Financial Independence: How Long Will It Take?

For somebody who has committed to building wealth through living well below their means and investing, how long will it take to become financially independent?

Often times we use simple rule of thumb calculations to make an estimate, projecting an average investment return until a 4% withdrawal rate will support a desired cost of living.

This has limitations, of course:

The stock market is a volatile and uncooperative beast, so our assumption of constant growth never materializes. How do real world investment returns impact our wealth accumulation?

Although I would recommend it, few people are willing to put 100% of their retirement savings in the stock market. Will a more “conservative” asset allocation be a boon or a boost?

Despite the data, not everybody is comfortable with a 4% withdrawal rate. Some require a 3% withdrawal rate, or even (gasp!) 2%. How much longer will it take to save 33x or 50x our annual spending?

To answer these questions, I used the same methodology as the Trinity Study… but this time, looking backwards.

“How long would it have taken to become financially independent throughout modern history?”

Financial Independence: How Long Will it Take?

There are 3 primary factors determining how long is required to become financially independent through saving and investing, all of them inter-related:

Savings Rate – What percentage of after-tax income is spent and thus gone forever?

Asset Allocation – How are assets proportioned between stocks and bonds? Arguably a key factor in Investment Return ->

Real Investment Return – A higher rate of return obviously increases wealth more quickly

Below I evaluate savings rates of 25% – 75% of after-tax income, asset allocation from 0% – 50% bonds (the remainder invested in equities), and investment performance since 1926.

A Good Savings Rate of 25%

The average savings rate in the United States is somewhere around 5%. Nobody will be retiring early with a 5% savings rate. So I begin this study with an example of someone already saving at a healthy clip of 25%.

I’ll go slowly through this first chart by focusing on some simple data points. This same chart format is used throughout.

First the bar-chart. If we had begun saving 25% of after-tax income in 1926, and invested it equally between stocks and bonds, it would have taken until 1959 (33 years) to become Financially Independent with a 4% withdrawal rate. The blue bar chart shows this uniquely for all years in our data set.

The red bar chart indicates how many additional years of saving 25% of income would have been required to increase assets to 33x total assets (a 3% withdrawal rate.) This would take an additional 3 years if we started saving in 1926; 36 years total bringing us to 1962.

The green bar chart shows the same for a 2% withdrawal rate. Again for 1926, it would take an additional 11 years to reach this lofty goal in 1973 (47 years in total.)

The purple chart (“75% stock”) shows the reduction in time to reach a 25x / 4% level if we increased our asset allocation from 50% to 75% stock. The “100% stock” line shows the same when we increase our asset allocation even further. (Note that in no year does a lower allocation of equities help us reach our FI goal sooner.)

On average, saving 25% it would take a little more than 32 years to become FI with a 4% withdrawal rate and a 50% stock / 50% bond asset allocation.

Increasing assets to 33x would add an additional 5 years on average, but as many as 19. To 2% would take 8 more years on average, but as many as 22.

Increasing the proportion of stocks to 75% reduces time to FI by 4 years on average, and to 100% reduces it by an additional 3 years. However in many years the reduction is substantially greater.

Increasing Savings Rate to 50%

Increasing savings rate implies two things:

More of each paycheck is invested rather than spent

Cost of living is lower, so fewer assets are required to become FI

Win, win. This is obvious from the chart. Pay special attention to the y-axis; FI has accelerated by as much as 20 years

Average time to reach a 25x asset level is only 17 years. An additional 3 and 5 years are required to reach 33x and 50x, respectively, on average.

A 75% Savings Rate

When we were doing our accumulation heavy lifting, we were saving 70%+ of after-tax income. For a few years I even deposited my whole paycheck into our brokerage account.

At this level of savings wealth grows rapidly, and things like interest rates, stock market return, and even asset allocation are almost irrelevant.

With a 75% savings rate, the time required to accumulate 25x annual spending averages only 7.5 years. An additional 2 years will get you to 3% / 33x, and 3.5 years on top of that will get you to 2% / 50x.

We were aggressively saving for 10 years, so despite the occasional disbelief that it is possible we were actually below average.

Ancillary Data

Working assumptions:

All examples assume an initial net worth of $0. Those with non-mortgage debt first need to get to zero. Those with assets will have a shorter path.

Annual Income is constant when adjusted for inflation (the corollary of a constant withdrawal rate post retirement.) Increasing income faster than inflation can provide a boost as long as lifestyle is not also inflated.

Taxes are a constant percentage of total income. Investments are inside a tax sheltered account. Reducing today’s tax burden can provide an additional boost as long as the tax savings is invested.

Investment fees considered part of annual spending. Our fees are less than 0.08%, or about $800/yr/$1 million. (Check yours with Personal Capital.)

The statistics for all 3 charts are shared here for those interested.

Conclusions

By far the most important variable in becoming Financially Independent is Savings Rate, even more important than return on investment. There are massive financial advantages to living simply and efficiently (amongst the numerous non-financial benefits.)

This is great news for young people who want to retire early, but also for late starters who want to secure their financial future before reaching traditional retirement age. It is never too late to start or to reverse lifestyle inflation.

The higher the savings rate the greater the benefits. For example, while saving 75% it is possible to accumulate even 50x in less time than it takes to accumulate 25x while saving 50%. Highly conservative individuals would obtain a greater security benefit through increasing savings rate versus working longer.

Asset allocation also plays an important role. The higher percentage of total assets allocated to equities, the faster wealth accumulates. So much for risk-adjusted returns. This impact is most significant for people saving a small percentage of income, but is also notable for those striving for assets of 33-50x spending.

tldr; Savings rates of greater than 25% are required to achieve financial independence through savings and investing. A greater allocation of assets to equities and higher savings rates accelerate FI.

How Quickly Do You Plan to Become FI?