The state where ongoing financial needs can be met exclusively through your investments, independent of you working or earning any further income.
FI (and the associated FIRE – Financial Independence Retire Early) became a movement as Millennials entered the workforce post-GFC, though it ranges from the Extreme (no relation) to some fairly traditional financial practices of spending less than you earn and saving / investing the rest.
One of my favourite bloggers on the topic retired in their 30s way back in 1992 and have been travelling the world since.
I shared our Financial Independence number as part of my monthly 2019 blogs of travelling the world with a baby; when Covid-19 kicked off we were 45% of the way to our number, and while we're not quite sure exactly how much we will need right now we're almost 90% of the way to the ballpark.
Based on historical analysis of investments, and combining our personal risk appetite, this amount of wealth ought to fund our lifestyle permanently.
Watch either of my videos below, and read on for how specifically to make the transition from income (as an employee or, like me, a business owner) to Financial Independence.
I have no desire to retire, let alone retire early in my 40s. Indeed, I wouldn’t be surprised if I earned more money post-FI than I do right now, as our investments allow our business to take more risks – no dependence on the Job Quadrant means more exposure to upside in the Wealth Quadrant.
Independence and freedom includes the choice to continue working, whatever that means to you.
The Wealth Quadrant Framework, its relationship to Financial Independence, and how this can help you move from a JOB (or a dependent business) into FREEDOM.
THE WEALTH QUADRANT
When I sit down with business owners, whether at the start of their business journey or towards the end, one of the key questions I always want to know is ‘What’s Your Number?’ What is the dollar amount that you feel you need sitting in a Wealth Quadrant in order to retire to live the rest of your life with the freedom to do whatever it is that you want?
Interestingly, when we analyze it for most business owners that number ends up being a whole lot smaller than they think. This Framework is what I call the WEALTH QUADRANT. It shows different types of money and financial assets that sit within your life. Some are Volatile: short-term, up-and-down, unpredictable. Some are more Stable. Some will provide an Income and some are more Equity-based.
Up in the Wealth Quadrant there are other forms of equity that you could be building: investment properties, a portfolio of diversified index funds, shares, bonds, and so on. You could even have a systemized business (that is not dependent on you) sitting up there, providing you with some long-term value.
THE JOB QUADRANT
Most of us start our life in the Job Quadrant (lower left), and even many small and micro business owners are still actually sitting in the Job Quadrant. Their income is volatile, they're not really confident about revenue coming in over the next three, six, or 12 months’ time. This is a quadrant that is inherently filled with anxiety.
The reason so many business owners put up with this anxiety is the belief they're building something of wealth for the longer term, optimistic that one day they'll sell and those years of anxiety and volatile income won't matter because they'll have graduated to Wealth (top right).
(Why employees do it remains an enormous mystery to me.)
THE FLIP QUADRANT
The Flip Quadrant (top left) is for assets that are turned over (flipped) in the short term, but which don’t provide any income. Flipping (renovating) houses for example, day trading stocks, even buying something at a flea market and selling it for a profit on eBay!
THE FREEDOM QUADRANT
Before we can set a target in the Wealth Quadrant, we need a figure in the Freedom Quadrant. To do this, ask yourself, 'How much Income do you actually need to live on each year in order to fund the lifestyle that you want?' Really think about this.
One of the benefits of doing a budget is that you'll often find a lot of the gut feelings we make about ‘what we need to live on’ are much higher than the reality, especially if you consider this is a future when you may have paid off the mortgage and the kids have finished school (maybe even left home). You may find that freedom to travel, to be philanthropic, to do things that you want to do with your time actually cost a lot less than you currently spend.
We take this figure and we relate it back to the Wealth Quadrant, which is where your Net Worth resides. There's a body of research that suggests that to be safe, you can draw 4% of your net worth at retirement, adjusted for inflation, every year to fund that lifestyle: in other words, if you need $40,000 a year to live then you need $1 million dollars in wealth. (4% x $1 million = $40,000) Now that's a medium risk approach. People with a low-risk appetite would treat that as 3% - they actually need more Wealth because they're drawing a lower percentage ($40,000 is 3% of $1.333 million).
Many business owners like myself and my clients have a higher risk profile of (eg) 5% Withdrawal Rate. This means a smaller amount is needed to fund this lifestyle year after year ($40,000 is 5% of $800,000).
My figures were last set in November 2018 (which astute readers will realise was just after we discovered we were pregnant for with our first live child)
Freedom income: $98,680.71 per annum. Including taxes. Our ‘Safe’ Withdrawal Rate: 5.5%.
This is higher than most people pursuing Financial Independence, because we can spend much less per annum, we will likely still be earning once FI, and we are comfortable taking higher risks. Therefore our Wealth Quadrant target: $1,794,194.65
The great thing about the Freedom Quadrant is that it doesn't necessarily mean retirement. Like many business owners I know, I have no plans to retire in the traditional sense. What I want to do is give my family choice, freedom, and flexibility in our life.