In this episode, we talk about pursuing early financial independence and what all goes into it. We explain what it means to be financially independent, how to calculate how much you need in savings/investments to become financially independent, and how to figure out how much to save and invest each year to reach that number within your desired time frame. We also talk about some of the potential trade-offs involved with pursuing early financial independence and how to think about them within the context of your overall financial life. Lastly, we wrap things up by covering some of the specific investment accounts that can be particularly helpful for anyone with an early financial independence goal.
Outline of this episode
- What is early financial independence? [1:01]
- How do you know how much money you need to become financially independent? [2:42]
- Making an assumption for the annual investment return of your portfolio [5:41]
- Trade-offs to consider when pursuing early financial independence [7:59]
- Accounts that will be helpful to use when saving for early financial independence [10:45]
- Summary of steps for pursuing early financial independence [14:45]
Getting a realistic ballpark number using the 4% rule
When talking about early financial independence, a natural question is “How do I know how much I need to become financially independent?” When trying to pinpoint your “number” for financial independence, there's a rule of thumb known as the 4% rule. This rule says that if you have a well-diversified investment portfolio of 60% stocks and 40% bonds, you can safely withdraw approximately 4% of the initial value of your portfolio year after year, over longer periods of time, without running out of money. This is not a hard and fast rule, but a way to get a ballpark number to plan with.
Assuming your investment return when pursuing early financial independence
Deciding what to assume for an annual investment return for your portfolio is probably the trickiest part of the early financial independence calculation. This will have a big impact in determining how much you need to save and invest each year. Historically, stocks have produced roughly 10% annual returns while bonds have provided closed to 4-5%. However, there's no guarantee that future returns will be similar. The actual return you earn will depend on how your portfolio is invested, how you manage it over time, and what investment returns the stock and bond markets actually provide. Also, the year-to-year market returns will inevitably be different than what you assume, which is why this is a constantly evolving process and you need to revisit it each year to tweak and adjust over time based on how things actually play out.
What trade-offs are you willing to make for early financial independence?
It might seem daunting to imagine saving and investing a large amount of money year in and year out for your financial independence goal, so we want to share a little perspective about the trade-offs involved and things to consider when pursuing early financial independence. If you've listened to other episodes of the podcast, you'll know that we're big fans of balance when it comes to managing your finances, and for life in general. Some physicians may be able to save and invest the amount required for early financial independence without making any sacrifices to their lifestyle, but for many, it'll require pulling back a little on certain areas of spending and avoiding lifestyle creep.
It comes down to what's most important to you in terms of enjoying more of your money along the way versus being financially independent sooner. On a personal level, we plan for the future but also know that we're never guaranteed tomorrow. So while we have target ages for financial independence, we don't want to make significant sacrifices to our lifestyles to be financially independent a few years earlier, so we both take a balanced approach. We don't want to pass on things right now like vacations with our families or other fun experiences to make memories with them, just to save more. That said, we also have the luxury of loving our jobs and never wanting to fully retire, which makes it easier to have this mindset. For us, financial independence is about freedom and flexibility, rather than wanting to stop working entirely. What about for you?
Resources & People Mentioned
- Blog post: The Math of Financial Independence
- Blog post: Pursuing Financial Independence
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup