Monday 11 May 2015

How much do I need to be financially free?

When I first started writing this blog I stated that my goal was to have $90 million dollars by the year 2031.  I gave myself 20 years to reach that goal of and to be rich.  However a question I haven't really considered before is "how much do I need to be financially free?".

Being rich is great but the real step change in ones life is when they are financially free.  When they are no longer tied to their job and have the freedom to choose what to do with their life.  I was recently reading a post on 2millionblog (the blog which motivated me to start writing this blog actually) where the author had a clear target for financial freedom and was measuring his progress towards this target.

I thought this was a brilliant idea and I've decided to give it a go myself.

Step 1: What sort of income do you require?


According to various sources a 'comfortable' retirement for older people is something like $60,000 a year for a couple in Australia.  I'm not really planning on living like a retired grandparent so I'm probably going to need more than this.

Having said that I won't need as much as my current income as when I am financially free I will not have a home loan to pay down and will not have many of the expenses that come with having to go to work and make a living each day.

I settled on $100,000 as the income I would need to be financially free (in today's dollars).  At $100,000 per year I would not be 'rich' but I certainly would not be tied to my job and I would have the freedom to decide whether I wanted to work or whether I wanted to do something else.

Step 2: Work out where this income is going to come from


This is a reasonably simple exercise.  What classes of assets do I feel competent investing in and where do I think I can earn income (and in what proportions).  I split it something like this
  • Cash / Bonds: $10,000
  • Rental Properties: $30,000
  • Stocks: $50,000
  • Business Income: $10,000
Don't forget that
this is just a plan for you - things can change and at any given point in time you may be making more from one part of your portfolio than others.  Also I skewed this split to where I see my core investing competencies (stocks and property).

Step 3: Assume your long term real rates of return

OK there are a few assumptions you're going to have to make here.  One is rates of return on various classes of assets and the other is an inflation rate.  Why do you need to assume an inflation rate?  Because $100,000 today is not the same as $100,000 in 20 years time.  If you strip out inflation you'll find out the actual number you'll need to achieve your financial independence.

My conservative rates of return figures are below. I have assumed a 2% long term inflation rate and I have subtracted this off my forecast nominal rates of return to get a real rate of return.

Nominal rate of return
Real rate of return
Cash / Bonds
3%
1%
Rental Properties 
4.5%
2.5%
Stocks
7%
5%
Business Income
10%
8%

Step 4: Work out what other (non income producing) assets you need


In addition to your income producing assets you're also going to need some large non income producing assets.  I have assumed that I will need 2: a family home and an emergency / rainy day fund.  I have assumed the following values:
  • Family home: $700,000
  • Emergency Fund: $80,000

Put it all together to work out how much you need to be financially free


The last step is to put it all together to work out how much you will need to be financially free.  This is what mine looks like:

Income required
Real rate of return
Assets needed
Cash / Bonds
$10,000
1%
$1,000,000
Rental Properties 
$30,000
2.5%
$1,200,000
Stocks
$50,000
5%
$1,000,000
Business
$10,000
8%
$125,000
Investment Portfolio
$100,000

$3,325,000
Other Assets



Family Home

$700,000
Emergency Fund


$80,000
Total Assets Req.


$4,105,000

I confess that it is a much larger number than I expected.  When I do my portfolio review in June I'll definitely be seeing how far along the path to financial freedom I actually am.  

How much do you need to be financially free?  I'd love to hear if you have done a similar exercise.

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4 comments:

  1. Great framework here 90M, something that I'll definitely keep tracking myself.. happy to keep swapping notes as we progress through our journeys and would be interested to see your post on this in June..

    Like that you have realistic & real rates of return as well.. While yeah you may out-perform those being conservative is great! :)

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    1. Thanks Jef! In the last few days I've really started thinking about cash flow generation rather than asset accumulation and it has really caused me to step back and assess my strategy...more on this topic to come I think!

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  2. That's great, if only cause it'll mean it's more aligned to what I'd like to achieve & it'd be great to have a chat with someone looking to do similar things.

    It really comes back to goals though and what you'd like to achieve I'd say! Interested to hear more though

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    1. Funny you should mention that. I have a post coming out early next week which has me mulling on what exactly that means to me!

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