The dream of financial independence is one that many Filipinos share. But what does it really take to reach this kind of freedom?
To achieve any money goal, it helps to have a target amount and a timeline to guide your strategy. In this article, we’ll help you define financial independence and estimate how much it’ll take to get you there.
What does financial independence mean?
Financial independence may look different for everyone. It generally involves being able to afford your needs, wants, and emergency expenses without living paycheck-to-paycheck or having to borrow money.
For some, it means quitting their day jobs and retiring early. To do so, they’d need a sizeable nest egg to live off for the rest of their life by sticking to a strict budget.
Others might want to fully support themselves while only working part-time. This way, they’d have more freedom to travel and pursue hobbies without being tied down by a work schedule.
Some people continue to work full-time. For them, financial independence means having a secure, worry-free future for themselves and their families.
Methods for reaching financial independence
Since financial independence can mean different things to different people, there isn’t a single approach that works for all. Instead, there are some popular methods you can consider when you’re just getting started:
1. The 4% rule
This rule is based on 50 years of data on stock and bond returns. It claims that retirees should only withdraw 4% of their money from savings and investments on the first year of retirement.
That amount should be adjusted for inflation in the following years. This is considered a “safe” withdrawal rate that can make your money – including profit from bonds and stocks – last for the rest of your life.
To achieve financial independence, some people suggest saving and investing enough to follow the 4% rule. This means having 25x the amount of money you plan to spend every year.
- Risks of following this method
Some experts say it’s safer to follow a smaller withdrawal rate to be better prepared for the worst, while others believe that this rule is too restrictive and that a higher withdrawal rate is more realistic.
This is because your lifestyle could change, and unexpected expenses (such as those related to health) might arise as you grow older.
Keep in mind that returns are not guaranteed when you invest. You can’t predict how the market will perform, which in turn determines the amount you can withdraw.
The 4% rule also assumes a 30-year retirement. If you retire early, you’ll face a higher risk of depleting your retirement funds unless you have stable sources of income.
Considering all factors, it’s important to view this number as less of a hard rule and more of an estimate. It can serve as a good starting point if you’re willing to adjust your spending habits or goals when necessary.
2. 50/30/20 budgeting method
The 4% rule may be a little too advanced if you haven’t started investing. It could be better to work on financial stability first. One way to manage your money is through the 50/30/20 method.
This involves allotting 50% of your income to your needs, 30% to your savings and investments, and 20% to wants. The percentage allotted reflects your priorities and you’ll need to adjust this allocation depending on your situation.
If you have loans, allocate everything above your needs toward paying them off. Once you have cleared your debt, prioritize building an emergency fund before you start investing.
An emergency fund generally should cover 3 to 6 months of your daily expenses. You can aim for this number first if having 25x your yearly allowance is too high for now.
Remember that planning out your life is rarely a one-time task. It’s important to be flexible and revisit your targets regularly to keep up with changes.
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