How to Calculate Your Financial Independence Target
By: Jessica Parks
Tags: Personal Finance, Personal Development, Money, Financial Independence, Finance

FI target value

Okay, so you’re free of that high-interest rate (read: BAD) debt, and maybe you already have started building your portfolio of assets. Your next step is accumulation and growth. We’re building a real-life dragon hoard of assets. But how do you know when it’s enough?

Image by ImaArtist from Pixabay

Answer: Do the math.

Traditionally, a 4% rule was recommended for calculating the portion of your investments that could be safely spent each year in retirement. Bill Bengen, the author of the initial study that determined this amount in the 1990s, recently released an update to the recommendation. You can find a summary at MarketWatch or read the full article at Financial Advisor.

Suppose you’re not excited by reading financial journals, tough luck. You really should check it out anyway. Set yourself apart from the financial illiterates.

In case you didn’t read it yet (yes, I’m looking at you) — The updated recommendation is a 5% withdrawal rate, while the average safe withdrawal rate was 7% historically (averaged over 1926–1990). The honest truth: This is more complex than applying a simple 5% rule. It depends on your appetite for risk in retirement and your willingness to vary your withdrawals with the market conditions.

For an extremely low-risk portfolio, you can use a 3% withdrawal rate. This will near-guarantee that your portfolio will outlast your lifetime and that you can continue withdrawals at a consistent rate. At the other extreme, if you’re willing to be flexible, you can use up to a 7% withdrawal rate. I like to think of this as a Financial Independence Range. Once you hit the low end (the number required at the 7% rate), you’ve reached a minimum for financial independence, and adding more will make your portfolio more resilient or provide a higher level of income from your portfolio.

The second factor to consider in the FI target calculation is your desired lifestyle in retirement. Will your expenses be minimal? Do you want to travel the world? Live on a luxury yacht? Travel to Mars? Nothing’s off the board — but consider: what will really make you happy? And, how long and hard are you willing to work for it?

Image by the author. | Financial independence target as determined by retirement income and withdrawal rate.

Let’s calculate your financial independence number. We can use a simple formula to arrive at the estimate for your FI target number. I’ve provided a table of pre-calculated values above. If your exact situation is not included, you can run the calculation as follows.

FI Target = Retirement Income / Withdrawal Rate

For example, for a yearly income of $55,000 and a 5% withdrawal rate:

FI Target = $55,000 / 0.05 = $1,100,000

Personally, I am both highly risk-tolerant and willing to be flexible with the amount I am withdrawing year-to-year, so I’ve set my withdrawal rate at 7%. I’m aiming high for the amount of income generated by my portfolio, at a target of $100,000. This results in a FI target amount of about $1.4M. It seems like an enormous amount, but with my current net worth, I am nearing 20% of this target value, and I have an increasing salary and compounding interest both in my favor, propelling this amount forward faster every day.

As my portfolio grows, I’m feeling an increasing sense of freedom. You don’t need to be at your FI target number to take a year off from work, make a risky career move, or start a new business. Simply being a few steps along the path is enough financial freedom to make a big life change without fear, or at least with less fear. Remember to live your best life while working towards your best future.

In the end, we come back to a single question:

How much do you want your freedom?

It’s going to take guts, grit, and perseverance to walk the path of financial independence. I believe the results are worth it. Do you?