How long will it take to achieve financial independence?

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Last time we talked about the 3 paths to achieve financial freedom.

Grow your income Cut your expense Leverage your creativity

The combination of these 3 things will grow your saving rate and help you reach financial independence quicker. So the follow up question is how long will it take to get there? If you want to retire early, what should your saving rate be?

The saving rate of Americans is pretty dismal at around 5%. I’m pretty sure it will be practically impossible to reach financial independence with that saving rate. Let’s crunch some numbers.

How long?

We’ll have to make some assumptions here.

Rate of return: The S&P 500’s inflation adjusted return is about 7%. We’ll use that figure for simplicity sake. You need to be aware that future return might not match this.

Goal: We aim to accumulate 25X expense. That way we can withdraw 4% from our portfolio every year. At this rate, your portfolio has a good chance of enduring your retirement. You can read a bit more about early retirement withdrawal strategy here.

Saving rate = Your saving divide by your take home pay (after tax.)

Let’s try to make it as simple as possible. John brings home $100k per year after tax. He saves $5k and spends $95k. At some point, his portfolio will be big enough so that 4% withdrawal will equal $95k, his cost of living. How long will this take? I’m ignoring a lot of variables, but let’s just run with it for now.

Total saved = (previous year saving * 7% ROI) + current year saving

Year saving rate total saved 1 5% $5,000 2 5% ($5,000*1.07) + $5,000 = $10,350 3 5% ($10,350*1.07) + $5,000 = $16,074 … 52 5% $2,337,525 53 5% $2,506,152

John will need about $2,400,000 to be able to withdraw $95,000 per year (4%.) At 5% saving rate, he’ll get there in about 52 and a half year. That’s a long time!

At the other extreme, he’d just need 3 years to reach financial independence if he could save 90% of his take home income. Of course, I don’t think anyone who brings home $100,000 per year would want to live on just $10,000.

Here is a visual aid for everyone.

The average retirement age in the U.S. is 62. That means most people have about 40 years to save and invest. If your saving rate is 5%, then you probably will not reach financial independence before retirement. Even 10% is iffy.

The problem with this formula is that it’s too simplistic. Most of us can’t keep a constant rate of saving every year. I think my saving rate was around 20% when I first started working. It increased to 60-70% for a few years before I quit my engineering career. Now, our saving rate is about 50%. It’s tough to keep track. There are more tricky variables as well.

Inflation – I’m not sure if inflation will make a big difference here. The 7% rate of return is already inflation adjusted. If I add inflation, then it will probably take longer to reach FI.

Tax during the withdrawal phase – You’ll have to pay tax when you withdraw.

Stock market – The stock market goes through long periods of busts and booms. The 7% average return won’t be accurate.

Social security will be helpful when you are eligible for benefits.

Start from 0 – This graph assumes you start from zero. Most of us are not even there yet. Debt is a big problem for the average household.

Lifestyle inflation – This calculation assumes lifestyle inflation is flat after achieving financial independence. If you’re planning to have kids and buy a house, then it’s probably not realistic.

What else am I missing?

Anyway, the data points on this graph are not accurate, but the shape of the graph is. The higher your saving rate, the quicker you’ll reach financial independence. Actually, this might be useful for some young folks who are just starting out. If you want to be financially independent in 10 years, then you need to save and invest at least 65% of your take home.

What’s your saving rate? Will you reach financial independence before turning 62?

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