Category: financial independence

From an early age, I heard about the importance of financial stability and standing on my own two feet. I heard that some things should only be undertaken when that stability has been achieved. For example, I heard that one should only get married and certainly to have kids once one is financially stable. Why? What does that even mean?

A huge percentage of Americans and the World live paycheck to paycheck. That means they don’t really have any savings and spend the money the get from their employer throughout the month after getting it. This is one of the reasons 40% of Americans don’t have $400 for an emergency. You could live like this for a long time, but you would be highly vulnerable to the random events that may occur and not really in control of your life.

So, one way to define financial stability is when you have enough savings to handle random events and not have to spiral out deep into debt, etc. Some financial advisors (e.g. Dave Ramsey) say you should have 3-6 months of cash to cover your regular expenses in your “emergency fund.” That’s a great step on the path to getting control and to be able to take a punch of a job loss or a health emergency.

Still 3-6 months is a short period of time and can only get you through a short-term emergency. I think that true financial stability is when you can be truly independent and not depend on anyone for your financial health. One way to describe this is through the 4% rule. This is a rule of thumb that says you can withdraw 4% of your portfolio value each year without incurring a substantial risk of running out of money, even if you don’t have other income coming in (e.g. from a job). Using this rule, for every $100,000 you have, you’d withdraw $4,000 a year. In other words, if your annual expenses are $40,000, then your portfolio should be $1,000,000. It’s important to note that for this to work, the suggested $1M is not just a cash pile, but a portfolio of stocks, bonds, etc. It should be generating a return. There are many different nuances associated with this rule of thumb, but the basic concept is backed by lots of research: that you can take your annual expenses, multiply them by 25, and that’s how much of a portfolio you should have for financial independence (meaning that you don’t have to work to survive if you don’t want to). Directionally, if you plan to retire early, the rule goes down to 3.5 or 3%, which means your portfolio needs to be larger to provider for a longer time horizon.

There is a financial movement happening now called FIRE, Financial Independence Retire Early. I like the FI part of it but I don’t necessarily think everyone should strive to retire early. Instead, I encourage you to do what you love so you never want to retire and you just get better in your field of work over time and more excited about waking up each morning to get to work. Warren Buffet, who is a very successful investor and is currently 90 years old, says he tap dances to work each day. I wish you the same. That is more likely to put you on the path to financial independence and happiness than many other things.