For the first time, I’ve computed my Financial Independence (FI) ratio. In this post, I’m going to explain to you what is FI and how to compute your FI ratio.
First, what is Financial Independence (FI) ?
It’s when you have enough money to sustain your lifestyle without working. For this, your wealth must generate income. And this income must be greater than your expenses. The main way to generate income from your wealth is simply to withdraw from it. However, you need to withdraw little enough to sustain your wealth for the longest time.
You may have heard of the 4% rule. It states that if you only withdraw 4% of your investment portfolio, it should sustain you for at least 30 years. This percentage is your Withdrawal Rate (WR) or Safe Withdrawal Rate (SWR). These rules assume that you invest your portfolio in the stock market. Generally, the rule assume 75% stocks and 25% bonds, but the asset allocation is up to you. 4% is the recommended SWR, but some people choose to be more conservative (<4%) or more aggressive (>4%). I am a bit more conservative and my SWR is 3.5%.
Now I got my SWR, how much do I need to be FI ?
In fact, it’s pretty easy. By dividing 100 by your SWR, you’ll have the number of years of expense you should save. For instance, for my SWR of 3.5%, I have to accumulate 28 years of my annual expenses. If you think your expenses are going to go up or down in the future, you should also account for that. You should use the amount of expenses you plan for FI. So, your target net worth is 100/SWR times your annual expenses.