A young professional once commented to his older co-worker, “anyone who hasn’t retired by 50 is an idiot.” All the insensitivity of his comment aside, lately this is not an uncommon assumption of young people entering the workforce. Spurred in part by rising incomes in certain sectors and a strong stock market, the last several years has seen a flurry of articles, financial professionals, and regular Joe-blows talking and dreaming about early retirement. This sentiment is fueled by early-retiree bloggers such as Mr. Money Mustache and Steve at Think, Save, Retire. Indeed, an entire movement has risen around this concept, collectively known as ‘FIRE.’
In case you’re wondering, the FIRE movement has nothing to do with setting yourself or anything else ablaze. Rather, FIRE stands for ‘Financial Independence and Retiring Early.’ However, amidst dreams of laying on a beach at 35 and sipping cocktails day in and day out, with no job to return to, the ‘Financial Independence’ part of fire often gets rushed over in favor of pursuing early retirement. This is a huge mistake!
But What is Financial Independence?
Before we dive into why financial independence is so important, we should first figure out what financial independence is. Financial independence is not declaring independence from money and living a Luddite existence. Rather financial independence in its purest form is being completely self sufficient financially, not dependent on anyone else for the money to cover your needs. In other words, financial independence is when you’ve developed enough passive income to cover all your necessary expenses each and every month.
Financial Independence is the Foundation of Early Retirement
How to Become Financially Independent
So financial independence sounds great. But how do you get there? Going back to what financial independence is, it is developing enough passive income to cover your necessary or regular expenses. So you can work on your financial independence from two angles- first by trimming your regular expenses, and second by building passive income.
Trimming your expenses is as simple as looking for unnecessary day-to-day spending and monthly bills. Perhaps you can cut out a daily coffee run, or maybe you can live without that cable subscription. Also key to trimming expenses is avoiding new ones. So think twice before you buy a fancy new car with a high monthly payment, or go on a shopping spree that lands you with too much credit card debt.
The second part of the equation is just as important. Since you’ll never be able to live completely expense free, you’ll need your passive income too. There are various ways to develop passive income, but by far the one that has stood the test of time is investing- specifically in stocks and bond funds. By investing a part of your income each and every month (which you now can do, thanks to trimming your expenses), you’ll develop a set of investments that will pay an ever growing dividend stream (your passive income), and eventually can be a nest egg that you can draw down late in retirement or pass on to your heirs when you pass. This is something that you can do on your own with a little research, or you can work with Certified Financial Planner. But the most important part is disciplined and consistent investing.
There’s More Motivation in Developing Financial Independence Progressively
Ok, so technically financial independence needs to come before early retirement. But otherwise aren’t they the same thing? Why make such a big deal over splitting hairs? Because functionally the two are quite different. It is much easier to become progressively financially independent than it is to become progressively retired. As soon as you trim your first expenses and make that first investment, you’ve already started becoming financially independent. Because you can see your progress in developing financial independence, you’ll be much more motivated in this than by merely chasing the early retirement dream. Of course, your retirement dream is still important, but only when coupled with financial independence.
Financial Independence Has Benefits in the Here and Now Too.
Perhaps the most important reason to focus on financial independence is because of how it also benefits you now. The more financially independent you become, the more resilient you become to the curve balls that life throws at you. Have you picked up some surprise medical bills? Not a big deal if you’re on the road to financial independence, since you’ve already trimmed your expenses and now have leftover income to cover the bills. Lose a job? You can deal with that too now that you’ve got money stashed away.
Of course you don’t want to tap your nest egg for every little surprise that comes your way. If you did that, you’d never actually retire. But at least you have a safety net in place for when you really need it.