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There is a simple answer to how much money you need to become financially independent, and it is known as the 4% rule.
What does this rule mean and how can you properly use it to build wealth? Here’s how the 4% rule works in achieving financial independence.
First, How Much Money Do You Need To Retire?
Let’s first look at financial independence from a retirement perspective. Many financial experts will tell those planning to retire they need to accumulate 25x their annual spending and invest it in a 60/40 stocks and bonds portfolio, said Scott Trench, CEO and president of BiggerPockets.
This is known as the 4% rule: a time-tested, conservative approach to defining a baseline state of financial independence (FI). Multiply how much money you will need to take out of your investments every year by 25. Through the 4% rule, you can safely withdraw 4% of your investment portfolio in the first year of retirement and adjust it for inflation in subsequent years without outliving your money.
Trench uses the example of someone who wants to spend $40,000 each year. This person needs 25 times $40,000, or $1 million, in net worth. A person who wants to spend $80,000 a year would need $2 million in net worth. Someone who spends $100,000 per year needs $2.5 million.
Additional Criteria for Becoming Financially Independent
Here’s the thing, very few individuals quit their jobs and abide by the 4% rule, especially early in life and in their careers. In order to achieve financial independence, individuals will need to get to a state where passive income is materially greater than the costs of their desired lifestyle.
“Almost every truly financially independent individual has one or several additional income streams, and/or a large cash cushion to supplement the 4% rule,” Trench said. “In practice, it is very hard mentally for folks to sell down their equity portfolio to sustain their lifestyles.”
Passive income includes dividends, interest income and rental or royalty income. Many individuals will, in addition to meeting this 4% rule criteria, possess the following assets:
- A large cash cushion, generally up to one to two years
- Rental real estate
- Business interests or royalties from intellectual property
- Social Security to supplement their income
- Work in a part-time job or side hustle
Tips for Reaching Financial Independence
Financial independence is starting to trend well above simply reaching retirement. Ameen Amin, VP and financial advisor at Morgan Stanley, said in his role he has noticed many clients, especially millennials, describe “financial independence” as their aspirations for the future.
Reaching financial independence requires following these guidelines.
Setting and Defining Goals
Goals are a central part of financial planning. Amin said figuring out how much you need to be financially independent is actually more difficult than figuring out how much you’ll need to not run out of money in retirement. You may be looking at the same variables, but this is a longer time frame. It can be difficult to account for and predict.
This is why it’s crucial to set and define goals that will lead you toward the path of financial independence. Amin uses the example of someone starting retirement. They have more predictability in their spending. Their biggest financial responsibilities, like purchasing a home, having children and getting an education, are behind them.
“Answering the same question for a successful 34-year-old is entirely different because there are more moving parts and curveballs to account for,” Amin said.
Understand Your Spending
Getting to financial independence requires understanding your spending habits. While many would imagine financial independence is exclusive to those with $5 million or more, it’s not. Amin said it’s your lifestyle needs that dictate how much you have to have in the bank.
“Everyone is different with varying obligations, wishes and lifestyles,” Amin said. “It’s essential a financial plan is done and constantly updated so it changes as their lives do too.”
Make Your Money Work For You
Finally, Amin often shares with his clients that even if they choose to have a more laid-back lifestyle, their money should not receive the same privilege.
Rather, your money should be able to work for you and ideally in a diversified manner through stocks, bonds, real estate and alternative investments. Between making up for a lack of earned income along with rampant inflation, Amin said funds will have to be more active than their beneficial owners.
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FAQs
Americans say they'd need to earn about $94,000 a year on average to feel financially independent. That's about $20,000 more than the median household income of $74,580.
How much money is enough to be financially stable? ›
The median household income in the U.S. is just under $75,000, so it makes sense that the largest proportion of those surveyed (45%) said that it's possible to be financially stable by earning between $50,000 and $100,000 a year.
How to calculate how much you need to be financially independent? ›
However, rather than assessing a safe withdrawal rate, it's a simpler calculation that assumes you'll require 25 times your annual expenses to retire early. Using the same numbers, if your projected annual expenses are $50,000, the 25x rule would determine that you'll need $1.25 million to secure financial freedom.
Can I retire with 500k at 40? ›
The short answer is yes, $500,000 is enough for many retirees. The question is how that will work out for you. With an income source like Social Security, modes spending, and a bit of good luck, this is feasible. And when two people in your household get Social Security or pension income, it's even easier.
At what age do most become financially independent? ›
Among the key findings: 45% of young adults say they are completely financially independent from their parents. Among those in their early 30s, that share rises to 67%, compared with 44% of those ages 25 to 29 and 16% of those ages 18 to 24.
What salary is considered wealthy? ›
Based on that figure, an annual income of $500,000 or more would make you rich. The Economic Policy Institute uses a different baseline to determine who constitutes the top 1% and the top 5%. For 2021, you're in the top 1% if you earn $819,324 or more each year. The top 5% of income earners make $335,891 per year.
Is 20K in savings good? ›
While $20K may not let you quit your job, it's enough to start building financial security, whether you max out your retirement accounts, invest in fine art, or divide your cash between multiple investments.
What is considered financially independent? ›
Financial independence is a state where an individual or household has accumulated sufficient financial resources to cover its living expenses without having to depend on active employment or work to earn money in order to maintain its current lifestyle.
What percent of 22 year olds are financially independent? ›
A new Pew Research Center analysis of Census Bureau data finds that, in 2018, 24% of young adults were financially independent by age 22 or younger, compared with 32% in 1980. Looking more broadly at young adults ages 18 to 29, the share who are financially independent has been largely stable in recent decades.
How much money can you live off of for the rest of your life? ›
The most common answer was between $1 million—$10 million (USD). That is a surprisingly low number when you consider that they were not asked “how much do you need to retire?” but how much to fund their “ideal life”.
If you have $400,000 in the bank you can retire early at age 62, but it will be tight. The good news is that if you can keep working for just five more years, you are on track for a potentially quite comfortable retirement by full retirement age.
Is $1,500 a month enough to retire on? ›
While $1,500 might not be enough for non-housing retirement expenses for many people, it doesn't mean it's impossible to stick to this or other amounts, such as if you're already retired and don't have the ability to increase your budget.
How long will $1 million last in retirement? ›
In more than 20 U.S. states, a million-dollar nest egg can cover retirees' living expenses for at least 20 years, a new analysis shows. It's worth noting that most Americans are nowhere near having that much money socked away.
How many people are financially free? ›
SAN MATEO, Calif., Aug. 22, 2023 /PRNewswire/ -- Despite most Americans having modest expectations of what it means to attain financial freedom, just 1-in-10 (11%) report they are living their definition of financial freedom, according to a new survey by Achieve, the leader in digital personal finance.
What is the best age to be financially stable? ›
That said, the typical age of financial independence should be between 20-23 years old, according to a Bankrate survey. Break the numbers down by cost category, and differences of opinion can be pretty wide.
Where should a 25 year old be financially? ›
By age 25, you should aim to have an emergency fund of 3-6 months of living expenses, and start regularly contributing to retirement savings to take advantage of compound interest over time, even if it's just small amounts.
Is $80000 a year a good salary? ›
By just about any measure, earning $80,000 a year is a good salary. It's about $5,000 higher than the U.S. median household income, per Census data.
What is the 70% money rule? ›
Set aside 70% for essential expenses:
A majority of the money you make should be used for the essentials in your life. Things needed to maintain a standard of living fall into this bucket. Monthly rent, groceries, utilities, any commuting costs, or insurance/credit card payments all fall into this category.
Is 100k savings good? ›
Having over $100k in savings is generally considered a good financial position in the United States.
At what age should you be financially stable? ›
That said, the typical age of financial independence should be between 20-23 years old, according to a Bankrate survey. Break the numbers down by cost category, and differences of opinion can be pretty wide.
