3 Essential Concepts To Reach Financial Independence
Financial independence—having enough financial resources to cover your expenses without working—is appealing to just about everyone. Even if you love your job and plan to work all your life, you might not always have that luxury as layoffs or health issues could affect your plans. For that reason, we at the Financial Gym believe that financial independence should be on everyone’s goal list, and no matter where you are starting financially, you can actively work toward financial independence. Here are three financial independence concepts that will help you get there:
Opportunity Cost
Opportunity cost is the potential benefit you give up by choosing one option over another. The $50 you spent on Doordash could have been $50 you saved for an upcoming vacation or it could become $800 in your investment account 40 years from now.
Considering opportunity cost every time you make a purchase isn’t practical (and it would likely drive you crazy). However, on a larger scale—like when creating your monthly budget or making a large purchase—factoring in opportunity cost can help you see the potential power of choosing to save and invest.
Savings Rate
Increasing the gap between your income and expenses is the quickest path to financial independence, and your savings rate is the best way to measure the pace of your progress. The percentage of income you save directly impacts how quickly you reach your goal. Saving 50% of your income will get you to financial independence in about 17 years while saving 10% will take 51 years. That’s because a higher savings rate, which measures the percentage of income you save monthly or yearly, translates to a lower spending rate. The assumption is that any money you’re not saving, you’re spending, and how much you spend is the most important factor in calculating how much money you need invested to be financially independent.
Safe Withdrawal Rate
A safe withdrawal rate is the percentage of income you can withdraw from your investments annually without running out of money. It helps answer the question “How much do I need to have saved to stop working?” Based on historical stock market data, many people working toward financial independence plan for a safe withdrawal rate of 4%. To estimate how much you need for financial independence, multiply your annual spending by the inverse of your safe withdrawal rate. If you choose 4% as your safe withdrawal rate, you will multiply your annual spending by 25 to get your financial independence goal.
Final Thoughts
Everyone deserves financial independence. It’s not a quick or easy journey, but if you start putting key concepts like opportunity cost, savings rate, and safe withdrawal rate into place today, you will get there!
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