Apparently, there were quite a few raised eyebrows when I posted last week that we are a mere 4 years away from Financial Independence.
I had people asking if we had inherited a large sum of money (nope). Did we win the lottery? Negative – we’d have to play to do that. Are we involved in some shady offshore dealings? Ha! OK – no one really thought this but I thought it sounded fun and made me sound cooler than I am.
The truth of the matter is much more mundane and boring. We saved. A lot. Our goal is to save 60% or more of our income every month.
The math is really simple:
If you save 100% of your income than you are financially independent. In other words, you don’t need to make any money to cover your expenses – thus you are able to save 100% of your income.
If you save 90% of your income then you are able to live off of 10% of your income and it will only take 2.7 years for you to generate that 10% passively for the rest of your life.
We save about 60% of our income which means that it will take us 12.4 years of saving 60% of our income to generate a passive income stream large enough to cover that 40% that remains.
Here’s the kicker: It really doesn’t matter how much you make. If you only make $100 a year but you are able to save 90% of that (meaning that you only need $10 a year to live off of), it will only take you 2.7 years to get there.
This is why being frugal matters. When we cut our food out monthly bill from $1,000 a month (don’t judge) down to $100 a month, we shaved over five years off of our retirement date. Moving the lawn myself instead of paying someone to do it shaved 6 months off of our date. Making my own coffee at home rather than getting a Starbucks everyday cut off almost a year. You get the idea.
I can get a side job and put all that money into our savings account, but ultimately putting even an extra $1,000 in the bank matters very little compared to cutting out expenses permanently.
But, wait a minute – if it is going to take you 12 years to retire why are you only 4 years away? In short, because we have been doing this for a while. We originally wanted to retire by the time we were 30 – knowing absolutely nothing about retiring or how to get there. We just wished really hard. Surprisingly, this strategy did not work, but it did start us saving and investing. We’ve spent the last half of our 20’s and first half of our 30’s buying houses and and investing in micro-lending. Watching our net worth grow.
Knowing a little bit more about how tax advantage accounts work (hello 401K and IRA) we are now switching our strategy a bit and saving a bit more, but ultimately it is just a lot of boring saving up. Trying to get to our magic retirement number.
Magic retirement number, you ask? Yep – its the magical number that once you reach you should be able to generate enough passive income to cover your expenses. In other words – once you reach it, you are retired!
While this number is different for everyone, the take-a-way is: the less you need the lower that number will be and the sooner you will reach it. To figure out your number, first figure out what your monthly expenses are, multiple that by 12 to get your yearly expenses and multiply that by 25. This is your magic number.
Mr Eivy just read over my shoulder and pointed out that it is a bit more complicated than just saving money. True. You have to invest this money and use the 4% safe withdraw rule to calculate your passive income. This basically means that once you hit your magic number and have it safely invested, you should be able to withdraw 4% a year without touching the principal (in fact, your principal should grow 3% with inflation using this rule of thumb). I promise I’ll write more about this later so stay tuned!