Our Financial Independence Plan: FI By 40

As I introduced in, Financial Independence: An Introduction, financial independence is the point at which your assets generate enough income to support your expenses and you no longer have to work a traditional job to pay the bills.  The freedom that comes with financial independence is something I haven’t been able to get out of my mind since I discovered the idea and started researching how it works.  After organizing our finances to see how much we were actually making and how much we were actually spending, it wasn’t too difficult to look out to the future and decide where we want to be in 10, 20, or even 50 years.  Now any number of things can change in those time frames (and they will), but Becky and I set up a rough outline that allows us to enjoy life now, but also save away a significant amount of money for the future.  By our conservative estimate and barring anything crazy happening in the next 15 years, we should be financially independent by 40 years old (we’re just under 25 right now).  By staying on top of our expenses, boosting our incomes, maximizing retirement accounts, and making smart long-term investment decisions, we can retire well before the mid-life crisis sets in (if we choose to).

Keep Expenses Down

Since Becky and I aren’t too far removed from college where a lavish lifestyle wasn’t an option, we’ve been pretty disciplined in not letting our spending get out of control despite the large increase in income.  While we granted ourselves with a couple luxuries like a California king sized bed and a big tv, it never added up to more than we made.  After buying the house this past year, I decided to dive into our spending habits and come up with a rough outline of where our money was going.  You could call it a budget, but we never intend to follow it when deciding whether or not to spend money on something, but rather just have an idea of where it all goes.  After inflating the vacation total a bit to account for future adventures, we discovered that our current spending level was just over half of our take home pay.  At that pace, we’re well on track to be financially independent by 40.

I can certainly picture a few ways our spending will go up in the future, but I anticipate our incomes will go up equally or even more to offset it.  There’s also a few places we’ve spent money in the past year that we might move away from (our food budget for example was rather extravagant in certain months), but overall I think we’ll maintain around the 50% savings rate for at least the immediate future.

Avoid Debts

Becky and I were fortunate enough to earn scholarships through college and were able to graduate debt free.  Our scholarship is also how we met, so it’s done far more than it’s fair share to get us where we are today.  We both had cars before we moved to our current location, but decided to sell one before the move and have been using the single 1999 Honda ever since.  It’s still going strong and despite the lacking feature set, we’ll probably ride it out for several more years, so that means no auto loans for us right now.  Practicing what I’ve preached, we only buy things with credit cards when we already have the money in the bank to pay them off, and pay all of our credit cards in full every month to avoid paying interest and fees.

For those reasons, our only outstanding debt is the mortgage on the house we bought just a year ago.  We tried to select a place that we’d be comfortable at for several years, but still well within what we could afford, and ended up putting 10% down to get it.  Putting less than 20% down means we’re currently paying private mortgage insurance (PMI), but we have been aggressively paying extra towards the mortgage to get up to 20% mark and drop the PMI, as it’s a wasteful expense.  Once we are able to cross the 20% equity mark and drop the PMI, we’ll switch to just paying the minimum monthly payment and focus on other investments that should yield higher returns.  Given the current Seattle housing market’s rate of growth, there’s a very good chance we’ll choose to rent this place out instead of sell it when we decide to move.

 

Boost Income

The lion’s share of our income comes from our full time jobs, but I am always looking out for new ways to boost our income on the side.  My recent adventure into buying and selling gift cards is one example of this, but credit card and bank signup bonuses are an additional way that I’ve been able to add to our bottom line.  We’ve found a comfortable level of spending that isn’t tied directly to the money we bring in, so all of this extra income goes straight to investments.  I think the primary motivating factor for me pursuing and enjoying these extra income opportunities is knowing that the extra money from these little side hustles brings me that much closer to financial independence.  The level of satisfaction that comes with an extra couple hundred dollars probably wouldn’t be as great for me if I just went and spent it on a shiny toy that I would get bored of a few months later.

A few hundred dollars here and there might not seem like a lot when we’re trying to build up to a million dollars or more, but given our ages and the powers of compound interest, a few hundred dollars invested now will equal thousands of dollars in a few decades.

Invest Efficiently and For The Long Term

Once we established that our expenses were safely below our income, we had to decide what to do with the rest of the money that was adding up in our checking accounts.  I did a lot of reading on both general personal finance, investing, and a lot of advice written with financial independence in mind (I link to a lot of these resources in my Introduction post if you’re interested).  We’ve chosen to essentially follow the Boglehead method of investing (inspired by Vanguard’s founder Jack Bogle) which encourages utilizing low cost index funds while maximizing tax-advantaged accounts.  The seemingly best way to invest money ended up much simpler than I originally expected going in, so I encourage you to just start reading if the idea of investing itself seems daunting.  By investing in the market as a whole through index funds, you don’t have to sweat over finding the right companies to invest in or trying to time the market.  Once you establish what percentage of your portfolio you want in stocks and bonds (we’re going with 90% stocks/10% bonds for now), you simply buy the cheapest index fund that broadly covers that entire space.

After establishing an emergency fund that will last us 3-4 months if both of our incomes stopped abruptly (fairly unlikely given our unrelated professions), we started putting the rest into investments.  A general priority in choosing what account to put your investments in is to start with your 401k up to the maximum employer match (free money!), HSA (if available), IRA, then the more into the 401k.  Our savings level allows us to maximize ALL of the retirement accounts available to us, so we don’t have to worry to much about the order that we do them in.  Once we crunched the numbers, we increased our 401k paycheck deductions to the max amount ($18,000 per year per person) and opened IRAs with what we currently had saved ($5,500 max per person per year).  Only I have access to an HSA because of our different employer’s health plans, so I increased my paycheck deduction for that as well.  A nice thing about investing straight out of our paychecks is that we never see the money aside from when we look at our investments, and are never even tempted to spend it.

While we haven’t reached that point yet this year, there should still be some money left over after maxing out all of our tax-advantaged retirement accounts.  As I mentioned above, paying the mortgage down to the 20% equity level to remove the PMI is a priority.  I decided that it was important to take advantage of all the tax breaks we could first, because they cap the amount you can contribute per year, but the mortgage will take priority over opening a regularly taxed brokerage account.  Once we are able to remove the PMI from the mortgage, the investment choice becomes either paying extra towards the mortgage at a guaranteed return of our interest rate (<5%), or simply investing in a regular brokerage account.  As the stock market has historically done better than our interest rate (after inflation) and we plan to invest for the long term, I believe it makes sense for us to purchase more index funds rather than speed up on paying off the mortgage.  This priority may shift sometime down the road, particularly if we’re considering retiring from our jobs, but for now I think we’re making the smart choice.

Now We Just Ride It Out

Our biggest advantage on our road to financial independence is time.  We’re both still under the quarter-century mark in age and have long lives ahead of us, so while our lifestyles will change, the investments we’re making now will help significantly wherever we end up in life.  The financial independence age of 40 that we chose is actually pretty conservative by my calculations, and it’s quite possible we reach our financial independence number years earlier than that.  Any number of variables such as where we live, how our professions change, when we have kids, how many vacations we take, and dozens more will impact our expenses and how much we are able to save/invest per year, but the beauty of the plan is it’s flexibility.  We invest everything we can now, but if our goals change in the future, we’ll be able to scale up or down accordingly.  There’s also plenty of things to think about in the meantime while we work toward financial independence.  Whether or not to leave our jobs or just scale down, and what we’ll do with all of our free time are fun conversations to have and I bet we’ll have a lot of them in the next 10-15 years.  We only started really pushing for financial independence a year ago, but are already about 7% there by my calculations.  It will be fun watching our net worth grow over time and some day we’ll be able to just sit back and relax while our assets earn a living for us, and who knows, maybe we’ll still pitch in a bit too.


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16 thoughts on “Our Financial Independence Plan: FI By 40

  1. Your interest rate in your house is near 5%? Just refi.

    Also, when calculating whether to pay down, don’t forget that’s tax free.

      1. Hey Mohammad, you’re way off base here as we hadn’t even signed up for our first rewards credit card back when we got the mortgage!

        The reason for the higher than average interest rate at the time was a combination of limited credit history (our scores were lower back then), only being able to put 10% down, and our limited job history (both of us recently graduated and got our first real jobs).

        I am most likely going to pursue a refinance early next year in order to get rid of PMI and possibly obtain a lower interest rate. I’ll definitely report back with a post on whether or not the many credit cards have an impact!

  2. Noah,
    Do you have a post on why you believe you should pay your mortgage up to 20% asap? A run through the numbers would be nice.

    1. Hey Mohammad,

      As I mentioned above, the primary motivator for wanted to get up to 20% on the mortgage is that it will allow us to drop the Private Mortgage Insurance (PMI) we’re paying each month along with our mortgage. PMI is required for most mortgage loans in which the borrower doesn’t make at least a 20% down payment and comes in the form of a monthly payment for us. Once we get the principal of the mortgage up to 20% though, we can get the PMI dropped and stop this newly “wasteful” expense. Wasteful because if we have enough to pay up to 20% in our bank account, there’s no reason to keep paying for PMI (it certainly wasn’t wasteful to start as it allowed us to buy a house with 10% down!).

      I should break down the math to this and might make it into it’s own post, but my back of the napkin calculation shows we would get an effective return of ~9.6% (guaranteed, tax free) by paying our mortgage principal down enough to have 20% equity in our house. It’s hard to beat that return.

      Thanks for the question!

  3. The most important thing is to figure things out early, and at under 25 you guys are way, way ahead of the game. I’m 35 now and discovered retiring early less than a year ago so we’re way behind you guys, though we’re still ahead of the vast majority of the population.

    We’re (hopefully) moving from high cost CO to low cost TX this summer, and we’ll hopefully be able to get a business or two off the ground before we move overseas in a little over a year to further lower our costs.

    Since I work from home already I have very little expenses, but my wife loves to spend money left and right so she will be the weak link here. She also needs knee surgery, so her getting a job in TX is our top priority right now so we can pay for her surgery.

    1. Starting early is definitely a huge advantage, but certainly isn’t required to reach FI as it looks like you’ve already discovered.

      Sounds like you guys have a pretty solid plan to cut spending and increase income at the same time. Coming at it from both angles can help grow the gap and increase your savings rate significantly. I hope it all works out well, thanks for reading Ken!

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