Determining Your Financial Independence Number
Passionate readers of this site have long understood I’ve never been fully convinced about the “retire early” element in the Financial Independence Retire Early (FIRE) movement.
That said, I am on the path towards financial independence. I think you can be too by determining your financial independence number.
I mean really, what 30- or 40-something is never going to work for any money ever again??
(Answer = you know it.)
Surely some of them will hustle a blog, a course, a book, a podcast or other at some point. The list goes on.
Such FIRE-seekers and very early retirees are not likely misleading people on purpose – some are just simply entrepreneurs…
Forget “RE”, “FI” is the worthy goal
While I couldn’t care less about the retire early part of FIRE, I am working towards the FI part and have been doing so for at least a decade now.
I think most people should absolutely strive for FI instead of early retirement:
How much do you need to save for any comfortable retirement?
“It depends”.
According to Fidelity, to be on track for a healthy retirement:
- You should have x1 your annual salary saved up for retirement by age 30.
- You should have x3 your annual salary saved up for retirement by age 40.
- You should have x6 your annual salary saved up for retirement by age 50.
- You should have x8 your annual salary saved up for retirement by age 60.
- You should have x10 your annual salary saved up for retirement by age 67.
As a 40-something, according to the pros we should have at least x3-x6 of our annual savings in the bank.
I’m glad I don’t listen to Fidelity. We’re beyond that milestone and we’ll be better off financially (sooner) because of it.
Here in Canada, MoneySense did some similar work on this a while back:
Do you really need this much? $1 million or $1.5 million? More?
“It depends”.
I can’t tell you unfortunately – since that answer comes with a complex set of income needs and wants and everyone’s spending goals are very, very different.
I can say with a rather firm set of certainty that if any Canadian or U.S. citizen that amasses this much portfolio value by age 65 and has modest spending needs they will be far better off financially than most.
How to achieve financial independence?
Generally speaking, I believe there are four (4) ways to achieve financial independence:
1. Consistent Savings Rate
The most common approach is also the most realistic approach – establish and maintain a high savings rate for retirement saving. This is a get wealthy eventually strategy.
2. Extreme Frugality
Although consistent savings and investing for retirement (over a long period of time) can allow you to reach your goals, extreme frugality is also an option. Extreme frugality involves cutting every expense possible, often making significant sacrifices or inconveniences in order to minimize expenses. That may or may not be an appealing option for you!
3. Entrepreneurship
Business ownership is also a great path to FI given many business owners can eventually sell the business for a large sum of money. Some successful businesses could be worth millions. Many people who are pursuing financial independence are effectively entrepreneurs – they simply run their business(es) after retiring from any traditional work. Business ownership mind you if not for everyone.
4. Geo-arbitrage
The last option is geographic arbitrage. Geoarbitrage involves moving to a place with a lower cost of living while keeping the same level of income or near income. You could move and travel abroad, for less, instead of living in North America for example. You could work on your own terms. This could be in the form of self-employment. That said, geoarbitrage is not for everyone as it may require some significant changes.
The My Own Advisor Financial Independence Number
For years, I’ve pegged our FI number to be around the $1 million portfolio value mark.
This excludes any home equity, this excludes our workplace pensions, and this excludes any future government pensions such as Canada Pension Plan (CPP) or Old Age Security (OAS).
For us, Financial Independence means:
- earning enough passive income from my assets such that my asset-producing passive income is > general expenses, and/or
- amassing a portfolio value such that reasonable withdrawals will be > general expenses for many decades on end.
Either way, we have sufficient cashflow to cover our retirement needs and expenses.
What are reasonable withdrawals???
You could argue the birth of any reasonable and therefore any safe portfolio withdrawal formula was originated by U.S. financial advisor William Bengen.
You can read about his genesis for the 4% rule and why it still makes some sense below:
Following Bengen and largely reinforcing his work, three professors at Trinity University published a paper about safe retirement withdrawal rates.
Those professors looked at stock and bond data from the mid-1920s through to the mid-1970s and their conclusion was that essentially over any 30-year investment period in that range, a retiree could safely withdraw 4% of their total assets per year without much fear (meaning barely any fear) of running out of money. Only in a handful of cases, the very worst cases in any 30-year period, would the portfolio go to absolute zero.
So, let’s look at that context when it comes to our goals:
If we managed to enter retirement with our desired $1 million goal of invested assets (along with no debt of course), then we could reasonably expect to assume we could withdraw $40,000 per year for our living expenses from that portfolio with very little fear of running out of money.
Henceforth, the study by those three professors from Trinity University, The Trinity Study, have set the framework for a gazillion FI number crunching exercises to this day and likely the same number into the future…
Determining your financial independence number
Here are some options to crunch your math.
- Determine your annual expenses and multiply by 25 / Rule of 25.
Essentially, this is leveraging the 4% rule albeit in a different way.
Should your general expenses be in the range of $40,000 to $50,000 per year (after tax) like ours intends to be, then spending $40K to $50K per year would translate into a FI number of $1 M to $1.25 M.
That’s easy.
But…this approach doesn’t really answer any cashflow questions to cover needs or expenses.
Let’s get into more fun calculators.
- Use the “When can I retire?” calculator.
While any 4% rule is a nice starting point, what is even better is using a calculator!
I found this handy-dandy tool below and used some fictitious numbers for an example:
You can find this FREE tool on my Helpful Sites page.
3.Work backwards using Vanguard’s Retirement Nest Egg Calculator
Another great tool from my FREE Helpful Sites page.
Using this tool:
With those inputs, you can run a simulation to see if that amount saved will yield to modest success:
4. Take a deep dive into your planned expenses and then consider using the VPM method.
I like the Variable Percentage Withdrawal (VPW) method for a few reasons:
- It combines the best ideas associated with constant-dollar withdrawal and constant-percentage withdrawal strategies.
- It adapts your withdrawals to market/portfolio returns so effectively you don’t drawdown your portfolio too quickly.
- It uses a variable, and an increasing percentage to determine withdrawals so effectively you don’t hoard your money “until the end”.
- This is one of the best approaches to increase spending in “good years” and decrease spending in “bad years” therefore giving investors psychological ease.
Here is how you can use the VPW method including a link to a FREE calculator to use.
How to draw down a portfolio using Variable Percentage Withdrawal (VPW)
Determining your financial independence number summary
Ultimately, I believe you’ll need to start with where you are to determine where you want to be.
This means getting a great handle on your current expenses as well as any planned expenses (in retirement), along with hedging the “what ifs” in life by keeping some cash for any plans that go awry is just smart planning.
This means, consider your expenses in retirement and then your cashflow needs to cover such expenses in retirement.
When it comes to safe withdrawal rates, if that is your thing, I believe you could use some very conservative 3%-3.5% safe withdrawal rates for longer retirement time horizons beyond 30-years and end up just fine. Even then, you might end up with a pile of money thanks to positive sequence of returns.
The future is always unknown.
Years ago my wife and I set some goals to hopefully retire or at least semi-retire around age 50. I would like to think we’re still on track. More posts this year will shed some light on that.
I would encourage you to figure out if you’re on track for your early retirement dreams by reviewing your own spending goals and/or using some of the FI tools and calculators above.
I look forward to hearing how you’re going about your business realizing your FI goals too.
How do we measure up? Can we hit 10 goals in 10 years for early retirement?
Thanks for reading and sharing. I look forward to your comments!
Mark
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've surpassed my goal and now investing beyond the 7-figure portfolio to start semi-retirement with. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
As far as I know, the 4% rule doesn’t consider taxes owed on withdrawals.
If I have expenses of $40,000, and my portfolio of $1 million is in an RRSP, I will need to add, say $6,000 to my annual withdrawal to cover the taxes i.e. more than 4%.
I think more should be discussed on this topic, including something about the basic “how soon can I retire” calculators not considering the implications of having to pay taxes.
Perhaps, we should add the anticipated taxes to our annual expenses, and then multiply by 25. So, with the above example, instead of $1,000,000, the individual would need $1,150,000 to reach their 4% rule FIRE number.
Correct Bob, the withdrawal doesn’t assume your tax rate but then again, it doesn’t really include what you may or may not earn in capital growth – there are a lot of assumptions with the rule but it’s a good rule of thumb to start the personal discussions about how much is enough.
If you’re already considering taxes in any FIRE calculation Bob you’re WAY ahead of most 🙂
Yes, I think I’ve got the taxes sorted out. My retirement planning spreadsheet calculates the pension splitting numbers and expected taxes indexed to a settable inflation level. It also takes accounts for the federal and provincial pension income and old age credits, so I can see the point at which it might be beneficial to take money from our non-registered accounts instead of the RRSPs. It took a long time to build the spreadsheet, but I had to do something while waiting for more money coming in to invest.
Kudos for building your own tool/spreadsheet to manage. I’ll be going through an exercise this summer for forecast my early retirement plans and I hope to share a few posts on that subject for readers, with real numbers. Brave but we’ll see!
I think our plan has always been to wind down RRSPs before non-registered but could always do a bit of both.
Hi Mark,
Kudos for getting so much great content out – it’s really impressive! Plus, making your examples personal is hugely beneficial for your readers and makes your advice quite ‘real’.
I’m 100% with you on the ‘FI’ vs. ‘FIRE’ part. Those people are going to earn money again, somehow.
I like that MoneySense took a stab at how much you might need saved up by a certain age. I’ve done the same thing with my own personal situation, as I am hoping to be able to have the choice to retire at age 55, which is in seven years (things were looking good in January!).
While I agree that the 4% Rule can be handy, I get very nervous when it is applied generally. Here’s an example. Let’s say two teachers are married and are renters. They’ve been teaching full time since they left university, so will get two DB pensions (indexed to inflation), plus full or near-full CPP (depending on when they retire and therefore how many ‘dropout’ years they have) and full OAS. This could easily be a total of $100,000 of before-tax income around age 57 (from their pensions) and another approximately $42,000 at age 65 (from CPP and OAS). This couple could literally have a net worth of $0 and have more than enough income in retirement to live happily ever after.
The 4% Rule would not work for them at all (4% of $0 = $0). While this example is not the norm, it’s quite possible that one person in a couple might have a DB pension, or you might be downsizing your home at some point, or have some dividend income, or you might receive a future inheritance, etc. These factors and others throw a wrench into relying on the 4% rule, which is having a customized financial plan comes in (not a plug. lol).
Ironically, for my personal situation, the 4% Rule is quite applicable. I am single, rent, have no pension, no inheritances coming, and won’t have much CPP as I lived overseas for 15 years.
Thanks again for the great posts, Mark.
Steve
Ya, I’ve been tracking “how much is enough” for us for about 10+ years now. I continue to conclude without any debt, a $1 M portfolio + our pensions + future CPP and OAS, etc. should be “enough” without any debt to work part-time at least… Those days are five years away I think.
Retirement or choice thereof to retire at age 55 would be ideal for many Steve. That is excellent.
I’ve calculated our CPP alone should be close to $1,500 per month each at age 70 if we defer. So, I’m likely to do that and draw down personal assets (i.e., all RRSP assets, all LIRAs, etc.) and only leaving TFSAs “until the end”. I’ll have a few more posts on this subject in future months… I like the idea of getting my fixed income, inflation protected as well, which could be used to fight any longevity without risking my own assets. The government takes the investment risk with CPP, not me. That’s good in any senior years I think.
OAS I’ve calculated I’ll get the standard rate as long I continue to live here (Canada) which I intend to do for another 20 years.
So, CPP and OAS alone should provide my wife and I about $4,000 per month at age 70 in today’s dollars. Again, as you know, both inflation protected.
With $1 M invested, I could therefore spend my 4% rule and even if I’m off by 1% here or there we should have enough given $4,500 per month after-tax is our planned spend. Half of that goes to property taxes, condo fees, utilities, car insurance and the like – the rest is for food, groceries and entertainment.
I think for you along with others, the 4% rule remains an excellent starting point but for the reasons in your post with me it’s far from an absolute and people need to go beyond that in any planning for sure. I intend to as well 🙂
https://www.myownadvisor.ca/does-the-4-safe-withdraw-rate-still-make-any-sense/
All the best and we should do another article again. I have a few ideas!
Mark
Mark,
I like your thinking around CPP and OAS at 70. I also like the plan to draw down your tax-deferred investments first, as you get them out of those accounts (RRSPs, LIRAs) at the lowest tax rate possible. This is often what I show clients is best for them.
What this also means is that the 4% Rule gets thrown out the window. Let’s say your pension doesn’t start until 65, or that it is in your best interest to delay that pension until 65. You might be drawing much more than 4% of your liquid assets from 60 to 65, then your pension kicks in and you draw less, then your CPP and OAS kick in and you draw even less than again. As per my example in my original comment above, depending on your spending needs, you might be in a position to have $0 left in your accounts at age 70 and still be totally fine (this is just for illustration purposes, as I realize you personally will likely want or need to draw from savings post age 70).
Another consideration is that once people hit a certain age, activity and spending levels go down (less travel, clothes, eating out, down to one or no cars, etc.). The future downsizing of a home will give a potentially large injection of cash, which can then be used for medical expenses, long-term care, or to give as an inheritance or donation.
Putting this all together is why I don’t use the 4% Rule at all and prefer client-specific planning. Using it in a situation as described above would result in having way too much money left over in the end OR paying way too much in tax.
(Irony alert! I will have a small amount of CPP as I lived overseas for 15 years plus I plan to stop contributing when I ‘retire’, leaving me with even more dropout years and a lower amount of CPP. On top of that, I rent, am single, will still travel, etc. so my overall expenses will remain fairly consistent. For my personal circumstances, the 4% Rule IS a pretty good guide!)
Steve
Indeed…re: all together is why we shouldn’t use any rule, let alone a 4% withdrawal rule blindly.
It is however a great starting point to have a discussion to determine how much is enough. I would think from all income sources, if you were to merge everything for clients, and determine they have “enough” using such a rule – the key decisions now become what is the correct order to draw more than 4% down and when (e.g., pensions, CPP, OAS, rental income/sale of rental, taxable investments, other.)
I’m looking forward to having some tax complications to figure out in the next 5-10 years. This is an indicator I saved enough 🙂
Mark
Everywhere I look about FI, I see the 2x 10x 25x annual salary calculation. But shouldn’t it be a multiple of your annula SPENDING and NOT your annual salary? If you are saving 50 percent or 40 percent of your salary in order to get to FI, then you aren’t living on your full salary…
That’s a fair comment. I wrote about spending is your ideal way to figure out your “enough” number about seven years ago and this post remains very true today.
https://www.myownadvisor.ca/consider-what-you-spend-for-your-enough-number/
I don’t consider any annual salary as part of my FI number although some calculators may include it.
All the best!
Enjoy Canada Day in our nation’s capital, Mark.
Gosh I have such fond memories of July 1st in Ottawa, of course that was long ago before I had children! We did visit Ottawa with the 3 of them just before moving to BC in 2001. That was the year that the fireworks were cancelled due to wind, but the entire day up till then was beautiful.
I did have more than one stock in my portfolio cut its dividend to zero this year, a big ouch because of course when this happens the price also drops dramatically. Well, you are unlikely to have all winners, so these downs are expected. I just wish that my losers were not in my registered accounts, it would be nice to have those losses to offset some capital gains.
“Well, you are unlikely to have all winners, so these downs are expected.”
Yes, I fully expect to have a few more dividend cuts this year but it goes with the territory to have some stocks up and others down in the portfolio. I still have the long view in mind and will stick with my plan!
Happy Canada Day back!
Mark
I’d argue to be more conservative and aim for a 3.0-3.5% withdrawal rate which would equate to 28-33 times your expected annual expenses once you retire. I also don’t include home value, car value, pensions, or CPP/OAS into our figures either. I understand why the 4% “rule” works (most people who “retire” early often shift over to some hobby/passion project that likely brings in some sort of income but I’d much rather be on the safer more conservative end especially as you design a happy life along the way.
Great to hear from you Court. Yes, trying to be conservative with my numbers as well and I figure anything in the 3.5% withdrawal rate for about 30-40 years is just fine with a bias to stocks over bonds. I can’t see bonds doing anything to help retirees for the next 20-30 years. I could be wrong of course!
All the best to you,
Mark
The Moneysense chart presented numbers that mirrored what I have been considering for my own situation. As a single person I am constantly reminded how much more I will need to save for low level middle class retirement than a couple. I wonder if singles need to take a different approach to savings and drawing down than couples.
I am also wondering how much, if any, of those savings numbers are from inheritances received. I assume that factors in to the earlier retirements of a lot of Canadians.
Singles do need to save more than couples I believe, on average, given some wildcards in life and the inability to share some major expenses like housing and transportation.
I have no idea how much those numbers include or do not when it comes to inheritances. I’m not banking on any inheritance in my future. I told my parents to “spend it all” since they’ve worked hard for it and I should be able to take care of myself.
Happy Canada Day Beth!
Hey Mark,
Like you I’m not interested in the second half of FIRE, the RE. I’m much more focused on achieving FI. The metric I use to track my journey to FI is determining the % of my dividends covering monthly expenses. Once I know that this is over 100%, I would consider myself “FI”. If my passive income streams cover 10% of my monthly expenses, I consider myself 10% “FI”.
DG Capital
I keep the same spreadsheet for the most part. We’re about 68% FI so when this income that I report on each month reaches 100% or $30K from taxable and x2 TFSAs (no RRSPs, no pension, other factored in) I figure we’ll have enough invested to start part-time work and work as we please.
https://www.myownadvisor.ca/may-2020-dividend-income-update/
All the best on your FI journey as well DG!
Mark
DG and Mark,correct if I’m wrong but isn’t your FI a variation on the method from “Your Money or Your Live” joe Dominguez/Vivki Robin? They used bonds as the the income source (not achievable now!) rather than dividends
Aside: what happened to those folks who followed the YMYL path and their bond income dropped over the years? did they go back to work ?
Mark, another ‘income’ source when you actually reach the retirement part is that your capital pile can be used (sparingly) over time (“eat the capital”) – personally I’d like my capital to expire shortly after I do 🙂 – tough scheduling problem though :).
I suppose it is…I prefer to have enough income generated by my investments, excluding future pensions, excluding future CPP and OAS, to pay for basic expenses. I’m/we’re 67% or so “there”.
I will definitely “eat capital” over time. I just think in the first 5 years or so in my future semi-retirement are the critical years whereby I need to ensure my capital lasts. Thoughts?
Cheers,
Mark
Mark, you’re absolutely correct that coming out of the gate , “eating capital” should not be an income source (it’s been a while since I “left the gate” so I forget that perspective 🙂 ).
I was thinking more about when firmly entrenched in retirement and there a shortfalls in income or unexpected (unplanned for) expenses or opportunities for that matter, that the capital pile can (and should be) be sparingly utilized.
Or alternately if you wish to see/enjoy the benefits of your capital, gifting/assisting before you depart is another use.
An ameliorating factor would be if one wants to leave a legacy – in my case I would prefer to be the beneficiary of my capital and/or gift prior to my departing, rather than my estate – get to see the smiles that way:).
I think some gifting might be in our future to nieces and nephews but that’s a LONG ways off. We need to meet our desired early/semi-retirement goals and then see what happens with life. I have no desire to leave any significant estate. I know of a few readers that might want to leave a legacy and that’s great for them. As always, “it depends” in life 🙂
All the best during these crazy times.
Never agreed that there should be a number that one should work towards, especially since most people refer to Market value. The future market value of investments is simply guesswork and a waste of time.
My personal opinion is that one should invest to generate and grow the income from their investments. The more they save and how they invest will determine how much income they will achieve when they retire. Whether the value of their investments works out to $250K, $500K, $1Mil or more is immaterial. It’s the income and the continued growth of their income that is the key to achieving financial independence, provided the income meets their particular needs.
I hear ya. I too believe that income from assets > expenses will really set most people up very well financially. This is my strive for FI cannew as you know, to ensure my portfolio does the work vs. me working.
Using a mix of CDN and U.S. dividend paying stocks it’s not hard to earn about 3-4% dividend yield. So, $1 M invested should likely churn out $30K-$40K in perpetuity assuming all dividends (although some might) never get cut.
It is my hope that I write about often on the site that our portfolio will deliver meaningful income such that was can work part-time in the coming years as soon as the debt is paid off. About five years and counting on that right now since we tend to prioritize our investments over mortgage payments.
How is your portfolio coming along this year? Still own your 12 stocks or so?
https://www.myownadvisor.ca/your-ever-growing-income-review-and-giveaway/
I recall you own a few CDN banks (BMO, BNS, CM) and utilities (EMA, FTS) and telcos (BCE, T) and pipelines (ENB, TRP) as core?
I own all those as well and DRIPping all of them every quarter at least 2 shares of each.