On our previous FI post we spoke about what financial independence means to us. We also explained how it gave us a purpose to start saving aggressively and invest until we get there. And we gave you the breaking news that you don’t have to wait until you’re 65 or older to leave a corporate job and start living a fulfilling life based on true happiness, aka early retirement. Can you visualize a life where you work only if you want to? Better yet, work only on what matters to you. It’s all within reach. I can visualize my future “work” day consisting of 3 hours a day, working on things that I enjoy most.
I do intend to be more active in early retirement than el asaroso, our welfare cat, Pushok. What a life that is! He has no worries and receives all social and financial support from the hard working Mr. & Mrs. Enchumbao. And, what do you get in return? Pet him for a few seconds, which he considers too long and you get scratched, guaranteed.
Back to our FI topic: to get to the FI stage, we have a plan and we want to share a simple rule, widely known rule in the FI community. To figure out how much we need to accumulate in income-producing assets in order to consider ourselves financially independent, we use the Multiply by 25 Rule.
Financial advisors have a rule of thumb that you may need 75% to 85% of your current annual income for each year of retirement. That might make sense for people that save very little. Would that rule still apply if you have a very high savings rate? I doubt it. To extreme savers like us concentrating on our annual expenses and using the Multiply by 25 Rule makes more sense.
The Multiply by 25 Rule implies that if we multiply our future annual expenses by 25, the resulting figure is the amount of net worth we need to have in income-producing assets to be financially independent. This is based on the fact that we’ll be able to withdraw, on average, 4% of our portfolio annually while giving our investments a chance to last indefinitely. The idea is that by withdrawing this amount your investments can keep up with inflation. So if you make a 7% return on $100 you could safely withdraw 4% out and leave $103 invested.
Let’s take our expenses from last year as example. We spent roughly $47,000 including gifts and donations. If we want to see how much we would need to have invested to be FI next year, we would take that number and multiply it by 25:
$47,000 x 25 = $1,175,000
That means we would need to have a net worth of income producing assets equaling $1,175,000, a little over a million dollars. This is just an example since our expenses upon reaching FI are projected to be different from now. This figure might sound shocking to you but don’t let it scare you, the power of compounding helps doing the heavy lifting.
We also need to account for inflation. If our annual expenses were to be higher, than well need to work longer to get there. This is one of the reasons why people can’t keep their lifestyles when they’re ready to retire. They spend so much that it’s impossible to have enough investments to maintain their lifestyles if they want to pull the plug on corporate work or retire.
At some point, they reach retirement age but can’t continue to act rich and have to downsize. Also, people spending all that they make, combined with a lack of financial education and planning keeps them living unsustainable lifestyles.
If we could manage to keep the expenses down to, let’s say, $25,000 a year, then we’d only need to amass $625,000 to be financially independent. Can someone even live on $25,000 a year? Of course, check out Mr. Money Mustache, he has a house paid off and lives like a king with his family on $25,000 to $27,000 a year in Colorado, U.S.
Also, once you’re FI, you are location-independent, which means you could live in the Caribbean or Thailand like a king/queen for $500-1000 a month. If you do your numbers with this rule and they seem so far out of reach, this might be the time to stop acting rich and start becoming rich.
Let’s break it down to some line items from our expense report to see it in full action. Last year we spent $878 on home supplies, (I tell you, that Charmin Ultra Soft tissue is really good stuff). If we take that number and multiply it by 25, we’ll need to have invested $21,950 in order to pay for home supplies for life. That means you can spend as little as possible and invest the rest to fill that FI bucket, and never have to work again to buy toilet paper and other household items! Then you can wipe without worries.
You can also eliminate certain expenses and still reap the benefits. For example, I used to buy books in the past, first physical copies and then e-books. By spending $20 monthly on books, I’d have needed to invest $6,000 to keep that expense. I brought it down to $0 by getting the books from the library. I now get to read more and Mrs. Enchumbao and I both take advantage of their e-books selection from the comfort of our home.
Aside from the fact that we rather spend satellite/cable money and time on experiences, we realize that if we want to have such a time waster of a luxury, we’d have to work harder than the “Netflix only” guy. With Netflix at $8, we only need to have set aside $2,400. If we were to pay $100 for cable a month, we’d need to have $30,000 set aside. I can geeky it out some more, but I think you get the point now.
This is what we use to measure our progress on becoming financially independent. How many expense buckets do we need to fill? By waking up and seeing how real this is, we’re drastically cutting our working years. We’re getting to FI in less than 10 years as opposed to what might have taken a lifetime.
Unnecessary or wasteful spending can keep us from becoming financially independent or early retired by adding way too many working years to our lives. We’re not willing to make that trade and instead prefer to spend our time doing meaningful things without time constraints, even when it means that we go against the norms.
Who says you have to work until you die? It’s your life, you get to dictate how you live it. And it’s definitely too short to spend more than a third of it in a cubicle!
To show you the power of compounding in action we want to share this exercise we found online: Would you rather have right now: $1 million or 1 penny? If you take the penny, you double the amount of money you have every day for 31 days. Comment below without cheating, please! I’ll post the answer at some point.