Everything You Need To Know About Financial Independence In 2021

financial independence

Note: This post was originally published in November 2019 and updated in January 2021

As one of your fellow readers helpfully pointed out in a recent email, for someone who never really defined financial independence, I sure spend a lot of time talking about the various ways to reach it.

Point taken. 

After all, the beauty of using writing as a creative outlet is the ability to focus on whatever topic interests me whenever I open my laptop. 

The downside, of course, is that I sometimes get ahead of my skis and refer to things that reside in my head as opposed to on this blog. 

To make matters even worse, financial independence means different things to different people.  For some, it’s sailing (and self-isolating) on a superyacht.

For others, it’s living it up in Goa for £10/day. 

And for most folks, of course, it’s somewhere in between the two extremes.

So let me address this oversight and lay out some key concepts and definitions you need to be aware of when it comes to financial independence. 

Hopefully, it will help contextualize the shared journey of financial and personal growth we are embarking on here at Banker on Fire. 

Financial Independence: What Is It?

This one is easy. 

Put simply, financial independence is the ability not to depend on anyone else for money. 

That means generating enough income from your investments to fund your desired lifestyle today, tomorrow, and for the rest of your life.

And by the way, financial independence is not binary.  As you will see below, even a little is better than none and can do wonders to improve your quality of life. 

Okay Great – Why Should I Care?

No one said you should. 

Many people spend their entire lives being financially dependent on their employers, their spouses, their children, the government, or even the kindness of random strangers. 

The popular narrative that financial independence = happiness is WRONG.

If you are unhappy today, chances are you will be unhappy when you reach financial independence.  I’m sorry but it’s true.

However, it is also true that financial independence can be a powerful building block of a happy, fulfilling life. 

It allows you to quit a job you hate – or simply take comfort in knowing that you can walk away anytime (bye-bye cortisol…)

Alternatively, it could actually supercharge your career progression

If you play tennis, you know that you play very differently when you are up 40-15 than when you are trying to save a triple break-point. 

Financial independence can help you relax, stop worrying about making all kinds of unforced errors, and start hitting more winners at work.  

It can also give you the flexibility – and the safety net – to start your own business, travel the world, write a book, stage a play, or volunteer at the local hospice.    

In other words, financial independence = flexibility. 

I See – So How Do I Reach Financial Independence?

The beauty of financial independence is that the maths are very simple to comprehend: 

  1. Figure out your annual spending needs
  2. Multiply by 25 (if you are mathematically inclined, divide by 4%)
  3. Stare at the number – this is the net worth you need to reach to be financially independent

Of course, it’s a bit more nuanced than that. 

When figuring out your annual spending needs, you need to make sure this number reflects your desired lifestyle upon reaching financial independence.

If financial independence means no longer selling your soul to the devil commuting to Canary Wharf five days a week (whenever that slog is back on), cut out the associated transportation, lunch, and office attire costs. 

Here’s to hoping this will never be a thing again…

But if you are planning to replace your commute with a permanent residence at The Mayfair (because God knows they will need your money after the lockdown),  then you’ve got to make an adjustment for that as well.

… but camping out here might take a bit more saving

And to state the blindingly obvious, the one thing you will NOT have to do when you are financially independent is to save for retirement. 

It pains me to say this but as much as you may share my love for pension contributions, they will become a fixture of the past. 

Simple Enough – But Why Do I Need To Multiply By 25?

Because it’s my favourite number.

Don’t like that answer?  Okay, let me try harder. 

The point of financial independence is to amass a nest egg sizeable enough to cover off your living expenses now and into eternity. 

It has been determined by some very smart people (hint: not me) that you can safely withdraw 4% of your investment portfolio without running out of principal. 

No Way! Are You Sure That’s Enough? 

Yes, I am.  Read this if you want to be convinced. 

It’s true that over the past year, the chorus of people challenging the 4% rule has grown louder.

Which is totally fine, of course. If you aren’t comfortable, you should reduce your safe withdrawal rate to 3.5% (i.e. multiply by 28.6 and not 25) or another number more to your liking.

Beware, though! The lower the percentage, the higher the “number” you’ll need to hit before you pack it all in.

And don’t forget that using a number like 2% or below is a bit ridiculous unless you have a time horizon of 50+ years.

Going down the rabbit hole of safe will mean that even millions will never be enough to retire.

Do I Need To Be A Stock-Picking Maestro To Achieve Financial Independence?

Absolutely not. 

As a matter of fact, you are much better off not being a stock-picking expert, assuming you won’t try to do anything stupid become one. 

Unless you may have been living under a rock for the past fifty years, you may have heard of a little trend called passive investing.  Do you know why it’s so popular? 

Well, it’s because (most) investors have finally realized that while paying someone to manage their investments sure helps that someone buy a new Ferrari, it usually does an absolute zilch for the value of the actual investments.

And to be clear, it’s zilch if you are lucky. 

The vast majority of the time, active investment vehicles underperform the very market benchmarks they are supposed to beat. 

Large-cap fund performance

That’s right.  It’s like failing to meet your performance objective every year yet demanding a raise.

I don’t have a Ferrari.  I am not in the business of buying one for anyone else.  I don’t suggest you get in on it either. 

So please do yourself a favour and put your money into a low-cost, passive index fund

Sign Me Up!  Can I Retire Next Week?

Maybe. 

As I said above, much of the beauty of financial independence is in the simplicity of the underlying maths. 

Some people will try and overcomplicate it, but the only thing that determines the time in which you will reach financial independence is your savings rate.  

The bookends are quite simple.  If you spend 0% of your income, you are financially independent. 

If you spend 100% of your income, you will never become financially independent

Take a look at the chart below and read this wonderful post from Mr. Money Mustache to see how long your journey will take.  

financial independence savings rate

Source: Mr. Money Mustache

All Clear!  What Will I Do Once I Reach Financial Independence? 

You tell me!  Perhaps relax a little and spend more time reading this blog?

Well, here it is.  Hopefully, this clarifies things and gives you something to ponder as we all head into the weekend.

Have a great day – and thank you for reading.

About Banker On FIRE

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Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker.  I am passionate about capital markets, behavioural economics, financial independence and living the best life possible.

Find out more about me and this blog here.

If you are new to investing, this is a good place to start.

18 Comments

  1. Thanks for another well-written and useful post. Older people like myself used to be able to rely on annuities, but rates are so low now. Are you recommending that we just stay invested in the markets and take out 4% a year?

  2. Use your money to invest in people. Help the children and elderly. You will be blessed indeed.

  3. I think the 4% rule is too simplistic since it does not allow for other income, primarily the State Pension. There are various views around regarding it becoming means tested or even being stopped altogether but that’s political suicide for any party in government……far better to assume that the politicians will keep pushing up the qualifying age or requirements.
    My wife and I are both 59 and qualify for the state pension at the age of 67. I’ve factored this into our financial plan and it makes a significant difference to withdrawal rates.
    I’m already drawing down at 3% per annum but there will come a time about 3 years away from state pension age when I will increase this rate to over 8% for 3 years until the state pension kicks in. Once that happens I can then drop the withdrawal rate back down to 4% forever. Once you factor this into the calculations you need to save significantly less than 25 x yearly income to say you are financially free.

    • Another thoughtful and well presented article 😀👍.

      One further consideration is of course tax and making sure people appreciate that 25 x expenses = an Fi figure to be achieved AFTER tax.

      So if pension pot was included in the FI figure and the person planned to withdraw more than £12.5k pa (£16.67k inc 25% tax free lump sum) from that pot, they would have to be mindful of the tax liability and allow for that in their considerations.

      Your blogs are fantastic!

      • Thanks for the kind words David.

        Yes, spot on. Forgetting to account for taxes and including home equity in one’s net worth (assuming no plans to move out) are probably the two biggest oversights when it comes to planning for FI.

    • @colinph970

      Agreed.

      To be frank, I have zero confidence that the state pension will be in any way meaningful by the time I get to pension age (currently 28 years away, assuming no pension age increases).

      The other problem (specific to our household) is that we’ve moved around so much that chances are we probably won’t qualify for the full amount of pension in neither of our adopted homelands.

      That being said, your broader point definitely holds, especially for those who are closer to retirement and have better visibility to what their government pension might be.

      • Hi Damian – can you expand on why won’t be eligible for state pension contributions ? I too have moved between US & UK so would be keen to understand better. Thanks!

        • Your state pension is typically determined by the number of years you are in the workforce and are paying taxes / making other payroll deductions.

          As far as I know, here in the UK you’ve got to be employed for at least 10 years to even qualify for the state pension. Even at that, it will be a minimal amount for someone who only worked for 10 years and will go up with tenure of employment.

          Hence I am being conservative / pragmatic and not counting on a meaningful payout in retirement.

    • I agree the calculation can be a little simplistic, sometimes requiring a deeper look at your needs and timing of cashflows. For example, I thought 4% would be sufficient for myself but then determined I should use 3.5%. This was due to U.S. Social Security being less than originally anticipated since I will be retiring earlier. There is a fantastic free Java applet out there (FRP) I used to help simulate these scenarios.

  4. Great simple article. How do you recommend calculating the savings rate. Particularly how to account for pension contribution including employer match. Thanks.

    • Cheers.

      Many different ways to skin the cat here. Personally, I don’t track my savings rate that closely – I know it comes in somewhere around 50-60%, but I choose to focus on my net worth instead.

      That being said, you could look at it on an after-tax basis.

      That is, your savings (excluding pension) + the net amount that gets deposited into your pension account (including employer match), all divided by your total after-tax income + the pension contribution from the numerator.

      The key here is not to aim for intellectual purity, but rather have a consistent way of measuring the savings rate. This allows you to focus on increasing it by reducing discretionary expenses.

      Hope this helps!

  5. Thanks Damian for another superb post.

    The wealth managers I have spoken to/am invested with (Fisher), tell me that the justification of being with them and paying fees is that I won’t do the panic selling with your passive investment which can happen when markets drop? As an emotional investor I can imagine doing that.

    Would the 75/25 portfolio you mention be constructed by someone else, or would it be a ready made vehicle like Vanguard Lifestrategy?

    • Thanks Sue.

      Fundamentally, you need to answer two questions here:
      1. Will your wealth manager actually do what they promise? Or will they tinker with your portfolio as well, leading to the same (if not worse) outcome?
      2. Is it worth the fees they are charging? As they say, performance comes and goes, but fees are always there.

      Perhaps there’s a cheaper / more effective way to buy and forget?

      If not, you could go with LifeStrategy but be mindful that there’s a pretty strong UK bent to the Vanguard LifeStrategy funds. As such, it’s better to construct your own portfolio – it’s quite simple to do and you only need two funds: a world equity tracker and a bond tracker.

      Hope this helps!

    • Just played around with it – very cool!

      Will need to spend some time on underlying assumptions but the visual representation is very impactful.

  6. Thanks Damian, I’m sure you’re going to refer me to a few previous posts to read more about “you only need two funds: a world equity tracker and a bond tracker”? Sounds intriguing.

    I think I need a manager overseeing things so I don’t panic sell in these troubled times, and so I can concentrate on other things, but have read more recently about evidence based investment companies, so will check that out, plus Ruffer.

    Love your blog!

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