As we approach Independence Day, I pondered what it means to be financially independent. Warren Buffett and Charlie Munger are still working; are they financially independent? What about Whitney Wolfe Herd or Robert Johnson or Jeff Bezos? If billionaires are still working, does it mean we need several billion dollars to be independent? I doubt it, but let's crunch some numbers to find out.
Other terms for independence include self-reliance, autonomy, and freedom. Self-reliance stands out because if I'm financially independent, I rely on myself to make ends meet, not a job, government assistance, or family support. If I retire from my vocation to take a less stressful job as a cabana boy at a beach club to cover my expenses, I'm not independent; I just changed jobs.
Retiring from your day job requires courage and financial assets. How much do you need to retire comfortably? The answer varies greatly, but, at a minimum, you need enough money to cover your living expenses. For example, if you spend $100,000 per year, you need enough assets to generate income to cover your costs. To produce an annual income of $100,000, you will need about $2 million to $2.5 million in assets. If your account balance is $2.5 million and you need $100,000 to live, then you're financially independent. If you're curious about your specific number, multiply your expenses by 20 or 25.
To start your journey towards financial independence, calculate your annual spending. Where does your money go? How much do you spend? After reviewing your expenditures, can you reduce or eliminate items from your budget because the less you spend, the less money you need to save.
What can you do if you're not financially independent? If you're short of your goal, reduce your spending, increase your savings, and allocate more money to stocks. Let's say you're forty, and your goal is to become financially independent at age sixty. After calculating your expenses, you determined you need $5 million. If your current account balance is $1 million, you need to save $1,845 per month to reach your target. Of course, you can retire whenever your account balance touches $5 million, regardless of your age.
Saving money is your best investment strategy, and the more you can save, the better. Contributing to your company retirement plan, an IRA, and a brokerage account provides several income distribution options when you're ready to stop working. Automating your savings plan allows you to manage your cash better, eliminating human error and emotions.
Investing in stocks eclipses bonds and cash. For the past five years, stocks produced a return of nearly 100% compared to 4% for bonds and .06% for T-Bills. Since 1926, stocks generated an average annual return of 10.3% compared to 3.3% for U.S. T-Bills. If you want to achieve financial independence, you must own stocks.
However, don't kill yourself by chasing financial independence. Life is to be enjoyed and shared with others, don't live like a pauper. What's the point of becoming independent if you're living in the middle of nowhere eating SPAM® every day? Instead, set a reasonable goal and timeline that allows you to live for today and dream for tomorrow.
If you live for having it all, what you have is never enough. ~ Vicki Robin
July 2, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.