Most financially keen doctors aim to become financially independent at some point in their lives. Today, let’s talk about whether we’re heading towards FI or far away.
What is economic independence?
Financial independence can be defined as having enough income to pay for the rest of your life without having to “work” again for money. While financially independent people may still continue to work, they can also live and support their families from savings and a completely passive source of income.
The formula for economic independence is relatively simple:
Financial Independence = 25× (annual expenditure – annual guaranteed income)
You take how much you spend in a year, subtract the amount of guaranteed income you have, and multiply the remaining by about 25 (as the 4% rule would cost about 4% each year, and you can expect it to last indefinitely). If your portfolio is more than 25 times the difference between spending and guaranteed income: Congratulations, you are financially independent!
Three situations that will distract us from economic independence
The normal direction of our economic life is to gradually move towards economic independence. But there are three situations where we may feel ourselves moving Get away From economic independence.
#1 Portfolio Loss
The first one is pretty obvious. It’s when the portfolio size drops. This may be due to spending that bundle, but it could also be due to market loss, divorce, inflation, forfeiture (government or creditors), or devastation. If your portfolio last year was $1 million and now $500,000, you’re probably farther away from economic independence than a year ago.
#2 Loss of income
The second situation is where something happens to your guaranteed income. Obviously, some warranties are stronger than others. Your Social Security or pension income can decrease with the death of your spouse. Income from pensions can decrease if the insurance company enters under (though it may be backed up to some extent by the state guarantee association). The source of income you think is guaranteed can actually fluctuate significantly, like real estate rents.
#3 Increase in spending
The third situation where we are not financially independent is much more insidious. This occurs when spending increases due to lifestyle creep. It’s a rare doctor who has not experienced lifestyle creep at some point in his life. Most notably, most new graduates succumb to the explosion of lifestyle as a quadrant of income. However, even careful doctors who live like residents for two to five years after residency to stabilize the rest of their financial lives can be caught unwittingly later in their careers. Even a billionaire portfolio can’t keep up with the speed of medium lifestyle creep.
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Lessons learned from achieving economic independence
Life after economic independence: two perspectives
Examples of not economically independent
Consider a doctor who doesn’t have a $2 million portfolio and a guaranteed income. They spend $10,000 a month or $120,000 a year. So the economic independence of this doctor is about $3 million, and the gap between what they have and what they need is $1 million. Let’s assume their portfolio has won 6% ($120,000) this year, and added another $100,000 in new savings. At the end of the year, their portfolio is worth $2.2 million. Certainly they are closer to economic independence than they were a year ago, right? It’s not that fast.
Additionally, if we increased spending by 20% to $10,000 a month to $12,000 a month, the number of financial independences also increased by 20%, to $3.6 million. Despite a portfolio that has grown by more than 10%, they are now even further away from financial independence as the gap has increased from $1 million to $1.38 million. At this rate of growth in lifestyle, no matter how well the portfolio is, they rarely reach economic independence, regardless of how much they save.
However, if the increase in spending is a one-time increase, they simply delayed the date (4-6 years) to reach economic independence. Mathematics also works inversely. If you can reduce your spending (such as paying off a mortgage), you can reduce the time to financial independence.
Of course, another consideration when increasing your spending is whether the purchase is a “one-time” event or an ongoing expense. In the example of a doctor, spending $10,000 on a very good trip to Europe has little impact on Financial Independence Day, unless it is an annual event. But too many high-income experts misconsulate expensive one-off purchases because they are a habit of buying expensive things every year. It’s a year’s boat, another year’s new car, and the major home may be remodeled in the third year. While all of these may feel like they are one-off events, in reality, it is at least a new, higher level of spending that will significantly slow down financial independence.
What is the solution for those who want to enjoy everything life has to offer, but want to reach economic independence well before the traditional retirement age? Like most of your financial life, solutions are multifactorial.
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Beyond economic independence: money irrelevant
Economic independence is not the Holy Grail
How to achieve financial independence and enjoy life
Being financially independent is not a small feat, but taking into account these five factors, it will facilitate economic independence as you enjoy life in the meantime.
#1 Frontload your retirement savings
Getting a large chunk of eggs in your nest relatively early in your career will make you a saving habit, but that portfolio growth will also reduce the impact of later lifestyle inflation on financial independence days.
#2 Put your money in a place that’s worth it
As a doctor, you earn enough to do whatever you want, not everything you want. With a gradual tax structure, normal student loan burden, and the high savings rate required to maintain a retirement lifestyle, you won’t be able to spend as much money as you imagined. Make sure you prioritize what’s most important to you and follow some type of written spending plan to make sure you’re spending on what you care most about. If you don’t have a plan yet, we Online Courses Specially designed to help you get cheap and fast.
#3 Keep fixed costs low
Fixed costs are usually more impacted on financial independence dates than variable costs, so keep them as minimal as possible. You can do so by buying a small home, paying a massive down payment, using a 15-year mortgage, quickly paying off student loans, living near the location of your employment and purchasing whenever possible with cash (this is almost always a high-income expert).
#4 Take extreme caution when increasing your spending
When you decide to use more, approach this decision with the serious care that is appropriate for it. We weigh the joys that come from spending on time (and in some cases work) required to reach economic independence. We honestly assess whether the increase in spending is a one-off purchase or a continuous commitment. We will also consider whether a one-time purchase will increase fixed costs (insurance and maintenance of items such as second homes, expensive cars, and recreational vehicles).
#5 Protect your portfolio and guarantee your income
Invest in a reasonable way, buy appropriate insurance against financial catastrophes, and prioritize marriage. You will consider increasing your guaranteed income through the purchase of a single premium instant pension (SPIA), but keep your pension amount below the state guarantee association limits.
Financial independence can be an inspiring goal, especially for those who carelessly increase their ongoing spending commitments. By following these tips, you can reasonably enjoy your high income without committing to staying in a “rat race” anymore than you would like.
What do you think? Are you heading towards economic independence or are you separated? When was the last time you moved? Why wasn’t that? Have you ever monitored this?
[This updated post was originally published in 2016.]
