Beginner's Guide To Reaching Financial Independence | ChooseFI (2024)

Hello to all that are new to Financial Independence, A.K.A. FI!

Welcome, we’re happy you’re here. This guide will walk you through the basics of Financial Independence but if something doesn’t fit your life that’s ok. This is your journey and your life. Use the tips you find helpful and toss the rest. We know as a group we can get a little extreme (ok, a lot extreme), but our community is full of diverse and wonderful people. There is no one way to reach Financial Independence.

A Quick Summary Of Financial Independence

Simply put, the goal of the FI movement is to save 25 times your annual expenses. It is thought that once you have this amount saved you can begin withdrawing enough from your investment accounts to cover your expenses. At this point, you would be considered “financially independent” and no longer need to work for money. Your time is your own.

Savings Rate

The FI community puts a lot of emphasis on the “savings rate.” This is the percentage of your income you are saving or investing.

As a rule, we aim for a savings rate of 40-50%. That probably sounds like a lot–and it is! Traditional personal finance usually aims for a 15% savings rate. But then it can take 40+ years to reach FI. We don’t want to work at a job we don’t love for 40 years. The FI community thinks differently. We are striving to reach FI as quickly as possible!

Click here to learn how to calculate your own savings rate.

Aiming for a 50% savings rate is one reason the FI community is so unique. We all work together to share tips and encouragement to live this lifestyle. This is support and information you won’t find at your neighborhood barbecue.

If you want to join the community you can join the ChooseFI Facebook group here.

The 4% Rule “of Thumb?”

We keep talking about having 25x times expenses, why? Where did this number come from?

This is largely based on a 1998 study called the Trinity study which looked at what percentage of investments a retiree could reliably draw throughout all investing timelines without running out of money. The study concluded that 4% was a safe withdrawal rate with a 95% + rate of success.

This study is not without some well-founded criticism. In particular, it has been questioned whether the data from this study could be extrapolated from the regular retiree with a 30+ year retirement to the early retiree with a 60+ year retirement timeline. If you’d like to learn more about this check out this article: Beyond 4%: The Argument For Flexible Spending Rules In Retirement.

The general thinking is this: the stock market has had an internal rate of return of 7-8% since 1950, and so if the market returns on average even 7% then you should be able to withdraw 4% in inflation-adjusted dollars year over year without drawing down on the principal.
Congratulations you have likely created a perpetual money-making machine.

Using some mathematical gymnastics we can calculate what we need in our investments by multiplying our annual expenses by 25. Note that it is not based on your income it’s based on your expenses. This is incredibly powerful.

Most retirement calculators on the internet are designed to calculate how much you need to have saved to replace your income. This is a fundamentally flawed approach that could have you working decades longer than necessary. Here are a few FI calculators that will give you a clearer picture of where you stand.

Whether or not you choose to RE (Retire Early) is a personal choice likely based on whether you get value from your job but is no longer needed to fund your lifestyle.

Lower Your Living Expenses

Lowering your living expenses is a major focus for the FI community. Having lower expenses allows you to reach Financial Independence more quickly for two reasons. First, it allows for a higher savings rate. Every dollar you don’t spend is a dollar you can invest. Secondly, lower annual expenses mean less needed in your nest egg.

For example, if your annual expenses are $100,000 you would need $2.5 million saved. But if your annual expenses are $30,000 you would only need $750,000.

Keep this in mind, for every $100 per month you spend that’s $30,000 you need to have saved. Yikes!

You can see how having lower living expenses can have a double impact! It allows you to save more while you are working, and at the same time need less. You will reach Financial Independence years or even decades earlier.

House Hacking

Housing is likely your largest expense. Getting this for free or very cheap goes a long way towards increasing your savings rate.

House hacking is when you find a way to eliminate or greatly reduce your housing costs. Typically, this means renting out a portion of your home. This may mean buying a duplex and living on one side while renting the other. Or simply rent out a spare bedroom in your home.
Here’s more info on house hacking.

It may also mean more creative ways of living, such as living in a modified van or living with an elderly person and trading rent for services around the house.

If you choose to house hack by renting a portion of your home this allows you to both reduce your housing costs and invest in real estate. For example, say you purchase a three-bedroom home and have a $1,500 per month mortgage payment. If you rent out two bedrooms for $700 each, your monthly housing cost is now $100 per month!

Remember when I mentioned that not everything in the FI community will apply to you and that you’ll likely pick and choose. We realize not everyone can “house hack”. But we can all be mindful of our housing expenses. If you ever find yourself in the market for a new home, perhaps downsizing will be right for you.

Travel Rewards

The path to Financial Independence is not about living a life of deprivation. You can travel more than you realize for free or very cheap using travel rewards. This is an easyway to reduce a large expense in your annual budget! The general idea is that you use credit card rewards (earned through sign-up bonuses) to cover your travel expenses.

There are two outcomes here if you take travel rewards seriously. Either you’ll go on the same amount of vacations for a dramatically reduced cost, or you’ll travel even more with the same (or maybe less!) costs.

Learn more about how to get started with and/or optimize your travel rewards strategy on our main ChooseFI travel page here.

Eliminate Debt

While the FI community may not be as anti-debt as the Dave Ramsey Community (leverage through real estate is common.) We prioritize paying down consumer debt like credit card balances and student loans. The sooner you pay off your consumer debt the sooner your financial freedom clock begins.

We look for ways to radically decrease our structural expenses. Paying interest and making payments to finance your life will slow down your path to Financial Independence.

If you currently have credit card debt, consider doing a balance transfer over to a card with a 0% intro rate and pay it off as quickly as possible.

If you have student loan debt, look into Credible to see if refinancing it would save you money. The less interest you pay the more you can save for Financial Independence.

Easy Ways To Reduce Other Expenses

Obviously, we all have more expenses than just housing and travel. Here are some easy ways to reduce the other expenses in your life.

  • Cutting the cord: Nowadays it is easier than ever to get all the entertainment you want without having an expensive cable bill. If you have a good internet connection, you can connect to some of the following services and probably still be able to watch the same content you were watching earlier!
    • Netflix, Hulu, HBOGo, Amazon Prime, etc
    • SlingTV, etc
    • Here’s an article that looks at a few different cable alternatives.
  • Learn to cook: With the vast amount of recipes online, it is easy to get started cooking your own meals. There are benefits beyond cutting your restaurant expenses, including healthier food, entertainment, and family bonding. We typically aim for a cost of $2 per person per meal. Check out our collection of $2 recipes and download the free e-book here.
  • Check your insurance costs: When you first got your various insurance policies you probably didn’t shop around too much, or at least haven’t shopped for them in years or maybe even decades. Policygenius can help you compare prices for all your insurance needs. Even if the savings per policy term are small, just imagine the recurring savings or decreased compounding interest.
  • Cell phone: Services like Republic Wireless,Mint, and GenMobile all offer great cell service at a much lower rate than the major carriers. This is an easy way to save money on cell service without affecting your lifestyle.
    • Here’s an article comparing several discount cell service providers.
  • Lower your utility bills: Bills like your electric bill, water bill, and others can be lowered by changing some habits. This doesn’t have to be extreme, sometimes it’s just a matter of being more intentional.
    • Here are our tips for lowering your electric bill.
    • Here are our tips for lowering your water bill.
    • Perhaps solar will work for you. Here’s a look at solar panels.
  • Car expenses: Biking to work can save big bucks on car expenses. Not only do you not have to pay for gas, but you will also save money on your car insurance by driving fewer miles. Of course, this will also extend the life of your car. Here’s how to get started biking to work.
    • Here are some tips to get the most mileage out of your car.
  • Sharing services: Sharing recurring expenses on memberships, services, and subscriptions is a painless way to cut these expenses. For example, Netflix charges per device, no reason those devices need to be in the same house.
    • Here’s an article that goes more in-depth about sharing these types of services.

Check out ChooseFI’s recommended resources for more info.

Investment Philosophy

The main focus of investing for the FI community is broad-based low-cost index funds. We talk a lot about Vanguard’s Total Stock Market Index Fund, VTSAX as marker/ticker for this type of fund but Fidelity and Schwab have equally good if not better funds with even more competitive/lower fees.

Here’s an article that compares Vanguard and Fidelity. See which one is right for you.

There is a multitude of studies that show that on average, actively managed mutual funds struggle to match and often underperform their relative indexes in large part due to the headwind of the higher fees that are associated with actively managed funds as compared to index funds.

An actively managed fund that charges 2% per year would need to outperform the index by 2% just to match what you could earn in the index. This is extremely difficult to do over longer periods of time.

A total stock market fund will track the stock market as a whole. Your returns will match the returns of the market. If you would like to include bonds in your portfolio the same can be said for a total bond market fund, such as Vanguard’s Total Bond Market Fund.

M1 Finance is another highly recommended investment platform. It allows you to invest in “pies” which are preselected investment portfolios that automatically rebalance. And the best part? It’s totally free. Yup, no fees. Here’s our full review of M1 Finance if you’d like to learn more.

One popular tool is used by the FI community is Personal Capital. It will pull in the information from all your investment accounts into one dashboard. This allows you to see all your investments in one place, including your overall allocations. It’s extremely handy and free! Check out our review of Personal Capital here.

Get your free Personal Capital account here.

Employer Accounts

As much as we love index funds, your first investment will likely be with your employer’s retirement account (401K/403B/457). You will want to take advantage of any match, even while you are paying off debt. While there will be exceptions to this (payday loans, credit card debt emergency, with 20% interest) the pre-tax match is incredibly valuable and acts as an instant raise.

What is great about contributions to employer accounts is that they are tax-deductible. Any contributions will reduce your tax liability this year. While you will pay taxes on your withdrawals you will likely come out ahead. The logic is that you will likely be withdrawing this money after you leave your job and be in a lower marginal tax bracket.

IRAs

Traditional IRAs offer the same tax advantages as employer retirement accounts except you have much more control of your investments.

Roth IRAs differ in one way. Contributions to Roth IRAs are not deductible but are tax-free upon withdrawal. They also offer several benefits for the FI lifestyle. Contributions to the Roth IRA can be withdrawn tax & penalty-free which makes it a compelling saving vehicle when you are in a lower tax rate. It also makes it easier to implement one of the more advanced tax strategies like the Roth Conversion Ladder.

Generally, you’ll want to contribute the maximum amounts to both your employer retirement accounts and an IRA.

Real Estate

Rental properties are loved by the FI community because for a small down payment there is the potential to immediately generate cash flow and many people in our community have beaten the game using this strategy. This strategy is put into overdrive when you stack with a concept like house hacking that we discussed earlier.

Listen to this episode with Paula Pant about investing in real estate to learn more.

Side Hustles

Side hustles are a perfect fit for those pursuing Financial Independence. Anything you do to make money outside of your regular job counts as a side hustle.

Before you reach FI, side hustles increase your income, which you can use to increase your savings rate. Then if you plan on continuing your side hustle after you reach FI it reduces the expenses your nest egg needs to cover, which allows you to need less, therefore reaching Financial Independence sooner.

For example, let’s say you are earning $60,000 and living on $30,000. To have 25x your expenses you would need to save $750,000 to reach FI. This would take just under 13 years to accumulate (assuming a 10% return). However, if you start a fun little side hustle that earns $1,000 per month your numbers will change dramatically.

If you don’t plan on continuing your side hustle after FI you will still need the full $750,000. But that extra $1,000 a month into savings would take two years off your FI journey. However, if you truly enjoy your side hustle and plan to continue it after FI, this reduces the expenses you need to cover to $18,000 per year. Which means you only need to save $450,000, and you will be able to reach FI in just over seven years.

In this example, a side hustle cut the Financial Independencejourney almost in half!

If you’d like to learn more about starting a side hustle check out this podcast episode. If starting a blog is something you’ve been thinking about (it can be a great side hustle!) check out this episode.

Bottom Line

If you are just discovering these concepts for the first time you may feel a little overwhelmed. I know I did!

You might have thought you were killing it with your 20% savings rate and now you feel behind. That’s normal. You don’t need to eat the whole elephant today, or even this year. Just focus on what you can do this week to get 1% closer to your end goal. We call this the Aggregation of Marginal Gains.

In the future, when someone asks you how you reached FI you can say “I packed my lunch and brought it with me to work each day.” While that may seem silly and insufficient, it isn’t that far off from the truth.

There’s not one thing that you can do, it’s a layering of all of these life optimization strategies that will propel you to Financial Independence. Just start optimizing your life 1% at a time and you will reach your goal faster than you ever thought possible.

Introduction

As an expert and enthusiast, I don't have personal experiences or beliefs, but I have been trained on a vast amount of information and can provide insights and explanations on various topics, including Financial Independence (FI).

Understanding Financial Independence

Financial Independence, or FI, is a movement focused on achieving a state of financial freedom where individuals have saved enough to cover their expenses without having to rely on traditional employment. The goal of the FI movement is to accumulate savings equal to 25 times one's annual expenses.

Once this target is reached, individuals can start withdrawing from their investment accounts to cover their expenses, effectively becoming "financially independent." At this point, individuals have the freedom to choose how they spend their time, as they no longer need to work for money.

Savings Rate

A key concept within the FI community is the savings rate. This refers to the percentage of one's income that is saved or invested. The FI community generally aims for a savings rate of 40-50%, which may seem high compared to the traditional personal finance recommendation of a 15% savings rate. The higher savings rate allows individuals to reach FI more quickly, reducing the number of years they need to work.

Calculating your own savings rate is important to track your progress towards FI. You can determine your savings rate by dividing your savings or investment amount by your income and multiplying by 100.

The 4% Rule

The 4% rule is a guideline within the FI community that suggests individuals can safely withdraw 4% of their investments annually without depleting their principal. This rule is based on the Trinity study from 1998, which analyzed investment strategies for retirees.

The study concluded that a 4% withdrawal rate had a 95%+ rate of success over various investment periods. However, it's important to note that the study primarily focused on traditional retirees with retirement timelines of 30+ years. Some critics argue that the study's findings may not be directly applicable to early retirees with longer retirement periods.

The underlying assumption of the 4% rule is that the stock market historically has had an average annual return of 7-8%. With an average return of 7%, a 4% withdrawal rate allows for annual withdrawals while the principal continues to grow.

Lowering Living Expenses

Lowering living expenses is a core focus of the FI community. By reducing expenses, individuals can achieve FI more quickly for two main reasons. First, a higher savings rate is possible when fewer dollars are spent. Second, lower annual expenses translate into a smaller nest egg requirement.

For example, if your annual expenses are $100,000, you would need $2.5 million saved to reach FI. However, if your annual expenses are reduced to $30,000, you would only need $750,000. Every $100 per month spent represents $30,000 needed in savings.

House Hacking

House hacking is a strategy embraced by the FI community to reduce or eliminate housing costs. It typically involves renting out a portion of one's home, such as a spare bedroom or a separate unit. By doing so, individuals can significantly reduce their housing expenses, allowing for higher savings rates and potential real estate investments.

Other creative housing options, such as living in a modified van or trading rent for services, can also be considered as part of the house hacking concept. However, it's important to note that not everyone may have the opportunity to house hack, but being mindful of housing expenses can still contribute to FI goals.

Travel Rewards

The FI community believes in living a fulfilling life while pursuing FI. Travel rewards programs are one way to reduce the costs of traveling. By strategically using credit card rewards earned through sign-up bonuses, individuals can cover their travel expenses at reduced or even no cost.

Utilizing travel rewards can lead to significant savings in one's annual budget. This approach allows individuals to maintain or even increase their travel experiences while working towards FI.

Eliminating Debt

While the FI community may not be as strictly against debt as other financial approaches, it emphasizes the importance of eliminating consumer debt, such as credit card balances and student loans. Paying off consumer debt allows individuals to accelerate their journey to FI by reducing interest payments and freeing up more money for savings and investments.

Various strategies exist to tackle debt, such as balance transfers for credit card debt and refinancing options for student loans. By minimizing interest payments, individuals can redirect more funds towards their FI goals.

Easy Ways to Reduce Expenses

In addition to housing and travel, there are many other expenses that individuals can optimize to reach FI more quickly. Here are some examples:

  1. Cutting the cord: Explore alternatives to expensive cable bills, such as streaming services like Netflix, Hulu, and HBOGo.

  2. Learning to cook: Cooking meals at home can save money compared to eating out, and it offers additional benefits like healthier food options and opportunities for family bonding.

  3. Reviewing insurance costs: Periodically assess your insurance policies to ensure you are getting the best rates. Platforms like Policygenius can help you compare prices for various insurance needs.

  4. Lowering utility bills: Simple changes in habits, such as being mindful of electricity and water usage, can result in savings on utility bills. Additionally, exploring options like solar panels can lead to long-term cost reductions.

  5. Reducing car expenses: Consider alternatives to traditional commuting, such as biking to work. This can save money on gas, reduce car insurance costs, and extend the lifespan of your vehicle.

  6. Sharing services: Share recurring expenses, memberships, and subscriptions with others to reduce costs. For example, Netflix allows multiple devices to access the same account, even if they are not in the same household.

Investment Philosophy

The FI community typically favors a long-term investment strategy focused on broad-based, low-cost index funds. Vanguard's Total Stock Market Index Fund (VTSAX) is often mentioned as an example, but other providers like Fidelity and Schwab offer similar funds with competitive fees.

Actively managed mutual funds, which charge higher fees, often struggle to consistently outperform their respective indexes over the long term. Therefore, low-cost index funds are popular among FI enthusiasts due to their historical performance and lower fees.

M1 Finance is a highly recommended investment platform that allows investors to create and manage customized portfolios without any fees. Personal Capital is another tool used by the FI community to track investments and overall financial progress.

Employer Accounts and IRAs

Employer retirement accounts, such as 401(k), 403(b), and 457 plans, are often the first investment vehicles individuals contribute to. Taking advantage of employer matches can significantly boost savings. Contributions to these accounts are tax-deductible, reducing the current year's tax liability.

Individual Retirement Accounts (IRAs), both traditional and Roth, offer similar tax advantages as employer accounts. Traditional IRAs provide tax deductions for contributions, while Roth IRAs offer tax-free withdrawals in retirement. Contributions to Roth IRAs can also be withdrawn tax and penalty-free, making them attractive for FI strategies like the Roth Conversion Ladder.

Contributing the maximum amounts to both employer retirement accounts and IRAs is generally recommended.

Real Estate

Real estate, particularly rental properties, is a popular investment choice within the FI community. Rental properties can generate cash flow, and the potential to earn income exists from the start with a relatively small down payment. Combining real estate investments with strategies like house hacking can further enhance returns.

It's important to educate yourself about real estate investing and carefully evaluate potential properties before making investment decisions.

Side Hustles

Side hustles, or additional income streams outside of regular employment, are highly encouraged within the FI community. Side hustles can increase income, allowing for higher savings rates during the accumulation phase. After reaching FI, continuing a side hustle can reduce the expenses that need to be covered by the investment portfolio, effectively shortening the path to Financial Independence.

Starting a side hustle can take various forms, such as freelancing, consulting, or creating an online business. It's important to choose a side hustle that aligns with your skills, interests, and goals.

Conclusion

Financial Independence is a personal journey, and not all concepts within the FI community will apply to everyone. The key is to optimize your life one step at a time, focusing on the areas that resonate with you and contribute to your unique goals. Small changes and consistent progress can lead to significant results over time. Remember, achieving FI is not about doing one thing perfectly, but rather about the aggregation of marginal gains that propel you towards your financial goals.

Beginner's Guide To Reaching Financial Independence | ChooseFI (2024)

FAQs

How do I become financially independent for dummies? ›

  1. Set Life Goals.
  2. Make a Monthly Budget.
  3. Pay off Credit Cards in Full.
  4. Create Automatic Savings.
  5. Start Investing Now.
  6. Watch Your Credit Score.
  7. Negotiate for Goods and Services.
  8. Get Educated on Financial Issues.

What are the 5 basics of personal finance? ›

There's plenty to learn about personal financial topics, but breaking them down can help simplify things. To start expanding your financial literacy, consider these five areas: budgeting, building and improving credit, saving, borrowing and repaying debt, and investing.

What is the formula for financial independence? ›

The Financial Freedom Formula Is Simple To Calculate And Understand. According to the FIRE (financial independence, retire early) movement, you need to have 25 times your annual expenses in investments.

What is the 30 day rule? ›

The premise of the 30-day savings rule is straightforward: When faced with the temptation of an impulse purchase, wait 30 days before committing to the buy. During this time, take the opportunity to evaluate the necessity and impact of the purchase on your overall financial goals.

What is the 50 20 30 budget rule? ›

The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.

How do I create passive income? ›

11 Passive income ideas
  1. Make financial investments. ...
  2. Own a rental property. ...
  3. Start a print-on-demand shop. ...
  4. Self-publish. ...
  5. Sell worksheets. ...
  6. Sell templates. ...
  7. Create content. ...
  8. Create an online course.
Mar 18, 2024

How to live off of savings? ›

There are a few different ways to invest your money to earn interest and live off of that income. The most popular investments are bonds, certificates of deposit (CDs) and annuities. The interest that you'll earn will depend on the amount of money you have in your account when you go to live off of that interest.

What is the #1 rule of personal finance? ›

#1 Don't Spend More Than You Make

When your bank balance is looking healthy after payday, it's easy to overspend and not be as careful. However, there are several issues at play that result in people relying on borrowing money, racking up debt and living way beyond their means.

What are Dave Ramsey's five rules? ›

Dave Ramsey: Follow These 5 Rules That Lead to Wealth '100% of the Time'
  • Get on a Written Budget. Ramsey advised to first make a written plan. ...
  • Get Out of Debt. ...
  • Foster High-Quality Relationships. ...
  • Save and Invest. ...
  • Be Generous.
Feb 22, 2024

What are the golden rules of personal finance? ›

The rule of 25X is the thumb rule when it comes to retirement savings, where you need to save 25 times your annual expenses. This rule says that an individual can think about retirement when they have funds worth 25 times their annual expenses.

How much money do I need to live comfortably for the rest of my life? ›

On average, an individual needs $96,500 for sustainable comfort in a major U.S. city. This includes being able to pay off debt and invest for the future.

How much money do you need to be financially free? ›

Americans say they'd need to earn about $94,000 a year on average to feel financially independent. That's about $20,000 more than the median household income of $74,580.

What is the FIRE rule? ›

It means that your retirement corpus should be at least 25 times of your first-year expenses post-retirement. So, if your first-year expenses post-retirement are Rs 12 lakh or Rs 1 lakh a month, then your retirement corpus should be 25 times that amount or Rs 3 crore. This rule is also called the 4% rule.

What are the Dave Ramsey 7 steps? ›

You can too!
  • Save $1,000 for Your Starter Emergency Fund.
  • Pay Off All Debt (Except the House) Using the Debt Snowball.
  • Save 3–6 Months of Expenses in a Fully Funded Emergency Fund.
  • Invest 15% of Your Household Income in Retirement.
  • Save for Your Children's College Fund.
  • Pay Off Your Home Early.
  • Build Wealth and Give.

What are the 3 building blocks of financial freedom? ›

The main aspects in achieving financial security is budgeting, reducing expenses, eliminating debt, and increasing savings. These four aspects are the building blocks to financial freedom and will help you kick-start your financial success.

What are the four pillars of financial freedom? ›

Regardless of income or wealth, number of investments, or amount of credit card debt, everyone's financial state fits into a common, fundamental framework, that we call the Four Pillars of Personal Finance. Everyone has four basic components in their financial structure: assets, debts, income, and expenses.

What are the three pillars of financial freedom? ›

The 3 Pillars: Everyday Money Management — Saving, Spending and Investing.

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