Beyond Financial Independence

How Much Money Do I Need to Achieve Financial Independence?

May 24, 2012 · Jay Bugg · Comments

How much money do I need?
A popular question for people choosing “traditional retirement” and those who have seen the light and want to become work optional while they still have the time and energy to enjoy their new found financial independence, is how much money do I need?


Lower your expenses.
The power of lowering your expenses is one that cannot be denied. You don't have to have an MBA to understand this. As you lower your costs the amount of money you need to get to financial independence drops drastically. For each $1 you cut from your monthly expenses, you lower your financial independence number by $300. To it another way, cut 1 buck from your monthly expenses and you are $300 bucks closer to financial independence! Not only that, but now you have more money to invest so you are getting closer to financial independence even faster.


The power of 25!
The quick rule of thumb for calculating how much money you need to cover your annual living expense is the following:


25 x Annual Expenses = How Much You Need


Yes it is that simple. What you choose to invest in has the potential to complicate the matter a bit, but only to the extent in which you let it. What you need is for your HOARD of investments to grow either through appreciation or dividends at a rate equal to or faster than your withdrawal rate. Targeting 25 times your expenses means you can withdraw 4% from your HOARD each year in perpetuity as long as the average return on your HOARD is 4% or more. You now have the formula for financial independence.


What to invest in.
That depends how much of a control freak you are. If you want to be hands off, then mutual funds are for you. You want a low cost index mutual fund. A total stock market index fund is all you really need. If you like, you can couple that with a index bond fund to diversify a bit and generate some interest cash flow.


Personally I like finding dependable stocks that pay right around 4% in dividends. I like picking stocks and enjoy the idea of paying one time for each purchase and not having to pay a fund manager each year to manage my money. But there is no shame in going with the index fund idea suggested above. Of course you can pick a few stocks and a few mutual funds to mix and match.


In the years before financial independence be sure you are setting every account/stock to reinvest dividends.


Going for returns higher than 4% puts your HOARD at additional risk. Remember this is money that is slated to last forever, chasing higher yields could be counter productive.


Which account to use?
If you are going to buy mutual funds then your best bet is to purchase them directly from the mutual fund company. Buying most mutual funds through a broker incurs additional costs up front or have higher annual costs. A popular low cost mutual fund company is Vanguard. The returns on their index funds are often exactly the same as the index themselves minus their famously low cost fees.


If you choose to go with the brokerage account be sure the account does not have margin or options trading. Save that activity for your VENTURE accounts.

CommentsTags: Hoard