Take an Adaptable Approach to Money

Financial Independence (FI)

Financial independence, I define it as the point at which your potential passive income, typically through investments, is enough. And so to break that down, potential passive income, or potential residual income, is money that you make that doesn’t require a heavy input of your time, energy, or effort. Money that comes to you when you’re sleeping. When that money, which typically for most people happens through investments, but not necessarily for all, is enough that you know you’ll be okay.

Now, that, of course, opens up these bigger conversations about how much is enough. So the common back-of-the-envelope calculation that a lot of people make is they’ll use what’s called “the 4% rule.” This is a rule that was first developed by a researcher named William Bengen and then later confirmed by research that’s called “the Trinity Study.” And it states that you can safely draw down 4% of your retirement portfolio in the first year of your retirement and then 4% adjusted for inflation every subsequent year. And if you do that, you have a fairly good chance of not outliving your money. That research became very popular, and a lot of people in the FI community use the 4% rule to try to determine what their FI number is. And based on their current spending at the time at which they learn about this concept, they say, “all right, well my current spending is $50,000 a year, right? So I’ll take $50,000, I’ll multiply it by 25 and that will give me $1.25 million. That’s the portfolio balance I’m aiming for, and I can draw down 4% of that and live on that in perpetuity.”

One of the mistakes that I think this very academic or textbook notion of financial independence makes is the assumption that your spending will stay constant. That you will draw down 4% of your portfolio in year one and then 4% adjusted for inflation every subsequent year. If you were to graph your spending across your entire life, every year, in fact, every month, you would have a different data point. Your spending is never going to be consistent. Sometimes that’s because of factors that are within your locus of control. It’s because your tastes, your preferences, your wants change. Sometimes it’s because the size of your family changes. Maybe you have children, or maybe your children grow up and leave the nest, and now you’re empty nesters. Sometimes it’s because you have to support a sibling or a grandparent, plus all of the broad macroeconomic forces. There are many reasons why your spending will change across the span of your life. And so to overemphasize a single data point that is essentially an arbitrary data point across that graph is shortsighted.

Defining “Enough”

Even though it’s comforting to run these formulas and say, “all right, you know, I think based on my spending for the last three months, I think I need exactly this precise number,” you’re trading precision for accuracy, right? Because what’s actually accurate is that you have no idea what’s gonna happen in the future. And so truly flexibility is the only true security. And if you can embrace an ethos of flexibility and know that your spending is going to change and your investment choices will probably also change depending on what’s happening in your life, your timeline, your goals — once you’ve embraced that, defining enough means having a sense of what would be enough money that you could at least cover basic bills. It doesn’t need to necessarily cover all of your expenses, but what is a reasonable level of enough in the city, or state, or country that you live in? Maybe even some multiple of that. If you want something a little bit better than that, right? But just get a reasonable sense of what it enough is.

And once you’ve achieved that reasonable enough, then from that point forward, depending on what’s going on in your life, something that used to be important to you five years ago is no longer important to you today. And that’s fine. It’s going to change your spending. Cool. Let it change your spending. That’s what we want. We don’t want the tail to wag the dog. You don’t wanna live under the cage of this budget that you arbitrarily set for yourself five years ago when you were a different person with a different life and different values, right? You want that change. You want the flexibility to be able to realign the way that you spend your money.

And so sometimes when times are tough, that means that you flexibly choose to drill down to focus on making sure your basics are covered and spending maybe more of what you otherwise would’ve spent discretionarily. Maybe you want to just pile that back into investments because maybe in those moments, the market is down. You want to draw down less from your portfolio. You want to buy the dip and buy assets when they’re cheaply priced. So there might be a year, two years, three years where that’s really your focus. And then when times are good, and your assets are flying high, you might then flexibly decide that you wanted to spend more. You want to draw down some of what you’ve made, harvest those gains, and use it to treat yourself a little bit. So having the flexibility to shift your spending and to shift the contributions that you make into the market, that’s how you build a long-term sustainably good life.