Financial independence: How much do you need

In this article, we will work out a rough number of how much you need to achieve financial independence and the path to get there. I’ve been asked this question so many times that I think it’s worth writing it down formally. This piece will be extremely pragmatic and no BS.

My definition of financial independence:

  • You have enough passive income to cover your living expenses. I don’t think there exists 100% passive income, so instead I’d rather call it non-active income. You still need to take some time to take care of your non-active incomes, e.g. investments, businesses, etc.

  • You are free to choose your work without worrying about the money. Or you can work for no money. Or you can stop working altogether.

How much do you need

Let me tell you my answer and then show you the details later. You need $1,000,000 to achieve financial independence (all my calculation is done in USD). I pick this number because it’s easy to remember and compute (without a calculator).

If you have $1,000,000 worth of assets, then they generate $100,000 annual income at the rate of return of 10% (the long term average annual return of S&P index is around 10%). Let’s also assume that the tax rate (e.g. capital gain tax, corporate tax) is 20%, so the after-tax annual income will be $80,000 (=$100,000 * (1-20%)). Let’s say we reinvest $30,000 of the income so that it can offset the inflation (the long term average inflation is around 3%), leaving us $50,000. Now, we get $4,166 per month (=$50,000 / 12). This monthly passive income ($4,166 for a single person) should be sufficient for living in cities with high living costs like New York or London.

Of course there are many factors which affect the exact number you need. For instance, if you’re living in a place with lower living costs, or you can consistently achieve a much higher rate of return, the amount you need will be much lower. But I want to keep it simple, memorizable and executable, so a precise calculation is unnecessary in this regard. You can work out your own number that fits your case.

Lazy estimation

Another lazy way to estimate the amount you need is to work backwards, starting from how much you need each month. Here are the steps:

  1. How much you need per month?

  2. Compute how much you need per year

  3. Multiple the number by 25 (reciprocal of 4%)

For example, suppose you need $4,000 per month. That is, $48,000 per year. You need $1,200,000 (=$48,000 * 25) to become financially independent.

This estimation method makes use of the well-known 4% withdrawal rate. You withdraw 4% off of your assets every year, i.e. $1,200,000 * 4% = $48,000. The formula becomes $48,000 / 4% or $48,000 * 25.

The path to financial independence

My proposed method is to get a full time job, save as much as you can and start to invest early in a stable growing asset like S&P index fund. There is nothing magical but the key is persistence. This is not a get-rich-quick scheme (e.g. speculating on high-risk stocks or starting high-risk businesses). Instead, this is a slow and boring way to accumulate and grow your assets which is likely achievable by normal people.

The factors that affect how long you need to get to $1,000,000

  • How much you save each month

  • How early you start to invest

  • How aggressive you are to get a high rate of return

The baseline

Suppose you save $1,000 per month, $12,000 per year.

At the end of the first year, you will have $12,000. And you invest the $12,000 at 10%.

At the end of the second year, you will have $25,200 (=$12,000 * (1+10%) + $12,000).

At the end of the third year, you will have $39,720 (=$25,200 * (1+10%) + $12,000).

And so on.

The following list shows the amount you will have in subsequent years (assume that you start working at age 22):

year age amount

1 23 $12,000

2 24 $25,200

3 25 $39,700

23 45 $954,516

24 46 $1,061,968

So, you will achieve financial independence at age 46 (in 24 years). Not bad!

Be more aggressive

You may want to reach financial independence much earlier. You can push yourself to

  • Save more money each month, e.g. saving $1,500 instead of $1,000

  • Invest more aggressively. What about aim for a rate of return of 15% or 20%? That’s not unachievable

Here are the results by tuning different parameters. I’ve skipped the detailed computation for brevity. You can easily plug the formula shown in the previous section to a spreadsheet to obtain your desired numbers.

  • Save $1,000 each month and grow your assets at 15% . You will have $1,058,542 at age 41 (in 19 years)

  • Save $1,000 each month and grow your assets at 20%. You will have $1,049,306 at age 38 (in 16 years)

  • Save $1,500 each month and grow your assets at 10%. You will have $1,111,680 at age 43 (in 21 years)

  • Save $1,500 each month and grow your assets at 15%. You will have $1,115,206 at age 39 (in 17 years)

  • Save $1,500 each month and grow your assets at 20%. You will have $1,001,331 at age 36 (in 14 years)

As you can see above, you can reach $1,000,000 at as early as age 36 (by saving $1,500 each month and grow at 20% for 14 years) if you execute the plan persistently.