When something aggravates you at work, wouldn’t you like to be able to walk into your boss’s office and quit with no ramifications? That is the dream of financial independence – when a person has saved enough that he can meet all the needs of daily living through investment income alone. A whole industry has sprung up around the idea, with authors, talk-show hosts, and the like extolling the virtues of living on invested money. But is this really an achievable goal for most people?
I put together a simple model, available at Google Docs (sheets 1 and 2 are filled). Assuming a 10% annual savings growth rate, if an individual earning $100,000 per year pays 33% in taxes, saves 33%, and lives in the last 34%, they can achieve financial independence in 17 years. I have assumed that financial independence is achieved when 5% of total savings equals the individual’s current after-tax income. Since investment income is taxed at a much lower rate than earned income, this will provide a standard of living close to that achievable by working full time and simply spending everything. These numbers don’t take into account the tremendous benefits that 401k’s and IRAs can add to the savings picture, which might shave a year or two off of the time required.
If seventeen years too long to wait? Perhaps, but someone starting at 25 and saving diligently would be rewarded with freedom for life after 42. Are these savings rates unachievable? They’re actually close to the norm in countries like Japan.
Taking a more extreme case, what if you make $200,000 a year and can thus afford to save 50% of your income? Saving at that rate enables financial independence in 13 or 14 years. Of course, this means you have to live on 1/6th of your income, since the government takes a third. Our 25 year old big earner could expect to have a retirement party before 40 at that rate.
None of these calculations take into account the further complexities and expenses of life, like educational debt, buying a house, children, and more. But these calculations also explicitly leave out earnings increases, thus leaving our saver’s salary increases free for all of these expenses. As long as he puts away 33k per year, he’ll make it to freedom on schedule.
Most people in the US (and the world) don’t make $100,000 per year, so for many this goal may be out of reach. But for those who do, discipline in spending can enable a much greater reward than the latest consumer gadget – the freedom to pursue whatever dreams the day job just doesn’t satisfy.