What is Financial Independence?
First of all, stop what you are doing right now (yes, including reading this blog) and read this post from the Father of the “FI” movement, Mr. Money Moustache, called “The Shockingly Simple Math Behind Early Retirement”. If this post does not hit you like a ton of bricks, reach out to me on Twitter and lets chat because you must be misunderstanding something.
So, now that we are on the same page in understanding the shockingly easy math, it’s time to define a few terms. Mr. Money Moustache’s math to “early retirement” could be used interchangeably with “financial Independence”, AKA “FI”. FI is the point where you can live off your investments, meaning you are no longer dependent upon the income from your job to sustain your lifestyle. If you don’t love your job or simply want to recapture more of your time, then this is the point where it becomes possible to pull the ripcord on early retirement. For me, I am more interested in achieving FI rather than retiring early. The difference being, I like my job, so for me it’s much more about alleviating my financial anxiety than retiring too early. Once I reach or get close to FI, I know that no matter what happens my family's financial security is ensured. I can only imagine how good I will sleep once I hit FI, I sleep 10X better than I used to now that I simply have a road map to FI.
What does that roadmap look like? Referring to Mr. Money’s shockingly easy math, I can see how many years until I reach FI based on my savings rate; by savings rate, I mean the percentage of my take home pay that I am investing or saving. This is an incredibly simple and powerful way to look at budgeting. It does not require you going through every line item of your expenses (BUT YOU WILL NEED TO DO THAT LATER TO GET YOUR SAVINGS RATE UP). It just asks, “How much of my take home pay am I saving in an investment vehicle that will provide a decent return?” and from there you know when you will hit FI (or can retire early).
I have always been a saver, but I never really thought of my “savings rate” being the only relevant variable to my dream of FI. So, here is a quick breakdown of how I calculated my personal savings rate. Keeping in mind I am Canadian, so you will see terms like Canadian Pension Plan (CPP), which is a federally mandated Defined Benefit Pension Plan, Employment Insurance (EI) which you may or may not have an equivalent of in your country. So, go grab your last pay stub, and the amount you are automatically saving every month. And follow along using a spreadsheet.
First, we need to calculate our “take home pay”.
Step 1- Start with your “gross pay” before deductions and tax are taken off.
Step 2- Deduct Taxes, EI, and Long Term Disability (LTD) from your gross pay.
Step 3- Add back in your contributions to CPP and your personal contributions to any employer retirement or pension plan (this is money you are forced to save, so it should be included as part of your take home pay)
Now you have your “take home pay”, time to add up your savings so we are starting a new calculation separate from the take home pay calculation.
Step 1- Start with your CPP contributions.
Step 2- If you have one, add your personal contribution to your retirement/pension plan at work.
Step 3- If your employer provided any matching contributions into your retirement/pension plan, add that as well.
Step 4- Add up all of your savings and contributions to investment accounts that you make in a month.
Step 5- We need to convert your monthly savings into a “per pay cheque” amount. Here is an easy way to do it: Take your monthly savings/investments and multiply it by 12 and then divide that number by 26 (assuming you are paid every 2 weeks). This is your“per pay cheque” savings/investing, add it to the previous savings from steps 1–4.
Step 6- If you are a homeowner go find out and add your monthly PRINCIPAL payments (do not include interest payments) to your mortgage and convert it into a “per pay cheque” figure in the same way we did in Step 5 .
Note: I realize that including principal payments is a topic of some debate in the FI community, we will deep dive into it a future blog post.
OK, all the hard work is done! Now, the fun (or scary) part, calculating your current “savings” rate.
Simply follow the following formula A ÷ B where;
A= your total “per pay cheque” savings we just calculated and;
B= your total “take home” pay per paycheque we previously calculated.
My personal savings rate, ended up at just over 50% which, when we look back to Mr. Money Moustache’s simple math puts me at 17 years until I reach FI. Meaning if I do nothing different, and have no pay increases above inflation, I will be financially independent by the age of 47. Now the fun begins, how much can I accelerate that number?
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