence, so utilize low-fee investment vehicles to ensure that all the money you’re saving works for you.
5. Pay off debt. You don’t want interest to eat into your savings, so pay off student loans, car loans and mortgages as quickly as you can.
6. Have a safety net. Life happens, and even the most disciplined savers encounter unforeseen expenses. Make sure you have enough liquid savings that you can draw on in case you need to make home repairs or pay for medical needs.
Financial Independence Is About Time
Now we get to the fun part: What are you going to do with all your free time? Do you want to build a house in the woods? Travel the world in a van? Sit on the back porch and watch the birds? Write a novel? Open a bakery?
Financial independence is a financial goal, but tying it to real-world hopes and dreams can help make the abstract math (and the penny pinching) all the more worth it for you and your family. Make no mistake, the path to financial independence won’t always be easy—and you’ll have to sacrifice short-term wants to satisfy long-term goals. Having a shared purpose for the present and the future is the key to staying on the path.
William Myers is a financial writer based in Dallas.
Watch this video with F.I.R.E. devotee Jamila Souffrant or listen to our podcast about the FIRE movement.