How to calculate your Financial Independence (FI) Ratio

Posted on Categories FIRE, Goals
My financial independence ratio Logo

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.

Finally, how do I get my FI ratio ?

You now have your target net worth. That is the net worth at which you’ll reach Financial Independence.  You FI ratio is simply your current net worth divided by your target net worth. If you have a target of 1 million and you have 100’000, your FI ratio is 10%.

If you need, you can see how I calculate my net worth.

My Financial Independence Ratio

I’ve calculate the results for my goal.  I’ve also calculated how many years it will take me to get there at the current pace. Here are my results:

Withdrawal rate3.5%
Annual Return5.0%
Years of expense28
Running expenses57’571 CHF
Target Net Worth1’612’015 CHF
Current Net Worth54’583 CHF
Missing Net Worth1’557’431 CHF
FI Ratio3.50%
Yearly income71’400 CHF
Running Savings Rate14.60%
Yearly savings10’424 CHF
Time to FI (w/o returns)149.39 years
Time to FI (w/ returns)38.83 years

I’ve computed my expenses over the last 12 months (not counting March). This gives me about 1.6 million CHF to save. Given my current Net Worth, I’m missing about 1.55 million CHF. If you compute the ratio of your net worth and the target net worth, it gives you your FI ratio. Mine is a meager 3.5%.

You can also calculate an estimate of how many years you need to save this amount. I’ve calculated my savings rate as the average of these twelve months. I’m making the assumption of a 5% annual rate of return, which is conservative. This gives me almost 39 years until I reach FI. This is not great, since I will already be past the retirement age in 39 years. Not considering any return on the invested portfolio, it will take me 149 years to reach my goal. I will be long dead! The difference between these two numbers shows the power of compounding!

My calculations are not entirely correct. First, my second pillar and my life insurance are not taken into account in my net worth yet. I will update my net worth this year to start including it. Then, my current savings rate is higher than 14.6% and I’m still working on increasing it. My current income is also higher than it was on most of the twelve last months. Finally, I’m also working on improving my expenses. The last twelve months include some pretty bad months.

There is another thing that is not taken into account.  The second pillar and the third pillar can only be taken out at the retirement age. And also that the first pillar will give you a retirement pension. If you want a really accurate calculation, you’ll have to integrate many more factors.

Keep in mind that all these numbers are only estimates. Your expenses could go up, your salary could change, the stock market could crash, … Your Financial Independence ratio and the estimated number of years left are useful numbers, but they are not definite. For instance, I plan to have kids, this will definitely increase my expenses. I will also change jobs in June, increasing my income.

Another thing you should keep in mind is that the SWR rule has been created for the US market. You may have to adapt it to your country. And, if you plan to retire really early (in your thirties for instance), this rule won’t cover you long enough. So take everything like this with a grain of salt. Every situation is different. If you want to read more (much more) about SWR, you can read the Ultimate Guide to SWR, by Early Retirement Now. It’s really good.

Summary

In the future, I’m going to try to follow the evolution of my FI Ratio. But for now, I will not pay too much attention to it. I will focus on decreasing my expenses and increasing my savings rate. I’m not really worried about the large number of years in the estimation. I’m just getting started with my budget overhaul.

By the way, you don’t have to do the math yourselves, there are plenty of Financial Independence calculators online, like this one.

What do you think of my results ? Did you ever compute your FI Ratio ?

14 thoughts on “How to calculate your Financial Independence (FI) Ratio”

  1. Hello Swiss! I wish I could change your domain name to “therichswiss” because I don’t like calling you “poor” lol!

    Based on your net worth, you are in great and healthy shape! And honestly, anything in life can happen. Nothing is certain!

    Like you, my fiance and I are focusing on savings rate, decreasing expenses, and increasing income. I think as long as you keep your mind focused on those areas, the net worth will gradually build over the years without you noticing. After all, this is a marathon and not a race! Not to mention, that number can drastically fall at any time especially when markets head south.

    Overall, this is a great post about what the FI ratio is. I personally didn’t look at my FI ratio because it feels like there’s still a long way to go to reach freedom haha! But still, doing whatever we can to sustain current lifestyle without going broke or eroding the nest egg!

    1. Hello panda,

      Do not hesitate to call me poor 😛

      It’s part of my strategy to make me believe that I’m poor in order to have healthier budget 😉 Moreover, if you consider the *rich* in Switzerland, I’m more than poor, but that ‘s another story.

      As you say, the net worth number can significantly fall. I totally agree with you! Savings Rate, Expenses and Income are the most important numbers to focus on. Once these numbers are good, the rest will follow: The net worth will increase, the FI ratio will increase and the years to FI will decrease.

      The only number I really follow each month is my savings rate. I computed my FI ratio for fun. It is too early for me too to see the possible early retirement.

      P.S. Maybe I should already buy the therichswiss.com domain for when I’m satisfied enough of my results!

      1. ahhaha~~~ i am waiting to hear you from the therichswiss.com domain one day . I believe time can tranform you from thepoorswiss to therichswiss .

    1. Hello

      It’s net salary, what I receive in my bank account, it’s after deductions (such as retirement). But before taxes. It’s not too bad, even for Switzerland, but it’s low for Computer Science. Not everybody in Switzerland have big salaries. I know a lot of people who have less than 5K monthly salary. The media do so much in showing that Switzerland is so rich that everybody think that every Swiss is rich, but this is far from true.

      P.S. Sorry for the delay, it seems WordPress didn’t like your username :s

  2. First of all, I love the name of your blog, I once had a Swiss guy tell me that I’m the poorest person he’s ever met. He wasn’t kidding!

    I’ve never computed this calculation before but I’m going to give a try. Thanks for sharing.

  3. Thanks for the article!
    Frankly speaking, I am amazed by the math you put together…it sounds pretty sophisticated what you are calculating. On the other hand, your FI ratio, is just telling you how far you are away from having saved up the amount of money needed to reach full retirement.
    I am well on my way towards financial independence, but have never calculated my FI ratio, oops! Why not? Because I count more on covering ongoing cost from passive revenue streams. As soon as I can see that my monthly expenses are covered from the cash flows generated, I would feel comfortable of calling me FI. Makes sense?

    1. You’re welcome 🙂

      Yes, the FI ratio is a pretty simple thing, just the fraction of the target net worth.

      It makes total sense! If you are able to cover all your expenses with passive income, you’ll also have reached Financial Independence 🙂 By the way, some bloggers compute a FI ratio as Passive Income over Expenses. This is just a different approach to FIRE that works pretty good as well. There is no one single solution to FIRE.

      Good luck on your way towards FI 😉

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