Financial independence bases its logic on acquiring enough money that you can securely live off of your portfolio in perpetuity, whether you live for another year or 100 more years. Your wealth grows enough so you never need to touch the principal. It also accounts for inflation, slowly growing both the principal and the amount of money you withdraw.
Having enough wealth accumulated to withdraw somewhere between 3–5% each year requires intentional saving and investing. If you assume a safe withdrawal rate of 4%, you need 25 times your annual expenses to reach your FI Number and achieve financial independence.
This means each expense you incur and plan to retain into retirement requires you to invest 25 times that expense. For example, if I spend $250 on groceries each month, that is $3,000 a year. I need $75,000 invested just to cover groceries in perpetuity. This is sensible. We are a pretty frugal household when it comes to groceries, and we will need to eat in perpetuity. The cost of groceries should be a significant portion of our overall FI Number.
Is Your Habit Worth It?
Groceries are an easy expense to justify because we have to eat. Other allocations of money may be more difficult. Criticize the latte factor logic all you want when it comes to the impact of lattes delaying retirement savings, but it is worth reconsidering a daily coffee when looking at how much money you need so you can retain that habit in retirement.
Here is the math: You spend $5 a day on coffee. That is $1,825 each year. To retain that one habit in retirement, you need to accumulate $45,625.
How much do you invest each year? If you opted to maximize a Roth IRA, HSA, and 401(k) in 2023, you invested $36,750 towards your future. That would be less than the amount needed to maintain that daily coffee habit.
If purchasing coffee every day is more of an unconscious convenience, you may find that cutting that expense out of your life is worth it to save what is likely around a year of working before reaching financial independence.
On the opposite side, do not feel ashamed about deciding to allocate large amounts of money for habits that give you joy! Intentionally deciding to retain an expense in perpetuity provides a new awareness of how much you value that little piece of joy in your life. If you need an extra $45,625 to reach a happy financial independence level, it is likely worth working longer to amass that additional $45,625 and live your best life spending on what makes you happiest.
Most folks will probably fall somewhere in the middle with a habit like purchasing coffee. While I do not drink coffee, I still fall in the middle with my hot chocolate habit. Purchasing fancy hot chocolate daily is not worth it to me because I have perfected a delicious stovetop recipe. However, purchasing a fancier hot chocolate and going on a long morning walk on a fall Sunday brightens my recovery Sundays. I also sometimes love to purchase a fancier hot chocolate before a long car ride to make it more tolerable.
Assuming these scenarios happen about once a week, that brings the annual cost of hot chocolate down to $260 a year. To maintain that habit in perpetuity means saving and investing $6,500 for hot chocolates for life. For me, investing one year’s worth of Roth IRA contributions to guarantee a lifetime of weekly hot chocolate purchases is more than worth its value.
Analyzing Different Spending Habits
You can take this methodology to analyze any of your own spending categories and decide whether the money required to sustain a particular spending choice is acceptable given how much you value that spending category. Whether you are looking at your expensive sneaker habit, annual luxury travel, or buying a Diet Coke on the way home from your friend’s house, any habit can be analyzed.
Simply multiply the one-time cost of your spending habit by its frequency. For daily purchases, you can multiply by 365. For weekly purchases, multiply by 52. For monthly, multiply by 12. You can also calculate any other frequency, like every work day of a five-day work week (260 times). This gives you your annual spending on that spending habit.
If you assume a 4% safe withdrawal rate, you can multiply your annual spending on the category by 25 to determine how much money you need to invest to maintain the habit in perpetuity once you are financially independent. This makes the formula for calculating any expense:
One-Time Expense × Annual Frequency of the Expense × 25 = Cost of Maintaining Expense
If you repeat this calculation for different categories, you are likely to find that some areas of spending are well worth the expense. You would likely even spend twice as much to maintain them. Others will prompt you to react negatively because you do not value the spending enough to justify the expense. If you feel repulsed by the amount of money it would require to maintain a habit in perpetuity, you probably do not value it enough to continue the habit.
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