When you think about Financial Independence, does it feel like you are standing at the bottom of a seemingly insurmountable mountain?
Looking at financial independence as the ability to live off your own financial resources for the rest of your life sets the bar quite high. Essentially, you’re trying to come up with your “never work again” number.
But, we need to work.
Abraham Maslow published his thoughts in a widely taught and cited paper “A theory of Human Motivation”. Since the time of publishing, Maslow’s Hierarchy of Needs has only grown in popularity, not for scientific reasons, but as a representation of what people see in themselves.
Maslow’s Hierarchy of Needs:
Image Credit: Wikipedia
Work is an essential part of our identity. It provides us a way to meet our needs - belongingness, accomplishment, and fulfilling our potential. Without work, we’d be lost.
But work doesn’t need to be a traditional 9-5 shiftwork. Work is ultimately a purpose, a reason for acting, a reason for living.
Of course, for many people, this view of work is an esoteric, almost mythical story. The idea of work has been corrupted by a sense of duty. You must work, because that is the only way to earn enough to fulfill the first two levels of the hierarchy; food, shelter, safety.
To grow beyond those first two levels, you need to know those are taken care of. To do that, you need another financial goal. A base camp partway up the mountain of financial independence.
You need a mid-term financial goal, a number that covers your food, shelter, and safety, so that you can focus on growing into your full potential.
Look at your monthly spending. How much do you spend each month on:
- Housing (rent or mortgage including property taxes)
- Food
- Utilities (Gas, Water, Electricity, Internet, Phone)
- Healthcare (Medical bills, Insurance)
- Transportation
These are your basic financial needs. Having these covered will allow you to focus on other of life's priorities.
This number is extremely important for two calculations, your emergency fund, and that base camp of Financial Security.
Emergency Fund
An emergency fund is important for everyone’s financial security. To be able to cover the unexpected, so you don’t get side-tracked from your true financial goals.
Take the cost of your basic needs, and multiply by a reasonable period of time. 6 to 12 months should be sufficient, in case of job loss or another type of emergency.
Financial Security
Your basic needs are significantly less than the cost of your total lifestyle. Understanding what those needs are will help you plant your flag at base camp on your financial journey. With those list of costs, multiply by 12 to find your annual expenditure, and divide by 6%. This gives you a target for Financial Security.
Take Sally’s example. She needs $3,000 / month for her basic needs. Her calculation would be:
$3,000 * 12 / 6% = $36,000 / 0.06 = $ 600,000.
A fund of $600,000 invested in a low cost index fund would provide Sally the financial security she needs to never worry about food, shelter, or safety ever again.
Why 6%?
6% estimates the total market return of a low cost index fund. Financial Independence looks at lower numbers, like 4%, to determine the appropriate levels of withdrawal to ensure you won’t run out. But Financial Security comes first. The Financial Security fund still expects you to work, to earn more, to be productive as you grow towards your potential.
By now you should have a few financial goals in place. How much you need in an emergency fund. How much you need to experience some financial freedom. How much you need to achieve financial security. And ultimately, financial independence, how much you need to live life the way you want to, without ever needing to work again, if you so choose.
What are your numbers? Imagine what your life will look like as you start to build these financial foundations. Imagine all you can experience, all you can do, all you can become. That is a life worth living.