How to Earn Your Freedom

If you enjoy your job and are content to continue working into your 60s and 70s, then by all means stay the course. Save a little bit each year, grind away, and hopefully when Social Security kicks in, you will have enough to retire. However, if you are looking for more security, options, and flexibility in your life – if you want the ability to fully pursue your dreams and passions outside of formal work – then you may want to earn your freedom sooner.

Earning your freedom means accumulating enough invested assets that you no longer need to work.  At that point,  your investments make enough money to support your lifestyle without a separate source of income.  You may still want to work in some capacity, but it will be entirely on your own terms. There are basically 6 steps to earning your freedom.  The first step is the most important, because like with most goals in life, if you aren’t motivated, you won’t actually accomplish anything.

Step 1: Decide that you really want to earn your freedom

To make this work, you have to really want it. You need to have goals and aspirations that you want to accomplish when you no longer need to work.  Sitting on a beach for years is generally not enough motivation for most people.  Maybe you want to spend more time with your kids, start a business, write a book, volunteer as an avalanche forecaster, or be a professional (but unpaid) athlete for a year.  The goal is NOT to be idle, but to do worthwhile things that you can’t do with the inflexibility, stress, and demands of a full-time job.

Step 2: Track your spending

In order to figure out how much income you will need when you no longer need to work, you need to know your current level of spending. One way to do this is simply to write down everything you spend money on, and then enter it into a spreadsheet.  I find this completely impractical.  Instead, I recommend using a credit card to make all of your purchases (paying it off each month of course), and then use a program such as Mint to automatically track your expenses.

Step 3: Determine your projected yearly spending

Once you know how much you are currently spending each year,  you can make a projection about how much you will spend once you are no longer working. There are several important things to consider when you are financially independent and no longer beholden to a full-time job.  In particular, you may have greater health insurance costs and greater travel expenses.  On the other hand, you may spend less in gas and you will no longer need health insurance or disability insurance.  Just get a ballpark estimate and don’t get too lost in the details.

Step 4: Spend MUCH Less than you make

Most retirement experts recommend saving some ridiculously small amount of each paycheck, on the order of 10-15%.  This is not going to cut it.  If you only save 10-15% of each paycheck, you will NOT earn your freedom anytime in the near future.  You will need to save a very large amount of each paycheck, on the order of 50%.  At this savings rate, starting with zero investable assets, you will earn your freedom in around 15 years.  This is a short enough time to stay motivated and intense.  However, any shorter, and you would need to save greater than 50% of your income, which is unrealistically challenging.

Step 5: Track your net worth

Again, you could do this manually, but I recommend a program such as Mint or Personal Capital.

In the simplest sense, your net worth = assets – debts.

For our purposes here, your assets include your cash (checking and savings accounts), liquid investments (stocks, bonds, etc.), and any investment properties.  It generally does not include your car and your other possessions since these do not generate income and do not appreciate in value.  An argument could be made as to whether to include the equity in your primary home,  but since your home is not particularly liquid, I would leave it out of the calculation.  If you do have a paid off home, however, it will significantly reduce your projected expenses once you no longer need to work.

Your debts include any credit card balances, student loans, car loans, and the mortgages on your home and any rental properties.  In general, you should pay off all high interest rate debts ASAP. It becomes a bit more controversial when deciding whether to pay off low interest rate debts or invest instead, and we will cover this in upcoming posts.  However, in general, when you have a debt, you are paying someone else for the privilege of carrying that debt, and our goal here it to accumulate assets that pay YOU. So when in doubt, pay off the debt!

Step 6: Once your net worth is 33x your projected yearly spending, you have earned your freedom

As your net worth increases, you can expect it to generate a certain amount of income per year.  There is considerable controversy about how much you can safely expect from your investments each year.  We won’t delve into the weeds here, but in general, you can expect to be able to safely withdraw 3-4% of your net worth each year and not run out of money in your lifespan.  I prefer a more conservative 3% withdrawal rate, which I will explain in upcoming posts.  Therefore, you will need a net worth that is 33x your expected yearly spending. If you are comfortable using a 4% withdrawal rate, then you may use 25x your expected yearly spending.

An Example:

To make this more concrete, let’s go through a quick example as it relates to me and my wife. We live in Anchorage, AK, a relatively high cost of living area, so this certainly affects the spending numbers.

Step 1: Yep, on board.  We both enjoy our jobs, and will continue to work in some capacity our entire lives, but we have many other goals that we want to pursue.

Step 2: Using Mint and Personal Capital, we estimate our current spending to be around $50,000 per year.

Step 3:  We estimate needing around $60,000 per year to support our lifestyle, accounting for the potential need for health insurance and desire for additional travel.  This number is obviously in flux but it’s a reasonable starting point.

Step 4: We currently save approximately 50% of our gross income, so we’re on track.

Step 5: We recently paid off over $420,000 in debt, but we are just starting with the investment stage.  Net worth is ever so slightly greater than zero.

Step 6: At a required spending level of $60,000 per year, we would need $2 million in investable assets ($60,000 x 33) to earn our freedom.  At our current rate of saving (>$100,000 per year), this will indeed take around 15 years, assuming a reasonable 5% rate of return.

So there you have it

Freedom in 6 steps.  Nobody said it was going to be quick or easy.  However, depending upon your goals in life, it may certainly be worth it.  Keep in mind that you have considerable control over these steps.  If you want to earn your freedom sooner, you can spend less or earn more, or a combination of the two.  The only constant is that your net worth must be 25-33x your spending for true financial independence and freedom. Some people have figured out a way to live on $25K per year, so they only need $600,000-800,000 in invested assets. You’re in charge and you make the decisions.

What do you think? How close are you to earning your freedom?  What assumptions do you use when calculating how much you will need to reach financial independence?

 Remember, it’s not about the money; It’s about the Freedom.