The following is a guest post from Amber Tree Leaves. He started investing 15 years ago and works in the financial industry now. He is passionate about financial independence and tracks his progress on his blog.
When talking about investing, there is a lot of focus on how to invest: What strategy do I pick, how do I select a stock, when do I take a profit. What if you think about the reasons to invest before deciding where to invest? What would come to mind?
Think about it… Why do you want to invest? What is your goal? There are no right or wrong answers: The future, my kids, my pension, a world trip. Those are all good answers.
Did Financial Independence/ Retire Early come to your mind, or short: FIRE?
The concept can be broken down in two parts. The first being Financial Independence, the second being Retire Early.
Let’s look at the first: Financial Independence. Wikipedia has a great definition:
Financial independence is generally used to describe the state of having sufficient personal wealth to live, without having to work actively for basic necessities. For financially independent people, their assets generate income that is greater than their expenses.
Aside from the definition, there is much more to add. I will address 3 aspects. 1. How much do you need? 2. Why would you aim for it? 3. How do you do it?
- How much do you need?
The definition gives it away: you need to generate more income out of your assets than you spend.
Imagine you live on 40K a year. You are then financially independent when your investment portfolio generates 40K in dividends. Or you are financially independent when you have rentals that generates 40K of income. What if you invest in ETF trackers, like I do? They accumulate and pay me nothing. When will I be Financially independent?
There is a rule of thumb (The trinity study) that says that you are financially independent when your investments portfolio has the size of 25 times your yearly living expenses. So, that would mean in the case above that you have a portfolio of 40K times 25, or 1 million.
Doing the math is easy. The difficult part is getting the right input. How much do you spend per year? Figuring that out means that you should have some basic record keeping and maybe a budget in place. Sounds horrible? I do this the light way.
I note each month what we earn and what we funnel to our investment accounts. Everything else is an expense. Also the money I set aside for an upcoming ski holiday or the road trips I dream off. I have no idea how much I spend on coffee or cupcakes. I do have a high level idea of our yearly total family spending. I now know how much we need.
- Why would you aim for it?
For the freedom that it brings.
When you are financially independent, you could stop working. Your portfolio is there to support you. Imagine what a freedom you have now. No more alarm clock, you are your own boss. You have the freedom to do only jobs and assignments you like, on your own terms. You have the freedom to decide to go on a world trip.
For me, that is the reason to pursue Financial Independence. To have freedom and more options to choose from. To design my life the way I want it.
Does that mean that I will quit my job the day I hit my number? Hell no! I advise no one to do the same. There is a lot more to worry about: a margin of safety is one of my concerns.
Am I happy with just equaling my number or do I take a 10 percent margin? Or maybe a 20 pct margin and a one year cash buffer. Or can I be flexible in my spending? What if the market crashes the day I quit my job? All good and valid questions. Figuring this out is part of the effort needed to become Financially Independent.
- How do you do it?
Does it take much effort to become Financially Independent? Yes, that is why people often call it the Journey To Financial Independence. It requires planning and then consistent execution of the plan. And it is very likely that the journey is better than arriving.
The plan starts with spending less than you earn so that you can invest the rest. That is not always easy. It means that you sometimes forgo on a splurge like a new car every 3 years or that extra pair of shoes. You need to be intentional with your spending.
The more you can invest, the faster it goes. And you need to invest wisely and consistently. The asset class you invest in can be anything, as long as it fits your personality.
Time to look at the second part of the concept: retire early.
In the literal sense, It means: stop working. This is a very controversial part. Some set this as the main reason: Quit the day job. Go travel, pursue that hobby… Not everybody wants strives for Financially Independence to Retire Early. And that is ok. It is your life. You decide what you do when you hit your number.
Just like it is your decision how much sacrifices you are willing to make now to be one day FI. Some make a lot, some make none at all.
As it is a journey, I have learned a lot the last 2 years. My current vision is to be intentional with my spending. I want to be sure to live now and enjoy the life I have now. I want to balance this with investing enough money to reach FI at a reasonable age. My wife and I have adjusted our life to that.
Being on the journey meant we have thought about what makes us happy now. We skip a few things that do not add value to our life now. We also decided to incorporate some of the freedom already now. Knowing our numbers and final destination made us realize that we could actually start today.