What is Financial Freedom? My definition is pretty simple. You have enough money to stop working full time. This means your portfolio and fixed income is enough to pay for your yearly lifestyle without running out of money down the road. This scares a few people. It excites others. Let's break down the process with some math, showing you how to do it. Here is Financial Freedom 101.
1. Identify how much you spend on a yearly basis, which includes food, bills, fun, etc. Include yearly taxes as well. This is a very important number and it is where the whole process starts. It's not just the monthly bills, it is everything. How much money do you need to live the life you want to live? For our example, let's say that number is $60,000. That could be for a single person or a couple, it doesn't matter.
2. What will be your fixed income? This could be a pension, Social Security, a side hustle, part-time work, an immediate annuity (buying a pension basically), etc. It makes this process so much easier and less stressful if you can create some fixed income that you can count on monthly. This will allow you to pull less from the portfolio, allowing it to grow bigger over time. For our example, let's say it is $30,000.
3. What is the size of your portfolio? This includes 401(k)s, IRAs, brokerage, HSA, bank, cash value life insurance, etc. Add it all up. If married, add up the entire family portfolio. Strive to get this number as big as you can (especially if the fixed income is low). This usually means owning mainly stocks in the working years and keeping the fees low with index funds. Let's say the entire portfolio is $750,000.
4. What is 4% of that portfolio? Decades of research have identified that with a portfolio of 50% to 75% stocks with very low fees and low taxes, you could withdraw up to 4% per year and you would not run out of money most of the time over a 30 year period. You might have more in the account than you started with! In this scenario that would be $30,000 (4% of $750,000). That leads to the next question.
5. Can you pay your yearly expenses (including taxes) with the fixed income and 4% of your portfolio? If the answer is yes, you can probably graduate to that next phase of your life. In this scenario, lifestyle was $60,000, fixed income was $30,000 and 4% of the $750,000 portfolio was $30,000. It works, but you are cutting it a bit close. What can you do to not cut it so close?
You can reduce your expenses and/or taxes? This could include paying down debt. It could include reducing some monthly bills. This might lead to a more minimalistic lifestyle where you spend less (pay less sales tax) and enjoy a lifestyle free of buying more and more possessions. It comes down to choices. How bad do you want Financial Freedom and what are you willing to give up to get it?
How can you increase the fixed income? Increase side hustles. Pull from the 401(k) at 55 without early withdrawal penalties. Do a 72t even earlier with no penalties. You could pull from Social Security as early as possible. Here is the rub. All of those options could hurt you in the long run. Yes, financial freedom is a wonderful thing, but be careful. We want that money lasting longer than we do.
Increase the size of the liquid portfolio. This is pretty simple. Cut your fees as much as possible with index funds or ETFs. Save as much as possible into the 401(k), IRAs, and a brokerage. Go heavy on stocks (80% to 90%) for as long as possible before launching. Do this as early as possible. Reaching Financial Freedom is much easier when you get started as a young person vs. waiting until your 30's, 40's or 50's.
You can cut your taxes. This can be done by moving to a place that taxes you less on your withdrawals and your spending (less important if you have chosen a minimalistic approach). This might be a different state, a different city, or maybe somewhere quiet and remote. America is full of choices and places to live. Remind yourself of this key point. You have many options on how to reduce your taxes.
You could pull more than 4% from the portfolio. This works if the portfolio is humming along at 10% or more. If not, you might run out of money in 20 years or less. That 4% number factors in not only spending and taxes, but inflation (historical average is about 3.5%). The portfolio needs to average 7% after inflation to sustain that 4% withdrawal amount. That means a sizable allocation to stocks is needed.
You could increase the stock allocation. This will provide you some really nice returns periodically, but you will see a nasty drop here and there as the volatility of the portfolio gyrates much more with the higher stock allocation. You can reduce some of that volatility by diversifying as much as possible in small and large stocks all over the world to include stock in commercial real estate. Learn more here.
What about health insurance prior to 65? Healthcare.gov works just fine as long as you keep your income at reasonable levels (under $50,000 single and under $70,000 for a couple for example). This income based plan also offers high deductible plans which could provide you HSA contributions to a Fidelity HSA, investing in FZROX or FZILX, building the portfolio even after leaving full time work.
You will need to be good at math (or find someone who is), and good at managing your emotions (becoming a robot as best you can). Finally, you will want to find purpose and meaning to your life. Why do it if you are not enjoying yourself and enhancing the lives of others? Run your numbers at fourpercentrule.com. Here is one more nugget. Make sure you are living out YOUR dreams and not someone else's.
Is it worth the trouble? Hell ya! Financial Freedom provides you the opportunity to be your true self in all your glory. You can stop playing roles that society shoved you into and start looking within for the answers. Opportunities present themselves to those who reach Financial Freedom. It is then up to you to seize on what your life is to become. Reach for more and take The Path to Prosperity. It's worth it!
