Why We Have Three Financial Independence Goals

Financial independence goals

If you read my last monthly report, you will know my wife and I have combined our finances, and you will also have noticed that instead of having one financial independence goal (as most people do), we have decided to strive for three different goals instead.

This might seem like we are making everything more complicated than it has to be, but for us it actually makes things more simple and easier to plan ahead.

I feel like we need to explain ourselves.

Why do we have three financial independence goals?

Normally, people pursuing FIRE have one financial independence goal. It is usually based on an FI number that is based on assumptions about future monthly expenses and a safe withdrawal rate.

The traditional financial independence goal usually assumes a few things:

  • You will never earn money again in your life
  • You will never have to go back to work to work for money
  • Your expenses will not change

While these three things are very attractive (and what we ultimately strive for), they also make the journey towards financial independence longer than if you wanted to compromise on a few of them – or at least take some chances.

Somehow we just felt that the traditional FI goal did not apply to the lives we see for ourselves in the future:

  1. We will definitely work for money after reaching FI – either freelance or part-time, or even full-time on things we are passionate about
  2. We do not fear having to go back to work if things don’t work out the way we had hoped
  3. Our expenses will change and it is impossible to predict how much/little we will spend (we might get kids, move out of the city, reduce living expenses etc.)

In essence, we felt the traditional financial independence assumptions were way too risk-averse and just didn’t apply to us.

We do not want to wait 10 years to achieve financial independence and then figure out what life as FI is like. We would rather start designing the FI life we want to live now and take some chances along the way to try to actually live it – and perhaps become financially independent faster.

The risk is of course we will fail and thus postpone our time to financial independence, but that is a risk we are willing to run.

It is a classic risk/reward choice and we are willing to run a bit higher risk of postponing our FI dreams by potentially becoming financially independent faster than we would otherwise have done.

This is the reason we are now chasing three financial independence goals.

What are our three goals?

Going forward we will pursue three financial independence goals:

  1. Three years’ expenses: Achieving liquid savings equal to three years of expenses
  2. Optimistic FI goal: Achieving liquid savings at the level of our optimistic FI number
  3. Traditional FI goal: Achieving liquid savings at the level of the traditional FI number

The first goal is relatively simple. We want to build up savings (liquid assets) equal to three years’ expenses. This means we will build up some flexibility to test different parts of our future FI life before reaching actual FI. For example, one of us might start working part-time or try to start a side project.

Of course, we might postpone the time to real FI a bit, which is a risk we are willing to run. On the other hand, we might also make more money on a side project and achieve FI faster. Nonetheless, we will be able to try out some things to help design our future FI life (and use the learnings to make our journey and end-goal even clearer) without going bankrupt – and that is why we have this first goal.

How do we calculate three years of expenses? We use our current monthly expenses (including nice-to-have expenses, buffers and emergency savings), which amount to roughly 40,000 DKK (6,040 USD), and then we multiply this with 12 months and 3 years.

This means that the first goal equals (40,000 * 12 * 3) = 1,440,000 DKK (221,538 USD).

The second goal is what we call the “optimistic FI goal”. For this goal we use the same methodology as for the traditional FI goal, but we just change the assumptions behind slightly.

Normally, we would take our yearly expenses and multiply by 25 to get our traditional FI number.

However, we tweak this slightly:

  1. We reduce our monthly expenses from 40,000 DKK (6,040 USD per month with 15% because we expect to move to a cheaper place and reduce housing costs in the future, which means our expenses will be 36,400 DKK (5,600 USD) going forward
  2. We assume a total part-time income for both of us of 20,000 DKK (10,000 DKK each)
  3. We choose a more risky safe withdrawal rate of 7% instead of the traditional 4%

This means that our optimistic FI goal becomes:

(36,400 DKK expenses – 20,000 DKK part-time income * 12 months * (100/7) ) = ~2,800,000 DKK (430,769 USD)

Our optimistic goal will enable us to reach financial independence faster, but the risk of us having to go back to traditional work is higher. This is because the traditional safe withdrawal rate of 4% has been designed to withstand all crises in a historical perspective (I know there’s some criticism of 4% being too high as well, but there are also proponents of higher savings rates).

We decide to live with a withdrawal rate of 7%, although it is not “safe”. Safe means you do not want to deplete your investment portfolio over time and only want to rely on your portfolio income – what you could call risk-averse.

When you use a withdrawal rate of 7%, you are more risk-tolerant and realize that relying only on your portfolio income comes with a high risk of failure (above 50% as far as I remember), but since we expect to still make money (and most likely more money than the 20,000 DKK we use as assumption right now) after reaching FI, we are willing to accept this while we still try to work towards traditional FI and remain flexible if we see things going south.

The third goal is the traditional FI goal most people use. Here we also assume 15% reduced expenses, but we assume zero income and use a safe withdrawal rate of 4%.

This means our traditional FI goal becomes:

(36,400 DKK expenses * 12 months * (100/4) ) = 10,920,000 DKK (1,680,000 USD)

As you can see, the traditional goal becomes nearly four times higher than our optimistic FI goal. It will probably not take four times as long time to reach due to compound interest, but it is still significantly higher.

Obviously, we will still strive to reach the third goal over time, but we will make changes to our lifestyle on the way there and experiment with different ways of living, so we believe the optimistic FI goal fits our current view on the future better than the traditional one. We might be wrong, and we will of course adjust the goal if we find out we are 🙂

We have chosen to take some acceptable risks to potentially reach FI faster and we will rather risk having to work again than waiting a long time to be 100% sure we will be financially independent forever.

How do we track our progress towards the three FI goals?

The goal values are only one part of the equation. We also need to track the different goals.

We will use the monthly reports to report how we track on a monthly basis.

For the first goal, we will only use our liquid assets (cash, stocks, peer-to-peer lending, cryptocurrencies) as our savings.

For the second and third goal, we will likewise only use our liquid assets, but we will also include 15% of our real estate net worth. Why? Because we expect to move to a slightly cheaper apartment/house in the future, and thus will realize some of the net worth we currently have in real estate (in fact, it is at the time of writing our biggest asset).

We include 15% of our real estate net worth for the second and the third goal, but not for the first goal. We expect to reach the first goal before we expect to move, so it would be unfair to include it for this goal. However, we expect to move before we achieve the two other goals.

Is it financial independence if you still have to work for money?

No, probably not in the traditional sense of financial independence where you are 100% sure you will never have to earn a single cent more in your life.

However, we still call our “optimistic FI goal” for financial independence because it gives us the same benefits as traditional financial independence does:

  1. We will have a much larger degree of freedom than we have today to spend time with the people we love and doing things we like
  2. We will only do part-time or freelance work for money that we actually like and care about (e.g. a side hustle like this blog) – and we will have the flexibility to say no and scale up and down in certain periods

In essence, we believe our optimistic FI life will be exactly similar to our traditional FI life, since we will be doing the same things. The only difference will be that we have a higher risk of depleting our portfolio and having to take on full-time work again for a while if things don’t work out the way we had hoped.

Your turn: Do you follow the traditional FI goal or something else? Do you have other perspectives on the FI journey?

4 comments

4 comments

Morten April 25, 2019 - 16:12

The unmodified 4%-rule does not account for taxes. Are you assuming 4/7 % after taxes, i.e. that you get to spent the pre-tax value of your investment returns?

Reply
Carl Jensen April 25, 2019 - 16:40

You are right. Theoretically, you should account for taxes for the part of your net worth that will be taxable upon withdrawal. So, you could calculate a more precise safe withdrawal rate for the country you live in.

To be honest, I’m not a big fan of making this way too technical in terms of calculating the exact safe withdrawal rate to be used. I’m more a fan of using approximate rates and then assess how the world looks like when I get close to reaching them. Over time, tax rates change anyway – just as average returns change, (side hustle) income changes, expenses change and the world as we know it changes.

Reply
Sabbaticalia November 16, 2018 - 19:26

My wife and I are further along the same journey as you’re on, Carl. We have 8 years of current expenses in hand, which is 13 years of post-FI-transition expenses. We plan to stay here in the United States, and to use stock dividends for our ongoing expenses. So, I express my goal in terms of “monthly income” instead of “liquid savings”.

As an extra twist, I map progress onto the calendar year. Right now, our dividend income is at 21% of monthly target, so that’s 77 days out of the year I can pretend to myself being “FI” already: start-of-year through 17 March.

Reply
Carl November 18, 2018 - 02:53

Congratulations on being far on the journey! I believe using your passive income as a share of your expenses as a goal makes great sense when you are a dividend investor in the US. Unfortunately, I believe this goal is only measureable on a yearly basis when you invest in index funds in Denmark (since dividends are paid out yearly), so it is not as easy to follow on a monthly basis, but I will definitely watch it on a yearly basis. Once this blog grows, I will consider using a similar goal for the income the blog generates.

Reply

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