Financial independence - what it is, and how you can get it sooner

Most people achieve financial independence when they start to draw a pension. This normally coincides with getting older and retiring.

But a few people manage to become financially independent earlier - sometimes a lot earlier. They can pay all their bills, and spend an amount of money they're comfortable with on top, for the rest of their lives, without having to do paid work.

People who are financially independent have more options. They can choose how much, or how little, paid work they want to do. They can do voluntary work instead. They can focus on their hobbies full-time, or take up new ones. Whatever they do, they can do it without having to worry about money. It's why financial independence is often called financial freedom.

To become financially independent, should you not win, marry, or inherit money, you need to grow a big enough nest egg by earning, saving, and investing. It usually involves paying off all your debts, living well below your means, and saving much more than the norm.

"Get rich and never have to work again? That's obvious - if easier said than done."

The philosophy of early financial independence is that you don't need to be that rich. Think rationally about what you actually need to spend, and less about what you earn, and you may find the numbers aren't quite as big as you expect.

You don't need to be a high earner to achieve financial independence. But it does help to earn as much as you can - as long as you don't spend it all, of course.

How do you earn more? You could ask for a pay rise, get a better-paying job, or find money-raising things to do on the side, so-called 'side hustles'.

Here are some useful things to read or listen to.

Date Source Article or episode
Jul 2020 The Escape Artist Earning more is not cheating (part 2)
Feb 2018 Financial Panther Monetize your life and get paid to live
Feb 2018 Derek Sivers The more they pay, the more they value it
Feb 2018 Derek Sivers Shed your money taboos
Jan 2018 Get Rich Slowly Five steps to make more money while growing your career
Dec 2017 The Escape Artist Earning more is not cheating
Nov 2017 The Escape Artist Financial independence is for everyone
Sep 2017 The Escape Artist Freedom through self-employment
Jun 2017 Monevator Seven reasons why you shouldn't start your own business
Mar 2017 Derek Sivers Think like a bronze medalist, not silver
Feb 2017 Financial Panther When leaving big law, the financial struggle shouldn’t be real
Nov 2016 Millennial Revolution How to find the perfect job

It's not unusual for people in the financial independence movement to have a saving rate of 50% or more - yes, they save at least half of their income. A few manage three-quarters or more.

Having a frugal lifestyle helps. This doesn't necessarily mean going without. But it does mean making better spending decisions and not throwing your money away. Most FIers prefer experiences to things, and tend to avoid buying 'stuff'.

The biggest threat to saving is lifestyle creep - spending more as you earn more. If your income goes up, the trick is to carry on spending the same as before.

Here's the bottom line: the less you spend, the less money you need to accumulate. And the more you save, the faster you become financially independent.

Here are some useful things to read or listen to.

Date Source Article or episode
Jan 2020 Liberty Through Wealth How the national media makes Americans poorer
Jan 2020 Morgan Housel Wealth is what you don’t spend
Jun 2018 The Escape Artist Power is the ability to control your own life
Mar 2018 Mark's Money Mind Who let that lifestyle creep in?
Feb 2018 Monevator Live it up like a graduate student and save a fortune
Oct 2017 Can I Retire Yet? The three great misconceptions about retirement saving
Aug 2017 Insourcelife Lifestyle deflation
Feb 2017 Financial Panther Do you use work as an excuse not to reach financial independence?
Dec 2016 Money Boss Is $10 million enough to never worry about money again?
Oct 2016 Mr Money Mustache How to be happy, rich, and save the world
Aug 2016 Done by Forty Early retirement isn't for you
Jul 2016 Money Boss Here's how much you actually need to save for retirement

Once you've started to save, the first thing to do is build up an 'emergency fund' - a pot of cash you can get your hands on quickly if, for example, you lose your job. The second thing to do is start investing.

You have to invest. You won't become financially independent by keeping all your money in the bank, especially today when interest rates are so low. If your money stays in cash, you risk not keeping up with inflation and running out of money.

There are different things to invest in, but the basic rules of investing are:

At its simplest, your investment plan might be to buy one or two investment funds that track the movements of the world's stock markets. The prices of those funds will rise and fall each day, sometimes steeply. But the long-term trend of markets is up. So as long as you don't panic and sell when prices fall, your nest egg should grow over time.

There are ways to try to 'beat the market' - to try to get a return that's higher than the market average. But many argue the market average is good enough, and that very few people can beat the market for more than just a short time.

Is investing in the stock market risky?

The answer is: it can be. But it really depends on what you mean by ‘risky’. There are different types of risk, and there are ways to handle them.

Some investors describe themselves as ‘risk averse’; others are happy to buy ‘high risk’ investments. You're always told to invest according to your ‘risk appetite/tolerance/profile’. But what does all this talk of risk mean in practice?

Many people define investment risk simply as ‘price volatility’ - so they say an investment’s risky if its price moves up and down a lot. This is a reasonable starting point. If the price falls sharply just before you need to take some money out - ouch. Especially if you’re about to put down a house deposit, or stop earning money. But if you’ve got many years of investing ahead of you, a falling price is much less of a risk. The stock market as a whole goes up over time, so it shouldn’t necessarily matter that it doesn’t go up in a straight line (if you think about it, you should welcome falling prices in the early years with open arms).

Let’s use a wider definition for investment risk - let’s simply call it ‘losing money’. There are three main ways* you can lose money when you invest.

  • Your investment becomes worthless one day, because, for example, the company you invested in goes under. Or your investment turns out to have been worthless from day one, because you were scammed.
  • The price of your investment falls, and you actually sell it at a price that’s lower than the price you bought it at. This is the price volatility issue.
  • The price of your investment goes up over time, but never enough to keep up with inflation. So when you sell, you get back more money than you put in, but its spending power has actually gone down. This way of losing money is often overlooked.

So how do you reduce the risk in each of these situations? It’s actually quite straightforward.

  • Don’t put all your eggs in one basket - spread the risk. This means not putting all your money into one company, or even one sector or one country. And try not to get scammed!
  • Never be forced to sell when prices fall, potentially turning a paper loss into a real one. This means having enough cash, or something similar to it, easily available when you need it.
  • Don’t keep all your money in cash or bonds if you need it to last a long time. This means owning shares, so you beat inflation.

So how you invest determines the risk as much as what you invest in. That’s why you need to question oversimplified statements like ‘the stock market is a casino’, or ‘bonds are safer than shares’. Yes, day trading is akin to gambling, and bonds tend to be less volatile than shares. But that’s not the whole story.

(*) There are other ways to lose money too. First, even if the price of your investment goes up over time, charges and taxes will eat into your return. To deal with this, you should generally keep the cost of investing as low as possible, and use tax wrappers like a pension or an ISA. Second, if you pick a handful of stocks, or let a fund manager do it for you, you might end up doing worse than the market as a whole. This is the, often-heated, debate around 'active' investing versus 'passive' investing.

Here are some useful things to read or listen to.

Date Source Article or episode
Oct 2020 Financial Panther Good enough investing
Jan 2020 Banker On FIRE Five tips to avoid getting hosed by your workplace pension provider
Jan 2020 Morgan Housel Risk is what you don’t see
Jan 2020 The Escape Artist Where do stockmarket returns come from?
Jan 2020 The Evidence-Based Investor Stock market games in schools do more harm than good
Mar 2019 Tony Isola Compounding boredom is simple, but not easy
Mar 2019 Behavioural Investment Most investors should be satisficers not maximisers
Nov 2018 The Evidence-Based Investor How to pick all of tomorrow's winning stocks
Nov 2018 Mr Money Mustache How to retire forever on a fixed chunk of money
Nov 2018 The Escape Artist Honestly, could this investing lark be any easier?!?
May 2018 Can I Retire Yet? The perfect storm – demonstrating conflicts of interest with investment advice
May 2018 Can I Retire Yet? The worst investment advice I ever heard
May 2018 The Evidence-Based Investor Warren Buffett's advice for investors in 25 quotes
Apr 2018 The Escape Artist Do you even know what's going on in your pension?
Mar 2018 Financial Panther An investing tip – learn to be happy with enough
Feb 2018 Talks at Google JL Collins: the simple path to wealth
Dec 2017 RockWealth Investing: the evidence
Jun 2017 Millennial Revolution Why everyone needs to learn to invest
Jun 2017 Monevator Investing for beginners: the global stock market
Jun 2017 Financial Panther You don't have to keep up with the Joneses when it comes to investing
May 2017 The Escape Artist What is a house? And can it make you rich?
Apr 2017 Sex Health Money Death Smash the system
Feb 2017 The Escape Artist What if you know nothing about investing?
Jan 2017 Monevator Volatility, inflation, and asset class returns
Aug 2016 Monevator This former hedge fund manager reveals how you can invest for life in five quick videos
May 2016 Money Boss The optimization trap