Many people have heard this term “financially independent,” but they’re not totally sure what it means—or if they know what it means, they don’t know how to achieve it.
Financial independence is a journey that takes a lot of hard work and serious planning. There’s no quick fix to get there. But it does also require a financial independence mindset.
However, by creating the right plan, and committing to it, even “early” financial independence is attainable. Here is a guide to forming your own FI path…
What is financial independence?
In order to become financially independent, you first need to fully understand what that means. Financial Independence means that you are not reliant on trading your time for money (that you need to live your life).
Often nowadays, when you hear this term, the goal is more to retire years earlier than the standard age of 65, and have the ability to live out the rest of your life without the need of income from full-time employment.
The F.I.R.E. movement (which stands for financial independence, retire early) really brought this “crazy” idea into popular culture. But their version means that you’ll need to either save large amounts of your active income and earn more passive income, much earlier than usual, to cover all of your living expenses.
However, what’s important to remember, is that there really is no specific age you need to achieve financial independence. The hope is that you will at least achieve it by the time you “want” to stop working.
For some people, they’d like to achieve this goal in their 30’s, but even financial independence in your 40’s or 50’s is still decades before your standard retirement.
Thinking of wealth as independent of income is part of the financial independence mindset
An important step of becoming financially independent is understanding the difference between income and wealth. Income is the amount of money you earn for a specific time period, while wealth is the total amount of money that you’re currently holding.
Just because you have one, doesn’t necessarily mean that you have the other. You could be a high income earner, but if you have poor spending habits or a lot of debt, then you probably don’t have much wealth.
On the other hand, you could be a low income earner, but have a decent amount of wealth by paying off your debt and practicing smart saving strategies.
In order to be able to retire early, you’ll need to amass wealth. Without a steady income from a job, your money will have to come from other sources like savings, investment portfolios, rental properties, etc.
So before beginning your path to financial independence, it’s necessary that you feel secure with your wealth, because it needs to last the rest of your life. The last thing you want to do is run out of money and need to go back to work near retirement age.
Implementing a financial plan
Before you begin your path towards financial independence, you need to come up with a plan. It basically comes down to just two things…
1) How much wealth will you need to retire early, and
2) What financial plan will get you there.
In order to figure out these plans, you need to begin by gathering some basic information:
- Annual income (after tax)
- Yearly expenses
- Current net worth
- Expected future growth on assets
If you want to quickly play around with a potential retirement age, you can use this fun FI/RE retirement calculator to get a general idea of how many years you are away from retirement. But you shouldn’t completely rely on this information because circumstances change and everyone’s financial health is different.
Spend time looking over the numbers and doing your own calculations. The basic premise is that you need to determine how many years you’ll spend in retirement (your lifespan minus your retirement age) multiplied by your average yearly costs during that time period.
Once you’ve determined how much you’ll need to save for retirement, you can factor in all of your sources of wealth to find out how you will finance your retirement plan.
After you’ve determined the total amount of wealth that you’ll need for retirement, you can calculate how many more years of saving and investing are required to reach your retirement age.
I go into the above, in more detail in this post…
The Financial Planning Process: How to Mastermind Your Retirement
There’s plenty of factors to consider when calculating this number, including the current amount you have in savings and retirement plans, as well as the outlook on your investment portfolio.
The difficulty can arise when you need to factor in variability, such as the anticipated growth of your investments. You can predict this within reason, but it’s never a certainty that your numbers will pan out the same, so it’s important to be overprepared.
MAJOR TIP! Try to amass even more wealth than you think you’ll need for financial independence.
Smart habits for financial independence
The earlier you want to retire, the more strict and smart you have to be with your money. Not only do you need more wealth to last you during a longer retirement, but you need to gain it in a shorter period of time.
This means you may need to make serious changes to your lifestyle and what you do with your money, at least in the short term. Here are several steps that will bring you closer to financial independence:
- Pay off all of your debts. The longer you have debts, the more you’ll be spending on interest payments. In order to build a net worth viable of early retirement, you should try to start with a clean slate and as few liabilities as possible.
- Increase your savings. There are a couple of different ways that you can increase your savings. First, you can adjust your budget to remove any unnecessary expenditures, allowing you to set aside more money on a monthly basis.
- Earn extra money. You can also try to find a side gig that will help you earn additional income on a monthly basis. Both options are helpful, but probably need to be done in conjunction. In order to save even more money, make sure to put your money into an account without banking hidden fees, this way you won’t be losing your hard earned cash.
- Invest as much as you can. Retirement plans and investment portfolios are going to be one of the main ways that you can continue to gain wealth, long after your days of earning an income are over. There are a variety of ways to invest, including 401(k), Roth and traditional IRAs, stocks, bonds, annuities, etc. Meeting with a financial advisor can help you decide which investments have the best outlook for the future and how to diversify your portfolio.
The financial independence mindset is really a way of life
Yes, achieving financial independence is all about looking at the numbers and calculating how much money you’ll need to retire early. However, as important as it is to create a plan, none of it will be possible without changing to a financial independence mindset.
Really think about what it would mean to retire decades earlier than you thought you would. You’ll have to be willing to make sacrifices and completely change your spending habits.
It’s not going to be easy. There will undoubtedly be struggles along the way. But a strong mindset will see you through the roadblocks. You have to be introspective and decide if you only like the idea of financial independence, or whether you’re actually committed to seeing it through.
For more details about the road to FI, take a deeper dive here…
Big Picture Investing: Why You Need to Get in the Game Now! (Short Version)
Early Financial Independence: Living Your Life in 4 Acts (Not Just the 3 You’ve Been Told About)!
Real Estate Strategy 101: Learn the Basics, the Lingo, and the Opportunities