A Beginner’s Guide to Financial Independence: the Concept, the Steps and the End Goal

Up until about two years ago, I didn’t know early retirement was an option. I’ve always been pretty frugal, but it never occurred to me that a normal person could save enough money to comfortably retire well before age 65. I knew retirement at 60 was doable, but retirement at 50, 40, or even 30?! I came across a FIRE (Financial Independence, Retire Early) blog one day that promised this exact thing, and I still remember how mind-blowing the realization was.

The Basics of Financial Independence

When I first heard the term “financial independence,” it confused me. I assumed I was already financially independent, because I pay my own bills. If I don’t need to borrow money from my friends/parents/the bank, doesn’t that count? Unfortunately, the answer is no. I have my own sources of income, but the primary one is a salary, which is paid by my employer. If they never gave me another paycheck, there would come a time when I would run out of money and not be able to pay my bills anymore. Financial independence means that time never comes.

It works like this:

1.  You earn money.

Depending on salary, spending habits and investment performance, some people earn enough in less than ten years to retire. For others, it takes longer.

2.  You save as much of your earnings as possible.

Ideally, you save more than 50% of your wages, but simple math proves that the less you can live on, the more you have to retire with, and the less you will need to retire. For example, let’s say you make $60,000 a year. You save $20,000 and live off $40,000. If you can live off $30,000 instead, not only will you be saving an additional $10,000/year, but when it comes time to retire, you’ll be in the habit of living off of $30,000, not $40,000, so your savings will last longer.

3.  You invest your earnings.

I’ll discuss investment options in much more detail in future posts, so I’ll keep this brief. A well-diversified portfolio is the best way to minimize risk and generate a consistent return. Keeping all of your savings in a bank account may be risk-free, but it makes very little interest, so it will take exponentially more time to save the same amount that you could in stocks/bonds/mutual funds/index funds etc.

4.  You retire and live off of your investment earnings.

The key is to have enough money saved and invested so that you can withdraw what you need to live and that withdrawal will be constantly replenished by investment earnings. Ultimately, the amount you have invested will rise and fall in line with market performance, but it shouldn’t deplete to zero because of withdrawals. Over time, the average balance of your investments should remain flat, even though you’re making regular withdrawals.

The amazing thing about this strategy is that it doesn’t matter how much you make. Anyone can achieve financial independence.

I know this sounds absurd – isn’t someone who makes $500,000 a year more likely to retire early than someone who makes $30,000 a year? The answer is perhaps – depending on their spending habits. When planning for financial independence, what you spend is more important than what you earn.

This took me awhile to wrap my head around, so here are a few examples:

Scenario 1: Jenny makes $200,000 a year. She spends $150,000/year. Ignoring the impact of interest for the moment, she saves $50,000/year. This is one third of what she needs to live off of for one year. That means, without interest, she’ll have to work three years to fund every one year of retirement.

Scenario 2: Bill makes $60,000 a year. He spends $30,000/year. He saves $30,000/year. Without interest, he only has to work one year to fund every one year of early retirement.

Even when you add interest into the mix, the premise doesn’t change. The higher the percentage of your income you can save, the more quickly you will become financially independent.

Let’s consider another example:

Scenario 3: Bill still makes $30,000/year. Instead of spending $30,000 a year, he cuts out some unnecessary luxuries, and lives off $24,000. The additional $6,000 helps in two ways. First, it is invested, and earns interest which compounds, so that by the time Bill retires, it is worth a lot more than $6,000. Second, it means that Bill is in the habit of spending less, so he ultimately needs less money to retire. Even excluding the impact of interest, for every one year Bill works, he has saved for one and a half years of retirement.

What It Takes to Achieve Financial Independence

It’s probably pretty obvious from the above that the number one thing it takes to achieve financial independence is diligence in spending.

As I said earlier, I’ve always been pretty frugal. I love a good deal, and I’m looking forward to sharing some of my best buys with you in the future (wait until you see my apartment – furnished entirely with things I bought second hand). I still have a ways to go, though. For example, I don’t have a budget, which is a big no-no in the FIRE world. I know that a budget is essential to keeping my spending on track, but I’ve been putting off making one – partly because it sounds like a lot of work, and partly because once I have one, I know I’ll have to stick to it and that doesn’t sound like a lot of fun…

Not to be overlooked, income is also important to achieving financial independence. If you can increase your salary or find an additional source of income and hold your expenses flat, all that additional income will go straight into your nest egg. For example, you might:

  • Get a raise at your current job
  • Move to another company that will pay you more
  • Change careers to a higher paying industry
  • Pick up a second job
  • Turn a hobby into a side business
  • Buy a business
  • Become a landlord, either by renting out your own home or by purchasing additional real estate
  • Sell the possessions you don’t need anymore

I’ll discuss these ideas, and more, in future posts as I try to maximise my own income. Clearly, they all require some degree of sacrifice, and I think it’s important to weigh the costs and rewards of each.

What Financial Independence Will Mean for Me

I’m currently in my early thirties, so there’s no way I can join that dedicated group who retires by thirty, but knowing I might not have to work ten or fifteen years from now is still pretty exciting. I wanted to start a blog to keep this goal forefront in my mind, share a few tips I’m learning along the way, and hopefully pick up some too.

It’s a winding path, not only because I’m relatively late getting started, but also because, first and foremost, I want to enjoy my life. That’s why I’m pursuing financial independence, but I also want to enjoy the years it will take to achieve. I know this journey will require sacrifice, but there are some things I won’t give up – most importantly, travel. I have family and friends all over the world, so one of my biggest expenses is flights.

I try to be mindful of cost when I’m planning a trip – I shop around for airfares, collect frequent flyer miles and bundle accommodation and rental cars with flights, but I know there’s more I can be doing. I’m hoping that over the next ten years or so, while I’m still working, I’ll become an expert on vacationing on a small budget, so that once I’m retired, I can continue to explore the world while remaining financially independent.

I’m also not sure if I will retire just because I have the means to retire, but I want to have the option. Maybe fifteen years from now I’ll be loving my job and feel entirely fulfilled. Then again, maybe I’ll want to work part-time or seasonally. I could choose to switch careers to something that pays a lower salary, or I could volunteer. I could quit working altogether and travel the world. The beauty of financial independence is that any and all of these are possible. I’ll be able to make a choice based on what I want to do and not what I need to do.

Why are you interested in financial independence? What will it mean for you?