When I was a kid, I had a poster on my wall with a big picture of Kermit the Frog and the slogan ‘life is hard then you croak’. Underneath this, in a parody of the ‘No Fear’ extreme sports clothing company that was popular at the time, was scrawled ‘No Frogs’.
I remember this now because it summarises quite nicely the generally-accepted way of doing things. We get a job, earn money, spend that money, do this repeatedly until we’re quite old, get tired and worn out, then retire and sit around until we croak.
As someone who’s trying to live consciously and intentionally, though, this doesn’t sound all that attractive to me. In fact, I’ve been trying for some time to avoid following this well-trodden path. And so I was particularly interested to learn about the financial independence (FI) movement. And relieved to discover that I’m far from alone in my desire to avoid going down the ‘no frogs’ route.
Financial independence is about getting to a position financially where you can live your life without having to engage in paid employment or other income-generating activities. This doesn’t necessarily mean that you retire and sit around on the beach all day, but rather that you enjoy the freedom to do things that are important to you without worrying about having to earn money.
There’s quite a community growing up around the notion of financial independence. Mostly in the United States (especially around the tech industries, where people seem to earn humongous salaries), but increasingly in the UK and elsewhere, too.
The FI movement, in the way that many groups do, is also developing its own language. And there are various schools of thought about what constitutes financial independence and how best to achieve it. But the fundamental tenets are actually quite straightforward.
Firstly, earn as much money as you realistically can. This includes money from your job and from any ‘side hustles’ that you may have. It also includes income from other things, such as letting out a room in your house. FI-ers, it seems, can be very inventive about finding new ways to earn money.
Your income also includes any contribution that you and your employer make to your pension fund. I’m not a financial adviser, but if you have a job and aren’t yet paying into a pension, start doing so right now. (I’ll write another blog post at some point about how the magic* of compound interest makes this a no brainer.)
Secondly, spend as little as you can. At its heart, financial independence is about frugality. About living in a conscious way that minimises the amount of money you spend on stuff. This means looking at how much you spend and on what, reducing (or eliminating) expenditure on things you don’t absolutely need, and finding cheaper – or, even better, free – ways of getting hold of the things you do need.
We’re talking here about more than just cutting costs, though. It’s about rethinking what you value and how you wish to live your life. It’s about not needing the shiny new car or the latest iPhone. It’s about being frugal rather than profligate. It’s about finding your own path and being happy on it, rather than seeking the approval of others.
Thirdly, save or invest the rest. This is the key to financial independence. By saving as much of your income as possible, you’re building up a portfolio of investments that will, in time – and, again, thanks to the magic of compound interest – provide a financial return that can take the place of a salary and fund your outgoings.
FI-ers have a preference for low-cost index funds, which track the performance of the stock market as a whole. This is because (a) you spend less of your hard-earned cash on fees and (b) you’re investing in a wide range of companies across different countries, so your portfolio is less vulnerable to short-term shocks. But other options are available.
The aim is to get to the point where you can cover your expenditure from the return on your investments. You then no longer need to work and have achieved financial independence. The remarkable thing about this, though, is that while it’s not exactly easy, its also perfectly feasible for many people with a bit of effort.
The general principle within the FI community is that you need to build up an investment portfolio that is equal to 25 times your annual expenditure. This is so that a 4% return on your portfolio (which is reasonably realistic based on long-term trends, but you might want to err on the cautious side) provides you with income equivalent to your annual expenditure.
So if you spend £20,000 a year, for example, you need to build up an investment portfolio with a value of £500,000.
The more you earn and the less you spend, the quicker you’ll reach financial independence. This is because (a) the more of your income you invest (as opposed to spend) the quicker you’ll reach your target portfolio value and (b) the less you spend, the less money you actually need in your portfolio to cover your annual outgoings.
Following on from the example above, if you can cut your annual outgoings from £20,000 to £15,000, for example, then you’d only need £375,000 to reach financial independence.
Furthermore, the greater the proportion of your income that you’re able to save, the sooner you’ll reach financial independence. According to Networthify, if you save 30% of your income, for example, you can reach FI in 28 years. Regardless of when you start, by the way. And if you’re able to save 60% of your income, you can reach FI in 12.5 years.
Clearly, not everyone is in a position to do this. And not everyone will want to. We can, if we wish, stick with the tried-and-tested approach of working hard until we croak.
But that’s not the only way.
Note: I’ll write about my own approach to frugality, saving and financial independence in another blog post at some point. But if you want to learn more about financial independence right now, I’d point you towards The simple path to wealth by JL Collins, Meet the Frugalwoods by Elizabeth Thames, and the Choose FI community and podcast.
* It’s not really magic. It’s just maths.
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Disclaimer: I’m not a financial advisor. The information on my blog doesn’t constitute financial advice or recommendation and shouldn’t be considered as such.