How to FI

Financial independence means having enough income from investments that you don’t need additional income from working. For some, this means retiring from work. For others, it’s peace of mind.

In the last year, I have been considering the best way for our family to approach FI. We are high income professionals but have a high overhead life. I don’t want to significantly contract my standard of living. And I’m not even sure if I want to stop working.

Figuring Out Our FI Number

The FI number is the sum total of investable assets available for producing income upon retirement. Everyone has their own number because everyone has their own daily living expenses and expectations for quality of life.

Many people use one million dollars as a goal for their FI number. I suspect this is partially because of the mystique of the number. Who wouldn’t want to be a millionaire?

And then others aim to have one million dollars based on the 4% safe withdrawal rule first described by financial planner Bill Bengen. This rule states that in a balanced 50%/50% equities/bonds portfolio, the portfolio can last 30 or more years if the investor takes withdrawals of 4% total value.

So, according to Mr. Bengen’s article, the $1M portfolio can yield $40,000 annually, ignoring the effects of taxes. This seminal paper was published in 1994. According to the Bureau of Labor Statistics inflation calculator, $40,000 in 1994 is equivalent to $81,000 in 2022.

Relying on a one million dollar portfolio seemingly ignores the effects of inflation. Some people can live well on $40,000 annually in 2022, it’ true.

But I know that my own family would be unhappy with that standard of living. Therefore a one million dollar portfolio, allocated 50% to stocks and 50% to intermediate-term US treasuries, falls short from our FI number.

Calculate Spending To Figure out FI Number

In order to understand how much you will need in retirement, have an idea of what you actually spend. From here, I’m going to talk about what my family does. Many people are more frugal than we are, but as I show below, you can achieve financial independence without arduous frugality.

The first step in determining your FI number is to calculate your annual spending.

My husband and I don’t budget very strictly at this stage of our lives. We have very stable incomes that exceed our spending. And we tend to buy the same things, down to the same groceries, week after week and month after month.

We’re high spenders. At this stage of our lives, we normally spend about $155,000 annually.

This number is quite rough and doesn’t account for furniture, clothes, gifts, etc. But I found it a helpful exercise to see that housing and childcare accounts for fully half of our expenses. If we did away with those costs, for example by paying off our house or stopping childcare, we’d spend far less money every year.

If I just account for expenses as they are today, I’d have to double my real estate holdings in order to make what I already spend. (How do I know that? I divided annual spending by 4%.) That is, $155,000 / 4% = $3.8M.

Saving to that extent before retiring is called Fat FIRE. Realistically, we’d be spending far less than that in retirement since we won’t be paying for childcare any more. Without childcare, I anticipate we’d spend $130,000, or about $3.3M of investable assets.

Real Estate Changes The FI Number, Or Does It?

After you know what you plan to spend every year, choose a path for investing. This can be investing in stocks and bonds. It can mean investing personally in real estate or using REITs and syndications. You can do any combination you like. If you want financial independence before traditional retirement age, you’ll need income generating assets available to you outside your 401K.

Rather than trying to use stocks and bonds to create financial independence, I decided instead we would use real estate as our income generating asset. Real estate offers the unique combination of leveraged returns, tax advantages, and high yield compared to other income producing assets like bonds and dividend stocks.

Right now we have three professionally managed houses which we’ve purchased with mortgages. Property #1 is rented significantly below market and represents a former home. The other two properties were intentionally purchased as long-term buy and hold rental properties.

In my case, if I pay off the mortgages on these homes, I will have income of over $71,000 annually before taxes. This represents a 4.5% of the total value of the portfolio ($1.65M). (We’ve seen a lot of appreciation in the last five years, particularly on property #1.)

If instead of the 4% rule, I use a 4.5% rule, what kind of portfolio will I need to retire? Because of my risk tolerance, I would strongly prefer to have a large proportion of debt-free or un-leveraged properties in retirement. If I use the annual number I calculated before, $130,000 and divide by 4.5%, that’s a $2.9M portfolio.

What if I achieve a better “blended” return for future purchases, so my real estate returns are closer to 7%? In that case, I’d need $1.85M. That’s a one million dollar drop in the FI number just based on returns. I can do this by bringing the first property rents up to market value and purchasing future properties more intentionally with higher cap rates. Many real estate investors don’t consider a purchase unless they are achieving 10% cash-on-cash returns.

What Is My FI Number If I Don’t Stop Working?

I can see that my FI number is very high – but I think it’s quite achievable, particularly at the $1.8M mark. Despite our high spending, we have a dual-income household with a high savings rate. My husband and I are both physicians and we live off one income. We save the majority of my income every month. And I am planning to continue to grow our real estate portfolio in order to meet this goal of replacing the income required to support our comfortable lifestyle.

I expect it will take seven or more years to fully arrive, but much sooner than that we will have remarkable flexibility. In ten years, my oldest son will be bound for college. But since my kids are already school-age, I might as well work. As for my husband, I hope he retires earlier than me, in his mid-40s.

Large corporations like Boeing and Lockheed Martin have studied retirement age and longevity since it affects their pensions. In one paper, Dr. Ephrem Chung shows that young retirees live longer lives than older retirees. If you look at the 50 year old retiree, he’s projected to pass away at age 85. If you look at the 65 year old retiree, he’s projected to pass at age 67.

In ten years, I’ll be mid-40s and might choose to work less. It’s very hard to imagine.

In the last month, I stopped working for my employer in order to start my own private practice. This has been eye-opening because I have always been a W2 employee. Like a hamster on a wheel, I have been accustomed to earning a fixed wage every month, no matter how many or few patients I saw that week in the clinic or hospital.

In September 2022, I have had the unique experience of working very hard in the hospital and also not at all when I haven’t been on call. This has been very nice since I am spending far more time with my children and in organizing my home.

If this goes well, I hope to continue in private practice for the long run. If it gets too hard, I imagine I can get another job.

But I never plan to stop working. The work is too interesting and impactful.

Will you fully retire when you reach financial independence?