How Much Does Financial Freedom Cost?

How Much Does Financial Freedom Cost

Financial independence is the freedom to make decisions based on what makes you happy instead of what makes you money.

It’s the ultimate financial goal. And the great part about it is that unlike the traditional view on retirement, you can get there a lot sooner than you think.

There are people making unconventional decisions to reach full financial independence in their 30s and 40s.

And there are many more people who aren’t fully financially independent, but can afford to take a temporary step backward financially in pursuit of a lifestyle that makes them happy.

That’s what financial freedom is all about.

So, how much does that kind of freedom cost? And how much financial freedom do you already have, given your current savings?

Those are some big questions and we’re going to answer them in this post.

Here’s what we’re going to cover:

  1. Your current level of financial freedom.
  2. The annual income your current savings would support right now if you stopped working.
  3. How much money you need to be fully financially independent.
  4. How much you need to save each month to reach your freedom number.
  5. Steps you can take to reach financial independence even sooner.

Let’s dive in!

How much financial freedom do you have right now?

There are two types of financial freedom that you can look at:

  1. Short-Term Freedom – This is the freedom to take a temporary financial step backwards in pursuit of a lifestyle that makes you happy. You probably couldn’t sustain the change forever, but your savings and other sources of income could support it for a period of time.
  2. Forever Freedom – This is the point at which you no longer need to earn an income in order to support yourself. Note that you still may want to work, whether for money or not. You just don’t have to.

Here’s how to figure out your current status towards each.

Your current short-term freedom

This is the kind of financial freedom that often gets ignored in all the talk about retirement.

After all, your life doesn’t start 30-40 years from now.

The people I work with want to be stay-at-home parents. They want to change careers, start businesses, and travel the world.

In other words, they want to pursue the things that are important to them, even if it means taking a temporary step back financially.

And with good financial planning, you can do it.

Here’s how to determine your current level of short-term freedom.

Step 1: Add up your available cash

This is all the money you have in checking accounts, savings accounts, and taxable investment accounts (NOT retirement accounts).

In other words, the money that’s immediately available if you need it.

Step 2: Subtract your credit card balance

If you use credit cards, you need to account for the fact that you have to pay them off using the money above.

Subtract your total credit card balance from the total in Step 1 to get your available savings.

Step 3: Calculate your average monthly spending

If you’re already using a tool like mint.com or YNAB, you’ll already have this number.

If not, you can sign up for one of those tools or go back through your recent bank and credit card statements to figure it out.

You don’t need to be super precise here or break it down by category. But you do need a reasonably accurate view of your total average monthly spending. And don’t forget to include all those irregular expenses!

Step 4: Divide your savings by your monthly expenses

Take your total savings that you calculated in Steps 1 and 2 and divide it by your average monthly spending from Step 3.

The result is the number of months you could support yourself without an income.

For example, let’s say you have the following:

  • $20,000 across all your checking and savings accounts
  • $2,000 credit card balance
  • $3,000 average monthly spending

The calculation would look like this:

($20,000 – $2,000) / $3,000 = 6 months

In other words, your current savings could support 6 months of average spending without any income.

That’s the amount of short-term financial freedom you have right now.

Your current forever freedom

Here’s a fun one: how much annual income could you withdraw from your savings right now without worrying about running out of money?

It’s actually not that hard to calculate. All you have to do is use the 4% rule, which is based on a LOT of rigorous research and says that you can withdraw 4% of your savings per year with little risk of ever running out.

Here’s how to run the numbers yourself.

Step 1: Add up ALL your savings

Similar to Step 1 above, but this time include ALL your savings. That means:

  • Checking accounts
  • Savings accounts and CDs
  • Taxable investment accounts
  • Retirement accounts

Don’t include college savings accounts, since those are meant for your children. And don’t include money that’s specifically earmarked for a purchase in the near future (like a house down payment), since that money won’t be available either.

All other savings are fair game though.

Step 2: Subtract your debts

Take the number above and subtract any:

  • Credit card balances
  • Student loan balances
  • Auto loan balances
  • Other consumer debts

The result is the amount of savings you have available to spend freely.

(You don’t have to subtract your mortgage because it’s secured by the value of your house and your mortgage payment is included in your income need anyways.)

Step 3: Multiple by 4%

Take your net savings from Step 2 and multiply it by 4%. The result is the amount of annual income your current savings would support indefinitely.

For example, let’s say that you have $100,000 in savings and $20,000 in various loans. That means you have $80,000 of net savings.

Multiply $80,000 by 4% and you get $3,200.

That means that you have saved enough money to create $3,200 in annual income year-after-year, for as long as you live.

Pretty cool!

How much does full financial independence cost?

Okay, so that’s your current level of financial freedom.

But how much money do you need to be completely financially independent? How much money do you need to never have to work for another dollar in your life?

Once again we’ll use the 4% rule to figure it out. Here’s how to do it.

Step 1: Total your monthly expenses

Once again you can use a tool like mint.com or YNAB to track your spending and get this number for you. Or you can figure it out using recent bank and credit card statements.

This time, you can also make adjustments based on your desired level of spending. That is, you can:

  • Add any expenses you would like to have going forward
  • Subtract any expenses you want to cut out or expect to go away in the near future

The goal here is to get a monthly spending number that reflects both the reality of your needs and your vision of the future.

Step 2: Multiple your monthly expenses by 300

This is the 4% rule in action again.

Simply multiply your desired monthly spending by 300 to get the savings needed to produce that amount of income.*

For example, if your desired monthly spending is $4,000, the amount of money you need to produce that income indefinitely is $1,200,000. (4,000 x 300 = 1,200,000).

One big thing to keep in mind here is that this doesn’t account for inflation. Which means that if you have $1,200,000 today you can support yourself indefinitely. But in 10 years you’ll likely need more than that because of inflation.

The good news is that you can simply re-run this calculation every now and then to get your new, up-to-date number.

*Why 300? You have to multiply your monthly expenses by 12 to get your annual expenses. Then you have to multiply your annual expenses by 25 (based on the 4% rule) to get your required savings. Multiplying by 300 simply combines those two steps into one (12 x 25 = 300).

Step 3: Factor in future income?

You could take this a step further and factor future income, like Social Security, into the equation.

All you have to do is subtract the amount of income you expect to have from your desired monthly spending. That gives you the gap that’s left over and needs to be supported by savings.

Then multiply that new number by 300 and you have your new savings goal.

How much should you be saving each month to reach financial independence?

Knowing the total amount of money you need to be financially independent is helpful. It gives you a sense of how close you are and it lets you know when you have enough.

But it doesn’t tell you what to do to get there. You also need to know how much you need to save in order to reach that financial independence goal.

Lucky for you, I have an easy-to-use calculator to help you figure it out.

It’s a relatively simple process, but not a quick one to explain. So instead I’ll simply link to this article that includes a calculator with step-by-step instructions for filling it out and getting your monthly savings goal:

INVESTING MADE SIMPLE
Learn how to create and implement an investment plan that helps you reach your goals, no matter where you’re starting from.

 

How to get there sooner

What if you’ve run the numbers and financial independence seems too far off? How can you get there sooner?

Here are four options, in general order of immediate effectiveness:

  1. Reduce future needs – The lower your future monthly expenses, the less you have to save. You can reach financial independence sooner even at the same savings rate.
  2. Earn more and save moreIncreasing your income is often the best way to free up more room in your budget. And of course, the more you earn, the more you can save. And the more you save, the quicker you’ll reach financial independence.
  3. Spend less and save more – Reducing your spending now reduces the amount you have to save AND gives you more money to put towards financial independence. It’s a double-win that can really accelerate your timeline.
  4. Earn more, spend less, and save more – Why not do all three at the same time? This is the kind of mindset that will supercharge your path to financial independence.

How much is financial freedom worth to you?

So, those are the numbers. That’s how you figure out just how much financial freedom you have right now and how much full financial independence really costs.

But remember, numbers are only helpful when you know what you’re working towards.

So before you dive in and start crunching the numbers yourself, I would encourage you to think hard about two questions:

  1. What kind of freedom do you want?
  2. What are you willing to do to get there?

Your idea of financial freedom doesn’t have to look like anyone else’s. You’re free to pave your own way.

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0 Comments... Be the first to comment
  • Ree Klein April 26, 2016

    This is a fantastic article, Matt! I’m a perfect example of someone who has achieved “short-term freedom.” I’m not ready to officially retire, but I wanted some time to unleash the entrepreneur inside and see what I could build.

    I’ve been living off a savings stash for the last three years while learning, building, tweaking, pivoting and growing my skills. It has been the most rewarding gift I could have given myself.

    If I’m lucky, I’ll be able to create an income stream from my own business AND take 4% from retirement savings for a comfortable “retirement.” I put that in quotes because I’ll never actually retire. I’ll always look for creative ways to generate income…just not through a traditional job working for someone else if I can help it.

    Now…I’m off to share this post with the world!

    • Matt Becker April 26, 2016

      Thanks Ree! I love your personal story as well. Such a great example of how having money in savings gives you the freedom to pursue something meaningful and potentially lucrative as well. Way to walk the walk!

  • Great, thorough yet accessible article. We’ve been talking about short-term freedom in terms of flexibility. Even if that doesn’t mean taking a “sabbatical,” gaining flexibility means we can travel more, take a few unpaid weeks off, or take opportunities we find because we’re not living at the outer limits of our income.

    • Matt Becker May 3, 2016

      That’s awesome Kalie! There’s a lot of lifestyle flexibility that comes with having savings and living below your means. It doesn’t have to be grand either, as you point out. It can simply lead to more freedom in everyday choices without dealing with financial stress.

  • Jess White September 9, 2017

    Loved the article. Also loved what Ree had to say in the comments. It really is true that we don’t always have to have our “full retirement” funded. Nobody needs to wait till 65 to live the life they love anymore. My personal recipe is
    to become debt free, save more than I make, and minimalize my expenses.
    That way, I don’t need a huge “nest egg” to survive in “retirement.” I can take a small draw down of my investments and have a small side hustle, which I would do without being relient on an employer. Work maybe 1-2 days a week (on something I enjoy).

    Retirement for me won’t mean not working at all. I love working, that is on things I love. For me, it’s flying airplanes and flight instructing and spending time with my newborn son!

    The rat race is actually really easy to escape, you just can’t get sucked in to the materialistic culture.

    Thanks for the article.

    Jess

    • Matt Becker September 11, 2017

      That’s a great plan Jess! Thanks for sharing.

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