If you didn’t need to work for a living, how would you spend your time?
Would you travel the world? Train to run a marathon? Write a book? Spend more time with your family? Volunteer to support causes you care about? Focus on hobbies or start your own passion-based business? Only do work you truly loved to do?
Record your answer in a notebook before reading on.
Here’s how I answer this question. I would slow travel the world for a few months each year while also keeping a home base in Boston. We have a strong community of support here, so that’s important to us. I’d want to have plenty of time to focus on my mental/physical health, passion projects, fun, and building strong relationships.
Now, review your list. (And if you didn’t actually record your answer, do that now.)
What if I told you that you could likely do all those things while still needing to generate income?
There are so many lifestyle design options that could allow each of us to pursue our goals, such as:
- Working part-time or seasonally
- Negotiating full-time remote work
- Taking a sabbatical or mini-retirement
- Pursuing freelance or contract work
- Starting your own business
As you consider these options, I imagine you had some anxious thoughts and emotions arise.
For most people, thinking about any significant change sets off a chain reaction of thoughts and questions, such as:
- Would I have enough money for retirement?
- What if another black swan event, like the pandemic, happens?
- What if I couldn’t ever find another job that pays as much as my current role?
- I’d love to do this, but I just don’t have the mindset to be able to take risks.
- What if I make this change and everything goes terribly wrong and I end up homeless?
- Other people might be able to do this, but I can’t.
It’s completely normal to have these thoughts when you begin thinking about making a change. You might also be dismissing any shift before even thinking about it because you assume it can’t be a reality.
The first step to working through these limiting beliefs related to scarcity is to understand your numbers.
Financial Metrics to Help you Design Your Life Today
The first and most important thing you can do is to understand your current financial reality. This way you can understand the actions you want to take next.
If your finances aren’t where you want them to be, that’s okay. It’s helpful to know, and you can hopefully take action to reduce your costs or increase your income.
For many people who are pursuing financial independence, having scarce resources is often not the issue. The issue is more often rooted in a scarcity mindset. We believe that resources are scarce, even if that is not actually the case.
So, we keep saving to accumulate more options. And, we don’t realize that we can actually start utilizing some of those options along the journey.
To be clear, working through these mental barriers might require us to use other strategies. But, having an understanding of a few important financial metrics can take us far in overcoming our scarcity mindset.
Baseline Financial Independence Metrics
There are a few important metrics that anyone pursuing financial independence needs to know, including:
- Average annual expenses
- Financial independence number
- Savings rate
These baseline metrics provide a foundation to help us understand our options.
Average Annual Expenses
Definition: How much money you spend on an annual basis.
There are a few different ways you can calculate your annual expenses. Some people use their own spreadsheets to track their expenses. This can be quite time-consuming. Other people use software programs to aggregate their spending automatically.
We use Personal Capital to calculate our annual expenses. All we needed to do was connect our various investment, bank, and credit card accounts to the platform. Personal Capital imports the data and categorizes our spending for us. It allows us to go back and look at our spending history and trends for as many years as we’ve used the application.
Note: Personal Capital doesn’t just track our spending. It also tracks our net worth and investment balance. It’s an easy one-stop shop for all our financial information. If you haven’t used it, we highly recommend trying it out.
Knowing your average annual expenses is important for many reasons:
- You cannot determine your FI or Coast FI numbers without knowing your annual expenses.
- Knowing how much you spend can provide you with the information needed to make decisions about your future. For example, if you are thinking about taking a new job, you can easily calculate whether it will allow you to cover your expenses and continue to save. If you are hoping to take a 3-6 month sabbatical, it will allow you to predict your costs so you know how much you need to save.
- Tracking your expenses also allows you to identify if you are spending money on the things you value. It can allow you to pinpoint areas where you want to spend less (or sometimes more).
If you’ve never tracked your expenses and want to get an estimate of your annual spending, I’d encourage you to check out this tool on Modest Millionaires to get started.
Financial Independence Number
Definition: The amount of money you need invested to live off the gains and never run out of money (i.e. to retire comfortably at any age).
To calculate your financial independence number, you need two pieces of information:
- Your average annual expenses
- The safe withdrawal rate (SWR) that you are comfortable with
We’ve already talked about expenses, so let’s dig into safe withdrawal rates.
What is a safe withdrawal rate (SWR)? How do I figure out the right one for me?
The idea of a SWR comes from the Trinity Study. The Trinity Study looked at a variety of retirement portfolios with different stock and bond percentages. They ran simulations (using actual stock market data from 1925-1995) to understand the likelihood of success for various portfolios.
To pull meaning from this, we must assume that past performance predicts performance. I feel good about this assumption because we’ve seen it to be true in the subsequent years after the study.
The study found that a 4% annual withdrawal rate, for a portfolio that was more than 75% stocks, was successful 94-98% of the time for a 30 year period. This means that a person with a similar portfolio would not have run out of money 94-98% of the time. In many cases, their portfolio actually grew. A more conservative withdrawal rate of 3% was successful 100% of the time. For a 40 year period, the success of a 4% withdrawal rate drops to 89-92%.
To figure out the SWR that you want to use, you’ll need to think through a few key factors:
- Your expected length of retirement. If you are planning to have a 30-year retirement, a 4% SWR would probably be fine. If you want to retire early and expect to have a 40+ year retirement, you may want to consider using 3% or 3.5%.
- Your ability to adapt. Will you have the ability to either decrease your expenses or generate income during retirement in the case of a black swan event? If you are willing to be flexible, you could probably use a 4% SWR. If you have a history of disability or illness in your family or expect that you will be unable to generate income in the future, you may want to use a 3% or 3.5% SWR.
When calculating our own FI number, we are more comfortable with a 3.5% withdrawal rate. We know that we may want to stop generating income in our 50s. We also feel like we will have some ability to adapt (reduce our expenses or generate income) if needed, so 3.5% feels good to us.
To calculate your FI number, you can use this formula.
FI number = (1/SWR)*annual spending
Here’s a cheat sheet of how to calculate based on different SWRs:
- 4% SWR = 25x your annual expenses
- 3.5% SWR = 28.5x your annual expenses
- 3% SWR = 33x your annual expenses
To be clear, knowing your FI number doesn’t mean that you need to try to reach it as soon as possible. It simply allows you to know what your baseline needs are. With this baseline, you can run calculations and scenarios to understand your options.
Definition: The percentage of your after-tax income that goes to investment or savings
To calculate your savings rate, you need the following information:
- The amount of money you save or invest over a certain period of time. We typically choose 1 year since there are month-to-month fluctuations in spending.
- Your net income (after taxes)
- Any retirement match from your employer
To calculate your savings rate, you would use this formula:
Savings Rate = ((Amount of $ saved and invested + retirement match) * 100)/(Net Income + retirement match)
If you don’t get any match for retirement savings, you can simply put zero.
Knowing your savings rate is important for a few reasons. First, your savings rate determines the pace at which you will reach financial independence.
This table share the number of years it would take to reach FI based on your savings rate, if you start from $0.
|Savings Rate (Percent)||Working Years until Retirement|
One important thing to note is that you can intentionally change your savings rate over time.
Having a super high saving rate forever is actually not ideal for most people. At some point, we all will need to start drawing down on our portfolio. That’s mentally challenging for a lot of people. Reducing your savings rate over time can emotionally help you make the switch from accumulation to drawdown.
Why would someone decide to reduce their savings rate?
You could choose to spend more, of course. More often, I see people who are designing their lives choosing to generate less income. They might do this by choosing to reduce their work hours. Or, they might see a temporary hit to their income by starting their own business.
You might be thinking, “Wow. This seems complicated.” Don’t worry; we’ve got you! We’ve created a Meaningful FI Metrics Calculator that will do all these calculations for you.
Meaningful Financial Independence Metrics
When I say “meaningful” here, I mean that the metrics will provide you with information about how you can live your life TODAY. They don’t just tell you what you will be able to do on some far-off future date.
The meaningful metrics include:
- Months of Spending in Emergency Savings or F-You Money
- Your Coast FI Number
- Expected Investment Balance at Retirement Age (if You Stopped Investing Now)
- Active Income Needed to Semi-Retire
These metrics provide you with meaningful information about actions that you could take in the short term.
Emergency Savings or F-You Money
Definition: The amount of money you need to feel comfortable to face emergencies, get out of a bad situation, or take advantage of an opportunity.
Typically, people think of emergency savings or F-You Money in months of expenses.
To calculate this, you’d calculate the total amount you have in savings and divide it by you annual expenses (divided by 12 months). As a note, you’ll want to exclude the amount that you expect to spend this month as well as money that is earmarked for another purpose.
Emergency Savings/F-You Money (in months of expenses) = amount in savings (that isn’t earmarked for another purpose)/(your annual expenses/12)
People often recommend having 3-6 months’ worth of expenses saved in an emergency fund. F-You Money is slightly different because it’s the amount you need to feel like you can use your options. Depending on the individual this could range from anywhere to 3 months to 2 years or more of expenses.
For example, we currently have about two years of expenses saved in our emergency fund (or F-You Money). We’ve chosen to keep this amount in savings even though we know we’d get a better return if we put it in the stock market.
Having this amount of emergency savings allows us to take risks and make decisions that improve our lives. This has allowed me to leave a toxic job without a backup plan, work part-time, and start a business. It also allows us to cover emergency expenses like car repairs, medical costs, and home maintenance.
Coast FI Number
Definition: The amount of money you’d need at a particular age to no longer need to save any more money for the traditional retirement. Once you reach this number, your investment balance will grow to your full financial independence number.
To calculate your Coast FI number, you need:
- The time horizon that your money will have to grow (your desired retirement age – your current age)
- An expected growth rate of the stock market that you feel comfortable with. We use 5% for index investments as a conservative estimate and to account for inflation.
- Your full financial independence number (Now do you see why knowing it is important?)
How to calculate your Coast FI number:
Coast FI Number = Your FI Number / (1+expected growth rate) ^ # of years until retirement
Wow, that’s complicated, right? Luckily, you don’t have to do it yourself. You can download our calculator spreadsheet below.
Knowing if you’ve reached Coast FI (or when you’ll reach Coast FI) is important for a number of reasons.
Once you reach Coast FI, you have 3 options:
- You can keep saving money at the same rate. But, now you know that any additional money you save is no longer for retirement. It’s for early retirement.
- You can scale back and only cover your actual costs of living until retirement age. Your money will continue to grow.
- You can gain a feeling of freedom and decide to slow down a little bit and reduce your savings rate.
I talk a lot about how financial freedom is not all or nothing. The same goes for Coast FI. You don’t have to choose to keep saving or scale back completely. There are many “middle-ground” options that will provide you with more freedom and still allow you to save at a lower rate. That lower rate of savings is all still going toward early retirement.
When we reached Coast FI, we decided to take a middle path. We slowed down and designed our lives without scaling back to cover only our actual costs of living. This provided us with the freedom to start our business and for me to quit my job when the revenue only covered half my previous salary.
While Corey (my spouse) is still working full-time, we have plans for him to scale back within the next few years as well.
Expected Investment Balance at Retirement Age (if you stopped investing)
Definition: This one is pretty self-explanatory. It is your expected investment balance at retirement age if you stopped investing now. If you decide to take the coast FI approach that only covers your actual costs until retirement, your investments would grow to this amount.
To calculate this, you need the following information:
- Your current investment balance (including all retirement accounts and taxable investments)
- The Growth Rate you are comfortable with (discussed above in Coast FI number)
- The number of years until you want to fully retire
To calculate this, you can use this formula:
Expected Investing Balance at Retirement Age (if you stopped investing) = Your current investment Balance * (1+Growth Rate)^# of years until retirement
We recently worked through our numbers as we considered different transition options over the next few years.
For us, this was the most impactful number.
If you’ve already reached Coast FI and have continued to save, the value of your investments at retirement age will be more than what you need. If you only cover your actual costs now, your investments will grow to higher than your FI number.
I theoretically understood this. But, until I saw the numbers on paper, it didn’t sink in.
We don’t share any specific numbers on our blog, but we are happy to share percentages. When we did these calculations, we realized that if we used a 5% growth rate and a 3.5% withdrawal rate (both very conservative), we could stop investing now. If we only covered our actual costs until the age of 60, our investments at retirement age would be 20% higher than our actual FI number.
Said in another way, we could stop investing now and have way more than what we’ll actually need to retire comfortably.
The reality is that we aren’t ready to slow down completely yet. Well, Corey’s not… He enjoys his work and wants to stay for at least another couple of years.
Here’s the reality. If he stays in his job for another 2-3 years, and then, we stopped contributed to retirement, we’d end up with 65-80% more than our FI number at the age of 60. If we reduce our full retirement age to 55, we’d still have anywhere between 25-45% more than we’d need.
This will provide us with even more freedom and the ability to give to causes we care about.
This realization gave us a true feeling of freedom to realize that we could scale back (and only cover our costs) now if we wanted to. Because we are continuing to save at a high rate for another couple of years, we will also have the opportunity to semi-retire if we want to.
Active Income Needed to Semi-Retire
The last metric that I want to share is the amount of active income that you’d need if you wanted to semi-retire right now.
Let me first define semi-retirement.
Definition: When someone begins to draw down their portfolio (or uses the cash flow from invested assets) to cover part of their expenses. The other part is covered with active income either from an employer or self-employment.
To calculate the amount of active income that you would need to semi-retire, you’d need to know:
- Your current investment balance
- The safe withdrawal rate (SWR) that you are comfortable with
- Your annual expenses
Here is the formula that you could use to calculate the amount of active income you’d need to semi-retire:
Active Income Needed to Semi-Retire = Annual expenses – (Current Investment Balance * SWR)
As a quick note, this is a simple formula that would tell you how much active income you’d need to generate forever (not just until retirement age). That’s why this number is only illustrative. It can provide a feeling of freedom and allow you to start drawing down from your portfolio.
When you know how much active income you still need to generate, you can start to feel comfortable utilizing additional options.
You could decide to take a break for 1-2 years from work and withdraw 3.5-4% of your portfolio to cover the expenses, knowing that you won’t deplete the balance. After that time, you could continue saving and investing in your future.
For example, I have a friend who is currently taking a sabbatical and building a business. She is okay with withdrawing 1-3% of her portfolio this year to help cover the gap in her business expenses if needed. She knows that this won’t deplete her portfolio, and she can continue to invest once her business grows.
For people who are close to reaching full FI, taking a semi-retired approach could provide them with tremendous freedom now. For example, my friend Rebecca and her partner decided to semi-retire in 2020. They realized that they could have worked for 2-3 more years to make sure they would be 120% set forever and never need to generate another dollar.
But, when they learned about semi-retirement, they realized that they could quit their jobs now. How much active income they would need to generate would depend on the cost of living of the place they chose to live. They realized that they’d only need to generate somewhere between $0-10,000 of active income to supplement their portfolio.
This will require them to keep tabs on how their portfolio is doing over time so that they can adjust if needed. That seems like a great trade for a lot more freedom a lot earlier.
You Don’t Need to Reach Full FI Before You Design Your Life
The traditional FIRE narrative tells us that we should try to reach financial independence as quickly as possible so that we can retire as early as possible.
I don’t actually think that is the ideal path. There are so many ways that you can use your financial freedom along the path to FI.
And, if you are already on a path to financial independence, you might be surprised at the level of freedom you already have. When I looked at the numbers in this way, I sure was.
Or, you may not yet be where you want to be. Maybe your full financial independence number feels unrealistic to you right now. Maybe you feel like you want to give up.
If this is you, I want to provide encouragement.
Don’t give up! If FI feels so far away, that’s okay. Retiring Early is not the only goal. There are so many waypoints along the path to FI that can provide you with options.
- F-You Money provides you with the ability to quit a toxic job without a backup plan, start a business, or even take a sabbatical.
- Coast FI could allow you to work part-time or seasonally. You could also be a location-independent entrepreneur!
- Semi-Retirement enables you to scale back and only do work that you truly enjoy.
How do you want to use your financial freedom to design a life you love?
Download our free Meaningful FI Metrics Calculator to figure out how you can start using your freedom today!
This article is a good start. Don’t forget in your expenses:
1) taxes unless every dime will be Roth. The Trinity study did not account for taxes. You need to add them to your expenses.
2) health insurance – unless you do a ministry plan, you should budget $15-30,000 if you no longer have an employer. If one spouse is still working, it’s good to plan for when you both stop. Even Medicare costs something.
3) long term care – half of those over 65 will need it. At $100k per year, you either need insurance or savings to self-fund … this could be called a black swan event but one that is on the more common side.
The above are the big three not discussed enough in FIRE sites.
And of course kids. There are a few sites that cover this.
All good points! Thanks for sharing them. Factoring taxes into your expenses is important at least for the portion that isn’t coming out of Roth accounts.
At this point, we’re already factoring in needing to pay $15K out of pocket for health insurance once we are both self-employed. Hopefully, it won’t be too much more than that.
What can’t be measured can’t be improved. Financial independence has to mathematically make sense. It’s prudent to track and measure your savings and spending rates so that you can see whether it can make financial sense.
Everyone needs metrics to benchmark against. The risk though is that the metrics become too much a part of your life.