So by now you probably got the itch to pursue financial independence. Maybe you were inspired by the OG Mr. Money Mustache's "simple math to pursue financial independence and retiring early" post. Or maybe you've read about the FI/RE movement and the success stories of people living a radically different life and retiring decades earlier than the norm. Whatever your motivation, this guide walks through the 5 simple steps you can take TODAY to start your financial independence journey. I created this guide because when I started my journey to financial independence, I had no idea how to start, the money mindset I needed or what steps I had to take to chart my own path.
How to FI in 5 Simple Steps
- Create your financial independence vision
- Calculate your savings rate
- Calculate your net worth
- Calculate your FI number
- Set your financial independence goals
1. Create your financial independence vision
The first step in developing any plan is to start with the end state. You need to understand where you want to go with your finances before you can start making progress on your FI journey. So start with your vision. I encourage all of my clients to start with the 10 years to a remarkable life exercise. You can read the 10 years to a remarkable life blog post to learn more about the exercise and how to start but the exercise is in short the following:
Imagine your most optimistic dream life 10 years from now and write it all down in deep, deep detail. That means everything from the moment you wake up in the morning until you go to bed, everything from what do you see when you wake up looking out your window? What clothes are you wearing? Are you drinking coffee in the morning? Where do you live? What kind of car do you drive? How are you spending your day? Who are you with? What do you do for work? Are you making any money? Imagine in great, great detail and write it all down.
Also, get as detailed as you can on your financial picture because this is what we're going to actually use to calculate our financial independence number.
Lastly, pick it up once a year and read it. That's it. You'll be amazed at what happens!
2. Calculate your savings rate
Alright, so now we have our vision of where we want to go. Let's start looking under the hood of where we are today with our financial picture. In this step we’re going to calculate our savings rate.
The first thing we need to do is pull together a few numbers to help us calculate our savings rate. We're going to use that savings rate as a part of our financial independence calculator to figure out how much we need in our savings to achieve financial independence and how long it'll take us to get there.
- Monthly Income After Taxes: The first number we need is our estimated monthly income after taxes. The number that's hitting your bank account every single month after taxes and any savings contributions for retirement, HSAs etc are deducted.
- Savings contribution in paycheck: Then we need to add up all of our savings contributions that are coming out of our paycheck. We add these back in to ensure we’re capturing all of our savings, our monthly cash flow (income-expenses) and any savings that are taken out of our paycheck.
- Monthly expenses: Lastly we need to add up our monthly expenses. This includes everything you're spending money on including fixed expenses like rent or mortgage and variable expenses such as groceries, clothing and kids entertainment. Ideally, you would take a historical credit card statement or bank statement and see how much you're spending every month , but this can be an estimate for now.
Now that you have your savings rate inputs, you can calculate your savings rate. Use the Money Optimist savings rate calculator to get your numbers today!
3. Calculate your net worth
Now that we have our savings rate, it's time to move on to net worth. We need our net worth in order to calculate our financial independence numbers and the time that's going to take us to achieve financial independence. Your net worth is basically the value of all your assets, minus all the debts and liabilities that you have. It's an important number to understand because it's your starting point for achieving financial independence.
In order to calculate your net worth, add up all of your assets, everything from your retirement savings, your other investments in brokerage accounts, bank savings, and any home equity that you have. Those are your assets. Now subtract out all of your debt. This includes everything from credit card student loans, mortgages, car loans, et cetera.
Subtract your debts from your assets, and that's your net worth.
4. Calculate your FIRE number
Now let's jump into how to calculate your financial independence number. We're going to calculate our actual FIRE number and how long it's going to take us to achieve financial independence based on where we are today.
Take the inputs you've calculated above and put them in the FIRE calculator .
- Net worth
- Current monthly expenses
- Total monthly savings (from the savings rate calculator above)
Also, if want to understand how long it'll take you to live your rich fire life, you can calculate your FAT FIRE number as well.
We're going to assume an annual growth rate of 8% which is the annual return of the S&P 500 after inflation over the last 100 years , from 1920 to 2020. So while we can't predict the future, it's a growth rate that should be reliable if we're looking over a long period of time (10+ years).
We're going to then choose our withdrawal rate which, for this exercise, will be 4%. The Four Percent Rule is known as the percentage amount a retiree should withdraw from their retirement account per year. This 4% rate is based on a well referenced piece of research called the Trinity Study, which basically looked at the past 50 years and concluded that you can withdraw 4% from your liquid assets for 30+ years and not run out of money.
Now we calculate! Your "FIRE Number" is the number you need to save up in order to live on the earnings from those assets on an annual basis. It's going to be a big number!
Then you have your "Years to FIRE". This is approximately how long it'll take you to achieve financial independence based on where you're at today.
The important thing to understand with these numbers is that the FIRE calc is largely based on how much you're saving and how much your monthly expenses are. As those change, your numbers will change.
So let's say your lifestyle increases after you have your first kid (all but guaranteed), but you're still saving the same amount. It's going to take you longer to hit your FI number and your number will be larger.
Or let's say, your expenses stay the same, but you got a pay increase and so now you're saving more. An extra $500 a month can shave off a few years in terms of achieving financial independence.
So that's the power of saving, and that's the impact that your monthly expenses and your lifestyle will have on your financial independence number.
The number you calculated is based on your expenses and lifestyle today. Next let's calculate our FIRE number based on your future vision you created for yourself earlier.
Take the estimate you calculated for your monthly expenses in your vision and swap it into the calculator. Keep all other assumptions the same. The new FIRE number is your FIRE number based on your future FIRE lifestyle. Now you can compare this FIRE number and time to FIRE vs your calculation based on your expenses today and you can create your FIRE goal based on it.
5. Create your FI goals
The last step in setting our financial independence foundation is to set our goals. We now calculated our FI number and years to FI based on our current expenses and our future life expenses. Use those results to create your goals for FIRE. Maybe you want to choose something in between your expenses today and your dream life. Or maybe you realized you need more than what your dream life number was. Take a few minutes and think about what you want your number to be.
Then we need to figure out how much in savings we'd need in order to get there. So what you can do is go back to the FIRE calculator and input the monthly expenses you landed on, input your current net worth and your current savings amount.
If the time to FIRE is more than you want but you don't want to change your expenses, you can start to play with the savings amount. Increase your savings in order to decrease the time it'll take to achieve financial independence. Maybe you found a way to save an additional $100. Great! Now let's use that number to calculate the time it'll take you to FI.
The last FI metric we're going to calculate is our savings rate goal. Let's jump back into the savings rate calculator and adjust your monthly income to include the new savings amount you calculated above. Let's add the $100. The "Monthly Savings Amount" should now be the savings number you included in your FIRE calculation. The new "savings rate" is what we're going to use as our last FI goal.
So now you have your:
- Financial independence number goal
- The goal for when you want to become financially independent
- The savings rate target you'll need to hit in order to achieve it.
That's it! Those are the 5 simple steps you can take in order to start your financial independence journey today! You now know where you want to go, the number you need to save and how long it'll take you to reach financial independence.
