How to Calculate Your Financial Independence Number
The Single Most Important Number in Your Financial Life
Welcome back to Free Range Finance! In the first post, I introduced myself and explained why I want to help regular people achieve financial independence. This week, we're diving into the foundation of everything: calculating your FI number.
Your FI number is the amount of money you need invested to never have to work for money again. It's the magic number that transforms you from someone who works because they have to into someone who works because they want to.
How Much Do You Actually Need?
I am going to present the simple version in this introductory post and we’ll dive deeper into this topic in the future. For now, this is the beautiful simplicity of financial independence: You need 25 times your annual expenses invested to be financially independent.
That's it. That's the whole formula. (No math skills required!)
If you spend $40,000 per year, you need $1,000,000 invested. If you spend $60,000 per year, you need $1,500,000. If you're a minimalist who spends $25,000 per year, you need $625,000.
Why 25x Works (The Math That Will Set You Free)
This isn't a random number. It's based on the "4% rule", the idea that you can safely withdraw 4% of your invested money each year without running out. The original study that generated the rule was performed in 1998 by the American Association of Individual Investors and is referred to as the Trinity Study.
The math is simple:
4% of $1,000,000 = $40,000 per year
25 x $40,000 = $1,000,000
These numbers are equivalent. If you can live on 4% of your investments, then you need 25 times your annual expenses to be financially independent.
But Max, are you 100% sure this will be enough?
No, but I also can’t guarantee that 100x would be enough. No one can. Instead, we use probabilities based on past returns to estimate the future. There is always the possibility your investments will decline in value and therefore the possibility you don’t have enough. That said, we do know from the Trinity Study (and its updates) the chance of success historically. It turns out there is an 87% chance your portfolio will last at least 30 years if you withdraw 4% (inflation-adjusted) annually.
We’ll go deeper into safe withdrawal rates and variable withdrawal rates in a future post! For now, let’s go with 25x as our goal.
Step 1: Figure Out What You Actually Spend
Before you can calculate your FI number, you need to know what you actually spend. Not what you think you spend. Not what you budget to spend. What you actually spend.
Here's how to find out:
The Easy Way: Look at your bank statements for the last 12 months. Total all the money that left your bank account. Subtract transfers to savings or investments (since you didn’t spend this money). Divide by 12. That's your monthly spending.
The Slightly Harder But More Accurate Way: Track your actual spending for 3-6 months using an app like Rocket, YNAB, or Monarch. (Not an endorsement! I have never used these apps. You can also use a spreadsheet.) This will give you a clearer picture and help you identify where your money actually goes.
Special Situations: If you purchased a car in cash, you can reduce that item by 90% when calculating your expenses for the year. If you include the full purchase price in year one, you’re accidentally assuming you need to budget for a new car every year! Similarly, if you paid out a large amount as a one-time item (such as paying years of back taxes in a lump sum), you may need to make an adjustment. Note: most people do not need to make any adjustments!
A Word of Warning: Don't use your gross pay minus savings as a proxy for spending. People do this and get wildly inaccurate numbers because they forget about taxes, 401k contributions, and other deductions.
Note: some of you may realize this ignores taxes because that money never reaches your bank account. For now, that’s okay. We’ll cover taxes in retirement later. It’s more important to cover your living expenses because those are less likely to decrease. Taxes often decline once you’re no longer working. (Not always!)
Step 2: Decide if You Want to Maintain Your Current Lifestyle
This part is trickier. Your FI number isn't based on what you spend today. It's based on what you will spend once you're financially independent. If today you commute 60 miles to work each way (this is bad) but you don’t plan to spend hours in the car every day in retirement, you can reduce your transportation expense.
Some subtractions to consider:
Will you have a mortgage when you retire?
Will you spend less on work clothes, commuting, and eating out for lunch?
Some additions to consider:
Do you want to take travel with your newly acquired free time? (Add that cost)
Will your health insurance costs be different? (Are you getting older? Plan for an increase!)
Surveys have found that most people find they can live comfortably on 70-80% of their current expenses once they're not working. However, some people increase their spending on hobbies and travel.
I can’t tell you what the right answer for you is. If in doubt, use a higher number, but hopefully you’ll learn some great ways to cut expenses in future posts that should help.
Important: Be honest with yourself. This is YOUR number. Don’t make adjustments based on what other people want for their lives. That’s literally one of the major reasons people wind up in debt. (“Keeping up with the Joneses”)
Step 3: Do the Math
Once you know your target annual expenses, multiply by 25. That's your FI number.
Examples:
Annual expenses: $35,000 → FI number: $875,000
Annual expenses: $50,000 → FI number: $1,250,000
Annual expenses: $80,000 → FI number: $2,000,000
"Haha, Max. That’s ridiculous."
OK, let’s take a moment here because I get it. If you have $50k in student loans, make $40k per year, and are thrilled when your checking account balance has four figures, talking about a million dollars seems absurd. When I first calculated my FI number, it seemed impossible.
Here's what you need to know: The number itself isn't the point. The process is the point.
We will do a post on mindset in the future, but having a specific target transforms everything. Instead of vaguely hoping to "save more money," you now have a concrete goal. Instead of wondering if you're making progress, you can track your exact percentage toward financial independence. You can plot your progress every single day and see it over the course of time.
This applies to other areas of life too. What goal is more likely to work? A) Lose weight. B) Lose 15 pounds over the next six months by going to the gym for 60 minutes 4x per week. Easy, right? (Please tell me you picked B.)
OK, so with a goal, you can now make informed decisions about the trade-offs in your life. Want to buy a $50,000 car (no!) instead of a $20,000 car? That's $30,000 more you need to save, which means your working life was just extended a few months (or years!). That $30k could be working for you, getting you closer to freedom. Or it could be inside a car, depreciating. Or you could add $30k in debt and move backwards! We’ll talk about cars quite a bit going forward because I believe they are the number one way Americans become poor!
What About Social Security? Pensions? Inheritance?
Fun (?) Story: I had a conversation once with a woman on a bus. She had a fistful of lottery tickets and let me know that she was going to be a millionaire. When I asked how she knew she would win, she told me that she takes all her leftover money each week and buys lottery tickets. She figures if she keeps playing every week, she’ll eventually win and can retire. This was her retirement plan.
While no one has asked me if they should play the lottery every week, I have often been asked if you should factor in Social Security, pensions, or potential inheritance when calculating your FI number.
My answer: Don't include money you don't control.
Social Security might be there for you. It might not. The June 2025 report says they will start cutting benefits in 2033. Maybe Congress fixes it. I won’t be discussing the politics, but I personally don’t rely on receiving anything, even though I likely will. Pensions are increasingly rare in the private sector and companies can go bankrupt, leading to benefit cuts if the plan was underfunded. Inheritance is unpredictable. (Surprise! You have a sibling you never knew about!)
Play it safe and build your plan assuming you're on your own. If you inherit money, you get to move closer to freedom! If you don't, you're still fine.
Your FI Number Will Change (And That's Okay)
When I first calculated my FI number in 2014, it was about $1M. By the time I actually pulled the trigger, it was $2.5M.
These are wildly different numbers! Why the change? 20s Max thought ramen and videos games were a great (and cheap!) way to spend an evening. 30s Max understands that eating processed foods and being sedentary are great ways to rack up healthcare costs. People grow and change over time. That’s okay.
The point: Don't agonize over getting the perfect number. Pick a reasonable target based on your current situation and adjust as you learn more about yourself and what you actually want. If you adjust the number two or three times along the way (up or down), it’s fine.
Next Time: The Simple Math Behind Early Retirement
Now that you know your target, next week we'll talk about how long it actually takes to get there. Spoiler alert: It has almost nothing to do with how much you make and everything to do with how much you save.
Until then, your homework is simple: Calculate your FI number. Write it down. Put it somewhere you'll see it regularly.
This number will become your North Star, guiding every financial decision you make from now on.
Here's to knowing exactly where you're headed,
Max