Would you like to retire one day? Do you want to leave work at some point and never have to stress about money? Then it’s important to understand your financial independence number!
The great news is that it’s not complicated to figure out, but understanding it can change your life. Once you know where you want to end up you can actually figure out how to get there.
What is your financial independence number?
I like to think of it as a money tree. It’s a specific sum of money that you “plant” (in investment accounts; please do not literally bury it in your backyard) and you get this magical money tree that throws off enough money for you to spend yearly that you can continue to do that FOREVER. If you plant the right amount for your lifestyle, the tree lives forever and you never have to work again.
Want your own money tree? You first have to determine your financial independence number because it determines how big your tree needs to be. So let’s start!
If I asked you how much money you’d need yearly to live your desired lifestyle in retirement, would you know the answer? Do you know how much you actually spend now?
Rather than guessing how much you will require monthly, I suggest tracking your expenses for 3 months and adding up how much you truly spend. It can be humbling to make a guess about your spending, then compare that guess to the reality you actually see after tracking your expenses.
How to use your spending to determine your financial independence number:
If you can determine how much you will spend monthly in retirement, you simply have to multiply that number by 12 to get your yearly amount.
monthly costs x 12= yearly spending
To then determine the required size of your money tree, you’d multiply your yearly spending by 25 (to understand why, read this).
For example, based on my calculations if I had a family in retirement I would require about $40,000 yearly x 25 = a one million dollar money tree (*assuming no CPP or pension).
This is where people panic.
I suspect if you tracked your monthly spending and multiplied it by 12 to get yearly spending, your number is MUCH higher than $40,000. So when you initially calculate your financial independence number it likely seems impossibly high. Stay calm; it’s not that bad I promise.
If you read my budgeting post you’d see my current expenses are about $3800 a month (~46k a year) for just me! So how the heck do I think my family will live on 40k?! Am I just terrible at math? Nope:
Your required spending will look MUCH different at retirement!
When people first read $40,000 yearly they picture a 40k salary and how tight that would be to live on. There’s a massive difference though: salary includes taxes. Taxes take a large amount of your salary before it ever hits your bank account.
$40,000 yearly spending in retirement is also not the same as 40k take home pay now. While you’re working you typically have multiple expenses that you will no longer have in retirement: mortgage payments, child care expenses, debt payments, and retirement savings (because jackpot- you’re there!).
If we removed those categories from the $3800 I currently spend monthly, it drops my expenses to $1730 a month, or just shy of $21,000 a year.
For every $1000 a month your spending decreases, your financial independence number decreases by $300,000!!
Spending has a profound effect on how much you’ll need to save. The beautiful part is that while you may not always be able to decide how much you earn, you have full control over how much you spend. You get to decide how big your magical money tree needs to be.
Calculate your financial independence number. Track your progress. Just like trees, money takes time to grow.