The world of personal finance is filled with all sorts of terms and definitions with the holy grail being financial independence, that magical point where you are not bound to your daily grind. Over the last 30 years, there has been a movement around financial independence called FIRE (Financial Independence, Retire Early), which essentially comes down to being well off enough that you don’t need to work to be able to live a comfortable life (AKA retiring). This is where the FI or Financial Independence number comes in.
What is an FI number? The net worth at which the annual growth of that net worth by itself covers your annual expenses.
Simply put, when you hit a magic number in your net worth, it will allow you to live off what you have saved up for the remainder of your life. Calculating this number can get complicated if you want to, but at its simplest, it is:
FI Number = Annual Expenses / Withdrawal Rate
An example of this would be if you’re spending $40,000 per year in regular expenses and withdraw 4% of your net worth, your FI number would be $1,000,000. These fundamental calculations give you a starting point for the topic. You can get into all sorts of questions such as what is a safe withdrawal rate (typically considered to be 4%), what should be included in your regular expenses, or how your life might change if you actually follow through with retiring early. The idea is to start with the basics because even if you are not trying to FIRE, you likely want to get to your FI number before you hit retirement.
Why it’s important
The FI number is incredibly important because when you hit a certain level of net worth, and I would say more specifically: investments, they will grow and produce income for you. There is a multitude of possible options of where you can put your money for it to grow, and that is a separate topic. For the sake of discussion, I’ll use a basic index fund, which historically produces returns of 7% annually (Note: I’m specifically not choosing a single one – this is to illustrate a point).
Once you grow your investments to the point where that 7% in growth or returns each year covers off your basic living expenses, then you get a very magical thing: Time. Then you can safely pull money out knowing there will still be enough to keep growing to cover your expenses. The amount of money you pull out is referred to as the withdrawal rate, and if that is less than the annual growth, you can pull money out each year comfortably, knowing you will always have more.
The importance of the FI number is in the fact that you can spend your time the way you would like to should you chose to maintain your current lifestyle. At the end of the day, if you have no debt, it covers the living expenses.
The safe withdrawal rate is often considered to be 4%, which will allow your investments to keep growing and will account for market fluctuations over time. It gives you some wiggle room for changes in the market or your spending over the years. In my example that I started with, if you spend $40,000 per year and use the safe withdrawal rate of 4%, you would need to have $1,000,000 to safely cover that ($40,000 per year / 4% = an FI number of $1,000,000). The safe withdrawal rate will change depending on how conservative you are; you will typically hear anything from 2% to 55.
Why an FI Number can be deceiving
The FI number is the point where you achieve theoretical financial independence, which is great, but that does come with some caveats. The FI number by itself can be a little deceiving if you aren’t careful. If you achieve your FI number and tell your boss where he can stick it, you’ll have tons of time on your hands. Great! You hit the proverbial American dream.
Do you know what you’re going to do with that time? I’m sure that most people can come up with something pretty easily and fill days and weeks. Unfortunately, most of that will require some monetary forethought. If you don’t plan for how you’re going to spend your time, then you might end up spending money to fill that time.
A perfect example of this is taking up a hobby, say Photography (have you accounted for equipment? Travel?) or my summer past-time, RVing around the country (Cost of the RV? Cost of the campgrounds? Repairs and maintenance). I mention this because it’s an easy trap to fall into if you only cover the day to day basics, and you choose not to work – what are you going to do? The other thing to keep in mind is lifestyle creep over the course of your life.
The other way the FI number can be a little deceiving is that very often, people include their physical assets in their net worth, while correct, they don’t usually produce a steady income. Your home is an incredibly important piece of the puzzle, but it doesn’t pay 5% back to you in dividends each year.
How do you use your FI Number
Simple: cover your basic monthly and annual expenses. Or, if you are still working, you can just leave it and let it grow. Once you hit your personal FI number, it gives you choices that don’t exist otherwise, let alone if you’re living from paycheck to paycheck.
It gives you a line in the sand that you can use to measure your progress. If you have a very modest lifestyle and save a lot, you can hit it quickly. On the flip side, it can show you that your lifestyle might be a little out of balance with your savings and eventual retirement.
Types of FI numbers
As with most things, it can be broken down further or given new classifications. If you’re persuing the PF world, you will see additional terms around what an FI number could be. If you are interested in FIRE, The Poor Swiss has some interesting definitions but here are the more common types of FI Number that are referenced:
Regular FI number
This is your average regular old FI number. Nothing adjusted or odd about this one; if you hit this number, you could theoretically not work ever again. This is where you get a choice.
Lean FI number
Lean FI is a different creature from the regular FI number in that is assumes you are going to be frugal and possibly still have some form of income. When you achieve this number, you are probably still working part-time, OR have gone so frugal that monks use you as an example for new recruits. At this point, you have options but likely will need to supplement somehow; it gives options, not complete freedom.
Personally, I see this number referenced a lot, and I believe it gives you options and flexibility only. It doesn’t give you complete freedom, which for me, is the point of FI.
Fat FI number
Want to run around like a baller? Or whatever the kids are saying these days? Then you need a FAT FI number. If you enjoy the better things in life and want a more lavish lifestyle, then this is where you want to end up.
The challenge with this number for me is that you can make the number really high really fast. You want to take a high-end vacation 3 times a year? Sure, add that in, but those 3 vacations could be 100K each or 5K each. If you’re not careful, this number can quickly end up being a moving target.
The changing nature of an FI Number
Yes, if you are single, your FI number is different than if you are married and have kids. Your expenses change over your lifetime; You don’t need to worry about your kids’ tuition when you’re 21, but when you’re in your 40s and have a bunch of kids, it’s something you think about.
Your lifestyle will change over time as will your interests; while you can’t really plan for them in advance, know that there will be changes.
In essence, your FI number is the point where you can choose to work or not. You no longer need to worry about the monthly bills. If you manage to achieve your FI number, you have the most prized possession you could possibly have: the freedom of time and the choice of how to spend it. I’ve covered the basics of calculating the number, but if you are serious or getting close to it, you may want to get more into the details, which will differ for everyone. Do you know your FI number?