Our strategy to reach financial independence is actually very simple – reduce our expenses, increase our income, and invest the surplus. I could go into detail for hours about each of these, but I will try to touch on each of them in brief here.
Cutting costs is the most important part of our strategy. This is because it possesses the ability to stand on its own in terms of affecting life changes. Reducing expenses not only cuts the money that we need to spend out of our current income, but in doing so it reduces our future expenses and thus the amount that we need to save in order to become financially independent.
I place this higher in importance than increasing your income. This is because if you increase your income, in most cases, you increase your tax liability. For example, if you can cut out your cable bill and save $100 per month – since you would be using after-tax dollars to pay that bill, this is effectively giving you a $1,200 per year raise. Using some rough tax math, you would need to get a $1,600 raise to get that same amount of money after taxes.
The best way to cut costs is to make a decision to live more frugally. Ok, I get it, this is where some people jump off the train when they hear stories like this. – “Isn’t frugality all about sacrifice and depriving yourself?” But let me break it down like this – frugality is simply a tool that we use to only spend money on the things that we do value, and very little to zero on the things that we don’t value. An easy way we have found to approach expenses is by asking ourselves these three question:
- Is this expense bringing us value that cannot easily be replaced elsewhere for less or nothing?
- If yes, do we really need that value in our lives?
- If yes, is this value worth extending our mandatory income earning years longer than they would need to be otherwise?
By “mandatory income earning years” I mean the years spent working at a job that, whether or not you truly enjoy the job, is financially necessary because of debt, lifestyle or (in most cases) both. There is no hard and fast rule that once you are financially independent, you need to stop working. But wouldn’t it be nice to work because you wanted to and not because you had to?
The line items that have the potential for the biggest savings by reducing costs are: housing, transportation and food. I will expand upon each of these individually in their own posts, but to sum up our frugal wins in each of these:
- Housing – Instead of buying the 3000+ square foot McMansion of our dreams with enough rooms for each of our kids plus an office and guestroom… We bought a 2 bedroom 1050 square foot energy efficient ranch and got rid of our junk.
- Transportation – We stopped using our minivan on a daily basis, traded in our other car (Mazda5) and got two very fuel efficient cars to use as commuter cars, saving the van for when we needed to have everyone in the same vehicle. And we paid off all of our cars* in full in just under one year.
- Food – We stopped going out to dinner and removed a lot of unnecessary luxury items from our grocery bill. We brought lunch to work and saved pizza nights and work lunches for special occasions.
Before I go down this rabbit hole, let me first acknowledge that some of this part of the strategy may not work for everyone. In some professions pay and advancement is dictated by company or union rules. This is another reason why reducing expenses is so important – to a varying extent, it can work for everyone!
My number one mantra about increasing income is “You don’t get a raise if you never ask for one”. A good way to look at it is that your employer may be more than willing to give you a salary increase, but if you never ask for one, how are they to know that you want one? In a perfect world, all managers would be proactive in their attention to their employee’s career growth and financial needs. But in my experience with corporate America, even in the best office environments, raises are rarely distributed without request. I have never been bashful about inquiring about my performance and my employer’s approach to salary adjustments. It has served me well – any significant raise that I received over the course of my career thus far has been because I asked for it.
There are other ways to increase your income as well. When searching for employers, we made sure to ask about their 401k and any matching program. While the money may not be readily accessible (more on that below), any money that they match in your 401k is free money! If you aren’t participating in your employer’s 401k program – you should contribute at least as much to trigger 100% of the employer match.
Another way to improve our income was to seek employment with companies that do health benefits right. In a former position, for family coverage it was just over $1,000 per month in premiums. On top of that, other than an annual “well visit”, nothing would be covered until the $5,000 deductible was met. So that meant spending $17,000 out of pocket annually before anything was covered…. Yikes! Despite those type of high-deductible health plans are becoming more common these days, we were both lucky with our current employers’ plans that properly cover our healthcare ($10-20 co-pays for most services) for a significant premium discount from my last place of work – saving us about $700 pretax. While this can also be viewed as a reduction in expenses, healthcare is directly tied to income in most cases, so I covered it here.
We have toyed with the idea of dipping our toes into “side hustles” (non-W2 income) down the road to boost our income. However, given our already reduced amount of free time and a desire to spend that time with family and friends these are not options that my wife and I have looked too deeply at. For now our approach is to keep our 9-5 gigs and optimize our income from those the best that we can.
Our investment strategy is heavily based on index funds, specifically low-fee index funds that track the total stock market. Historically these funds tend to outperform actively managed mutual funds that charge a much higher fee. We also don’t attempt to time the market – while the market may drop severely in the short term, it always goes up. I could sit here and try to type out a more masterful defense of index fund investing but a clearer explanation on index funds and investing in general has already been written – the JL Collins Stock Series. This is hands down the simplest and most valuable resource out there on investing, and I can’t recommend it enough. If you are not familiar with the subject, do yourself a favor and take a few days and soak all of that in.
The backbone of our strategy is investing in low cost index funds and utilizing the 4% SWR (Safe Withdrawal Rate) rule. This in short, states that you should be able to withdraw 4% of the total balance of your retirement nest egg every year, and that balance will last forever (or as close to forever as matters). How this applies to financial independence is that you can take your yearly spending (what you need that 4% to cover) and multiply it by 25 to get you the amount that you need to have in your portfolio – what some like to call your “FI number”. You can read more about the ins and outs of the 4% rule here, here and here.
When we first got into the idea of financial independence, we perceived the FI number to only apply to the amount that we had in our taxable brokerage account. We completely wrote off the money in our tax deferred investment vehicles (401ks) as “for later” and not able to help us on our path to early financial independence. This is because we were unaware of the various strategies available to access those funds early and in some instances… tax free. Spending countless hours structuring out my own spreadsheets to account for strategies like the Roth Conversion Ladder – I came to the conclusion that, whether the money is in our 401ks or our brokerage account, it all still follows the 4% rule.
- Max out our 401k contributions as we are able.
- Any surplus that we have after taxes and expenses will go into a brokerage account portfolio focused on low cost index funds.
- Somewhere in the between now and our FI date, set aside enough money to pay off our mortgage (currently sitting at about $158,000). Right now our approach to that is in four years to begin diverting 50% of the money that had been going to the brokerage account towards paying down the mortgage principal. We will continue that 50/50 mortgage / investment split until the house is paid off.
A few notes should be made about our projections.
Our expenses in any given year account for the different ages of our children – specifically whether or not they are school-aged (and thus not needing childcare, except for the summers). For example, right now with three children in some form of childcare, that sets us back $2,200 a month. In a year that will be significantly less. In five years that expense will be gone completely.
They also account for certain debts being paid off by certain times. Non-mortgage debt isn’t as important to our plans going forward as we spent a good portion of the last 1.5 years paying off a student loan, three cars and funding a modest addition to our house. Our only debts going forward are one very small car loan*, my wife’s student loan and a loan for our solar power system. We hope to pay these off before reaching financial independence but the interest rates and principal amounts weren’t sizable enough to warrant us deferring funding our brokerage accounts for any longer than we already had.
Finally, our model also counts on us each getting at least 3% raises every year. It may sound risky to rely on any raises or count any chickens before they are hatched. But even if we never got raises again, it would only extend our mandatory income earning years by one year.
Right now our projections of have us reaching financial independence somewhere around the beginning of 2028 with a portfolio large enough to sustain $42,500 in living expenses per year. If we can get our living expenses down or accumulate more income from other sources, that date gets closer. This number is based on 7% growth in the stock market averaged out over the next 10 years, and anything can happen – related to the stock market or otherwise. It’s not a perfect plan but it’s a heck of a lot better than working for the next 30-40 years.
* We had paid off all three car loans in about a year. Then an opportunity came to replace my car for a small amount of money. It’s a long story but as mentioned above the loan payment is so small and the interest rate so low, that focus on our savings is more important at this point.