How to calculate your financial freedom number
A Google search of “how to calculate my financial freedom number” returns ~300 million articles with the first page being a who’s who of financial media accounts. Said more simply – EVERYONE has an article on how to calculate your financial freedom number and many claim to have better approaches than the others. I’ve read ~25 articles and what I’ve found is that most methods end up getting to roughly the same numbers and It’s far more important to use A method rather than get lost in all of the noise and never get started. Below are my simple tips for taking action.
- Calculate the expenses you’ll need to create the life you want. This is a little nuanced because most advice is to calculate your current expenses, but I suggest you calculate the expenses that you’ll need to create the life you want. For example, I want to travel more so I include another $1,000 per month in my travel expenses when I calculate what I need for financial freedom. When you calculate each expense, bucket each expense into critical, necessary and nice-to-have. The critical expenses for your basic needs – think shelter, basic food and stuff like that. Necessary expenses could be your car, cell phone, some entertainment and generally what you would need to live an okay life. Lastly, your nice to have expenses are the ones that are needed to create the life you want. For me, this is travel, golf, fancy gym, etc.
- Calculate your financial freedom numbers. Yes, I said numbers, plural. There are different levels of financial freedom, starting with being financially free on your most critical expenses. I find it helpful to create a ladder, with milestones at each level of financial freedom, to make the journey seem less cumbersome. This is a proven mental trick to keep you engaged while on the journey to overall financial freedom.
For example, if I need $2,500 per month to meet my most critical expenses, I need $2,500 in passive investment cash flow. There are several ways to achieve $2,500 per month, but it’s important that it’s not trading your time for money. We want this to come from passive cash flow and not a W-2. Some examples could be investing in rental real estate that cash flows $2,500. Another option is to invest in the stock market. Specific to the stock market, the commonly used math here is to multiply your monthly number by 12 to get an annual number ($2,500 x 12 = $30,000). Then divide that number by 4% which in this case is $750k. In this example, we would need $750k invested in the stock market to be free of our $2,500 per month of critical living expenses. It may seem like a big number, but putting a plan in place makes it much more achievable.
- Create a plan and put it on paper. Now that we have our goals, we must set up a plan. For me, I lay out my plan on an annual basis and list what would need to be true each year for me to reach each level of financial freedom in the time that I want to achieve it.
I find it most helpful to start with the end in mind and back into what would need to be true each year. For example, if I want to be financially free of my $2,500 critical monthly expenses in 10 years, I will need a mixture of investments (stocks, rental real estate, other investments) that would return $2,500 per month passively. I calculate how much that I would need each year and then create a plan that is realistic. Using this example, we would need an average of $75k invested each year in the stock market for 10 years straight or rental real estate cash flowing $2,500 per month or other investment returns or a mixture multiple forms of investing. I personally am a big fan of mixing multiple forms primarily for diversification purposes.
In my example below, I outline a path mixing rental real estate and stock investments to achieve $2.6k per month in 10 years. That would require me to invest +$30K in the stock market each year and purchase one single family house per year that produces $100 per month in cash flow. At the end of 10 years, I would have $2.6k in passive monthly income (highlighted in yellow). I would venture to say that you could easily beat this plan once you got the ball rolling on your plan.
- Accountability and Tracking. Next we’re ready to create some accountability and track results. I find that tracking either annually or every 6 months is the right amount to stay engaged and excited, but also not lose motivation due to lack of progress. Remember these are big goals that take patience over long periods of time. The worst you can do is to set everything up and then give up after a year or 2. I update my progress every 6 months, tracking how close I am to achieving my goals. While this step may seem the easiest, it’s often the hardest mentally. I find it helpful to put a calendar appointment on my personal calendar to update my plan – it helps me stay accountable. Accountability and motivation are a big topics that I plan to write extensively about.
