For 2018 I am spending each month working on improving a different area of my life and discussing it with all of you. January was life planning month and we’ve spent February exploring the basics of personal finance.
In the personal finance space, we tend to treat the concept of financial independence as a more advanced money topic. We view it as something to move on to after you’ve mastered the basics.
I don’t think this is the right approach.
I think we need to teach financial independence as an introductory personal finance topic. It should be a basic of learning about money.
I say this for two reasons.
Financial independence is simple.
Financial independence is necessary.
Financial Independence is Simple
Keeping in mind that simple does not mean easy, financial independence is a simple concept.
We all understand the goal of funding our retirement. We want to have enough money to live on for the rest of our lives without needing to find a new job.
We use a combination of tools – pensions, social security, self-funded retirement accounts – but the goal is to make sure we can live without needing to work from around age 65 until the end of our life.
Now remove the arbitrary retirement date and you have financial independence. That’s it. Simple.
You don’t have to retire at any particular point, but you want to have enough money that you could if you wanted.
Aim for 25 Times Your Expenses
One of the reasons that financial independence can seem complicated is that there are lots of different opinions on how much money you need.
And that’s fair. Honestly, it depends on a lot of things. What happens to health care costs in the future? Do you want to pay for college for your kids? Do you want to travel more after leaving the workforce? Do you want to do new work that will result in some income? Does your family tend to live a long time? Are they healthy in their advanced years?
It can get complicated when you start dealing with the details.
But there’s no reason that we need to address these uncertainties before starting – we know a good target.
We’ve explored the 4% rule before, but the gist of it is this: If your investments are 25 times larger than your annual spending, then you are in a good position to retire, regardless of age, if you want.
Again, this may not necessarily be easy, but it is simple.
Easier That It Looks
Looking at the raw numbers makes this feat look intimidating. It may even look impossible from where you’re sitting.
But it gets a whole lot easier when you consider the power of compound interest.
We’ve explored this concept before, as well, but I’ll provide a quick example.
If you invest $100 per month for 30 years and the market grows at 8% per year, you will walk away with over $150,000 even though you only invested $36,000.
That’s huge. You save $36,000 and you are given an extra $114,000 for leaving your money invested.
Take a little bit of time to play with a compound interest calculator and see how powerful this force can be.
Don’t sleep on the power of time.
People in the financial independence space spend a lot of time arguing over whether it is better to cut your spending or to make more money. My personal take is just do both.
But if you’re looking for a way to make your financial independence number look less intimidating, check out how powerful cutting your spending can be.
Because you need to save 25 times your annual spending, every dollar of spending that you cut is $25 that you don’t need to save.
When my wife and I replaced cable with Netflix and Hulu we saved $100 per month. This means that we cut $1,200 from our annual budget. This, in turn, means that we lowered our financial independence number by $30,000.
$30,000 less that we need to save from one simple and easy change.
Think about areas where you can cut your spending without decreasing your happiness. This will make your number seem far more attainable.
Financial Independence is Necessary
I hope you’re now sold on the idea that financial independence is actually much more simple than we often perceive. But maybe you’re not convinced that it is necessary.
People generally sell financial independence as a positive option. You get to quit your day job! Pursue your dreams! Do whatever you want with your time!
And that’s true. I believe that financial independence buys options. Once you hit your number you can make all sorts of choices that weren’t previously on the table.
You can stay at your job or quit. You can find a new career you might enjoy more. You can pursue a hobby full time, even if it doesn’t pay much or anything. You can pursue creative endeavors. You can spend your time volunteering for causes you believe in. You can become a full time activist. You can stay home with your kids. You can stay home with your books and pets.
You detach yourself from a need for a paycheck, and that frees you up to do pretty much anything you’d like with your time.
But if the optimistic view doesn’t sell you, then the pessimistic view should.
Your Job Isn’t Safe
Technological growth is exponential.
The tech that we have now can do things that we could not imagine 20 years ago.
With that in mind, are you really confident that your job won’t be automated out of existence 20 years from now? 10?
Even if it isn’t automated out of existence, what will automation do to the jobs that remain?
I’m a lawyer. I believe that there will still be lawyers in 20 years. But we’re already automating document review, searching for case law, and simple brief writing. We’ve got companies like Legal Zoom and Novo charging low rates for simple tasks by maximizing automation.
This means that even if there are lawyers in 20 years, there will be a whole lot of lawyers competing for far fewer legal jobs. This should drive down wages dramatically, so that even if I have a legal job, it may be far less lucrative.
Maybe your response to the positive view of FI was “I love my job!” or “I don’t want to stop working.” Those are both totally valid opinions. But when you leave your job may not be up to you.
We’re entering a new technological era and a new era of employment. Even if everything turns out perfectly wonderful in the long run, there’s going to be a lot of short term turbulence that we need to be prepared for.
The Value of Labor
Workers are being paid less and less relative to the value that they produce.
This is an idea that generates a lot of instinctive push-back from the personal finance community. People want to believe that the free market works. That you’re paid what your worth. That you will be rewarded for creating value.
This is becoming less true over time, though. And the stats back me up.
There are a lot of different causes that all contribute to this trend, and we can spend all day debating which are the most important, but the practical takeaway is that unless the economy suddenly and dramatically reverses course from the direction it has taken for the last 50 years, the chances of building significant wealth through working hard for employers will continue to drop.
Our parents were taught to get a good job at a good company, work hard and climb the ladder, and be rewarded with a nice retirement at the end.
That’s not the world we live in anymore. That’s not the economy we work in.
If we want to build financial stability we need to do it ourselves. We need to do it with investments rather than employment. And we need to do it as soon as possible.
Join the Conversation!
Financial independence is something that should be taught as a personal finance basic for all of these reasons. It is less complicated than we tend to imagine and far more important for our generation than we can comprehend.
Because of this, I’m working on maximizing my investments. How about you? Do you agree that FI is simple? Important? What are your thoughts? Let us know in the comments!