Defining Financial Independence

by Michael on Mar 20, 2014

Photo of Hikers on Mountain

If you prowl around the internet a bit, it won’t take you long to find someone chronicling their journey toward “early retirement.”

Of course, what these individuals are seeking isn’t really early retirement, but rather financial independence.

In other words, they’re trying to reach the point at which they no longer have to work to support themselves. Whether they choose to continue working once they get there is another issue entirely.

One of the best illustrations of the concept of financial independence that I’ve run across is the “crossover point” featured in Your Money or Your Life. I’ve included the graphic below to help illustrate the point.

Illustration of Crossover Point

In short, once you’ve reached the point at which the income from your investment portfolio exceeds your living expenses, you’ll have achieved financial independence. At this point, work becomes optional.

Some things to consider…

First and foremost, you’ll see that there are two main variables here: your living expenses and the income produced by your investment portfolio. Note that, while you can take steps to grow the latter, you have the most control over the former.

In fact, minimizing your living expenses has a dual benefit. It reduces the amount of investment income required to cover your costs (since they’re lower) and it frees up more cash to invest while you’re still working, helping to grow your portfolio.

Related: Your spending will (probably) decrease in retirement.

Another important point is that you don’t necessarily have to reach your crossover point to have a comfortable retirement. Yes, if you can get to the point at which your investment income completely covers your living costs without touching the principal, then you’ll have a perpetual source of income.

But guess what? You’re not going to live forever. Thus, it’s okay if you spend down a portion of your investment holdings. Just be careful to do it slowly enough that you don’t run out of money before you run out of time.

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