Have you ever been for a long hike in the mountains?
Imagine the scene.
You have a long days hiking in front of you but its do-able: you know that other people have done it before.
Its a marked trail with milestones that show the distance to your destination. As the miles pass you can quietly take satisfaction from your progress during the day.
And, as a reward at the end of the day, you will get a hearty meal, a drink (or three) and a warm bed. That sounds pretty good to me.
But the challenge is part of the attraction…so you don’t cry when it rains or when the slope gets a bit steep. No, you have to experience the rough to appreciate the smooth. A bit of effort makes the meal at the end of the day even more of a prize. Without the challenge of the weather / distance / altitude, have you really earned the food & drinks & the comfy bed?
Now please hold that hiking image (its really a mental model) in your mind because we’ll be coming back to it shortly.
In the meantime, I want to correct a common error about financial independence. And that’s the assumption that it’s binary. This binary thinking appears in a couple of forms (both of which are
- Firstly, its only success if you get to full financial independence and then retire never to work again. Anything else is failure.
- Secondly, life pursuing financial independence is all sacrifice and deprivation as you wade through the lowland swamps of saving…and then its all unicorns and flowers as you enter the sunlit uplands of financial independence.
Of course, no one spells it out in those terms but, if you look at many media articles, blogposts and comment threads, you can see the binary thinking. In their worldview, you’re either retired or you’re not…just like you’re either pregnant or you’re not.
In that worldview there is nothing in between. No room for concepts like working part time. No working flexibly as an interim or a contractor or starting your own lifestyle business. No gap years for grown ups. No such thing as career change. No working because it can provide meaning and purpose. Binary thinking is for computers, idiots and (some) journalists.
Financial independence is like life: you should be enjoying the journey not just the destination. And you will have more fun along the way if you celebrate the milestones as you progress along The Path.
So a more sensible way to look at your journey towards financial independence is to think of it like a long hike in the mountains. Yes, the destination matters…but so does the journey.
Maybe you’ll choose a shorter trail or a different destination? That’s fine. Maybe you’ll get lost along the way sometimes: its all part of the process.
A journey of a thousand miles may seem impossibly long, so it helps to break it up into stages. So its encouraging when you are on a hike to see milestones showing how far you have come. You can see and celebrate the progress as you get closer to your personal destination.
For several years, I’ve had an unfinished draft post on my computer titled “Milestones on The Path”. But I was recently reading the excellent new Choose FI book which contains a summary of the milestones of FI which I’ve
stolen adapted below (the bad taste jokes are mine):
1. Getting to Zero
“Normal” for most people means having debt from credit cards/ car loans/ student loans and consumer debt. To get to zero net worth means paying this off…or at least having savings and investments greater than your debts.
My credit card company wrote to me last week telling me that their interest rate is now 22.9%. I pay my balance in full automatically each month because paying 22.9% interest is like being raped in The Prison Camp showers. Without soap.
THIS IS AN EMERGENCY!!!. If you are in this situation, let’s not waste time arguing whose fault it is – it’s your responsibility. You shouldn’t be spending on anything other than rice & beans and work expenses. In the immortal words of Fergie:
If you ain’t got no money, take your broke ass home
2. Emergency fund
Having an emergency fund of 3-6m living expenses in cash in an instant access bank account is solid advice for most people. It protects you from most financial stresses (e.g. car breaking down, boiler needing replacement). Having an emergency fund can be the difference between inconvenience and disaster.
The lower your monthly expenses and the higher your savings rate, the quicker it is to save this emergency fund. At the risk of stating the obvious, at a 50% savings rate it only takes you 3 months to get an emergency fund of 3 months expenses.
Once you’ve eliminated the expensive debt and have an emergency fund you can start investing so your money works for you; earning passive income even whilst you sleep.
3. Hitting six figures
If you have invested net worth of £100,000 and a burn rate of £20,000 per year then you have 5 years of runway. Not only can you take a gap year, you can also afford to retrain and move jobs / careers / countries.
This is sometimes known as “Fuck You Money”. With this, you have a lot of power to control your own life. This is good for you and its good for your ethics.
4. Halfway there
This is when your assets (your invested net worth) reach 12.5x your annual spending. While this is half the amount that the 25x rule of thumb suggests, you are more than half the way to financial independence.
That’s because after about 6 or 7 years, the J curve of compound interest starts to kick up and from here on your investment returns contribute meaningfully to the heavy lifting previously being done solely by saving hard.
5. Getting close
Imagine that your portfolio reaches 25x the annual spending required to cover all your essential (non-discretionary) spending like food, utilities, housing costs etc. This excludes “fun money” spending on restaurants, going out, holidays etc. At this point, you probably couldn’t maintain your current lifestyle but you could stop working without having to worry about going hungry or having a roof over your head.
Now imagine another milestone: your portfolio reaches 20x your annual total spending (including the fun money spending). You could cover your total cost of living by drawing down say 5% of your portfolio annually.
Dangerous heresy? No, its just a thought experiment to illustrate the non-binary nature of FI. While less safe than a 4% withdrawal rate, this gives you roughly an 80% chance of maintaining your spending without running out of money based on historical data. You could safely leave your job at this point if you were willing / able to be flexible with your spending and / or part time work.
6. Financial independence
The next milestone is when your portfolio reaches 25x your entire annual spending which is, for practical purposes, a good enough definition of how much is enough.
This doesn’t guarantee safety because there are no guarantees in investing or in life. But in the Trinity Study, portfolio success was defined as not running out of money within a 30 year retirement period. And, under that definition, with a 75% US equities : 25% US bonds portfolio and 4% inflation adjusted withdrawals, the portfolio success rate was 100%.
[Side note: It’s bizarre when people say: “yeah but the safe withdrawal rate in [the UK / insert country name here] is lower”. Errrr…you do know you’re allowed to just buy a global tracker fund, right?]
With some flexibility in spending or willingness to work to earn some extra income from time to time you can now declare yourself fully financially independent if you want. Watch out for One More Year Syndrome which may mean you end up at milestone #7…
7. Financial independence with cushion
Achieving a portfolio of 33x your annual spending would equate to a 3% annual withdrawal rate. Achieving FI with a cushion or extra safety margin (on top of that already provided by the ability to be flexible) allows for a feeling of abundance rather than scarcity.
Just be aware that for some people, no amount of money will be enough to get that feeling of abundance. You may need to do the work to re-wire your brain away from a fear-based mindset. This takes some time and effort but it’s absolutely possible; I’ve done it myself.
Its not binary!
So, to sum up, when The Escape Artist says that Financial Independence is for Everyone, I mean that everyone can use the tools, techniques and mindset of FI to go some or all of the way along this path.
If more people choose the FI mindset just long enough to get out of debt and build an emergency fund, that’s fine by me. If they get themselves and their family more money and more freedom but choose not to go the distance to full financial independence, that is not failure.
That would be a huge win for our society and our environment.