You already know that spending less than you earn is the main key to reaching financial independence. You’ve very likely already heard about the 4% rule. It’s the idea that if you spend no more than 4% of your total investments per year, there’s a very high probability (over 95%) that your money will never run out.
So that means that your investments need to be equal to 25 times more than your annual spending, which also equates to 300 times your average monthly spending. This is a rough guideline to how much money you need to save in order to become truly financially independent assuming you have no other income besides your portfolio proceeds.
While these guidelines will give you the end goal number that you are ultimately aiming for, that number can tend to be a bit abstract and distant. I have found the following exercise very valuable to make things more relatable and create an easy system for meaningful actions to reduce spending. By breaking down your individual expenses you can evaluate your spending and make value based decisions. This is especially true for recurring monthly or annual expenses.
Let’s use “Cable TV” as our first example. Say you sign up for Comcast’s Triple Play at $99 a month. $99 a month seems pretty reasonable you might say. Well, using the 300 times your monthly expenses rule, that $99 recurring monthly charge means that you will need to build an extra $29,700 into your investments to sustain that expense. Now go ahead and double that after the 12 month introductory rate is bumped up to $200 a month, and the total climbs to a staggering $59,400.
So let’s be generous and say that you are saving $5000 a month. If you were just plunking that cash into a savings account it would take you roughly a year to save that much. Assuming you make a 6% return on investments (I’m keeping it conservative here), you will be working an extra 10 months in order to support that expense!
Assuming that pretty much everyone will want or maybe even “NEED” internet service, you can get a decent plan for about $60 a month, which would reduce that 10 months down to 3. Take a moment to think about that, would you rather have 7 months of your life…or cable TV?
Example #2 looks at coffee shop habit that many people have. I love lattes, those suckers are great. What I don’t love is that at $4 a pop, a daily latte habit will require me to save $36,500 if I’m using the 4% rule after FI. If I am earning $130,000 and am a way above average saver (60% +/-) that invests $5,000 a month, I will have to work for an extra 5 months in order to build up this amount. That’s also assuming that I don’t buy a cake pop, or sausage egg muffin, or any other tempting treats while I’m there.
I haven’t crunched the numbers, but I’ll bet I can make myself a top shelf latte at home for about 50 cents, which equates to a savings of $105 a month vs the coffee shop route. That takes the $36,500 investment balance I needed for a $4 a day habit all the way down to $4,562 to support my 50 cent a day home latte habit.
This means that I now need to accumulate $31,938 less to reach financial independence just by simply switching to home brewed coffee, pretty sweet, right? And that’s only part of the equation, if I invest the money that I’m saving over time, it gets even sweeter.
Let’s play it out over 10 years. I’m choosing 10 years because it is about the timeline for a 60% saver to achieve financial independence assuming they start with a $0 balance. Factoring in a conservative 6% return on investment, investing that $105 every month means that after 10 years that investment would be worth a cool $17,600.
Here’s how the numbers break down assuming that I have annual non-caffeine expenses of $35,000.
Annual spending: $35,182.50
Annual spending on lattes: $182.50
Pre-FI investment contributions per month: $5,105
Investment balance needed to reach FI: $879,562
Times to reach FI: 10 years, 5 months
Annual spending: $36,460.00
Annual spending on lattes: $1,460
Pre-FI Investment contributions per month: $5,000
Investment balance needed to reach FI: $911,500
Times to reach FI: 10 years, 10 months
Hopefully this help illustrate how making a simple change can have significant impacts to your Financial Independence journey. Does my quality of life go down by making a latte at home? Likely not. Does an extra 5 months of freedom improve my quality of life? Indeed it does!
As a last point, I’m not saying that you should not buy lattes. I am saying that you should be sure that you understand how your spending relates to your savings and your journey towards financial independence. If a latte a day is worth the extra time of employment to you, then drink on my friend!
Also, please keep in mind that these numbers are what it looks like for someone comfortably in the six figure salary world and is a way above average saver. If you want to know what it looks like for your situation, I recommend that you run the numbers for yourself.