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I love targets! Tell me how to do something and I will fulfill my job to the level you expect. Tell me what to reach without telling me how and I will blow your mind. Well, at least that is how I perceive myself and this is why I set out to find my perfect milestones of FI.
It motivates me to find ways to accelerate my path there and it gives me a “happiness hit” when I reach a target.
Below, you will find my personal list of milestones to FI which are loosely based on the “Milestones of FI” post from Joel at FI180.com and the podcast episode he did together with Jonathan and Brad from ChooseFI. Plus I mixed in some ideas from Fiology.com’s post on the same topic.
Intro: The 4% Rule of Thumb
The general rule within the financial independence movement is that when your annual expenses represent 4% of your net worth, then you can consider yourself financially independent (FI). In other words, you are at financial independence when your net worth is 25 times your annual expenses.
If you want to find out more on the 4% rule and how to calculate your net worth, read Letter 5in the basics section of the Chocolate and Money blog.
Let me introduce a fictional character with whom we can illustrate the 4% and the milestones afterwards. Tom is a standard Swiss citizen and has annual expenses of CHF 40’000 per year which he does not plan to increase or decrease for the rest of his life. His FI number therefore is CHF 1’000’000.
The 4% rule of thumb basically states that Tom could take out 4% of these USD 1.0 mio every year (adjusted for inflation) and never fall beneath a net worth of USD 0 (i.e. go bankrupt).
In my mind there are two approaches to set milestones on your way to FI:
- Based on your absolute FI number.
- Based on your passive income.
Milestones Based On Your Absolute FI Number
This approach is expressed as a percentage of your FI number and has roughly XX milestones:
1.Positive Net Worth
It is possible to have a negative net worth. Remember that your net worth is calculated as your assets minus your liabilities (or debt).
Especially in the US where many people take on a huge amount of student loans to obtain a prestigious college education, getting to a positive net worth may take quite a while. Basically, you pass this threshold when your net worth is CHF 1.
If you had a negative net worth and you manage to get to this level, pat yourself on the shoulder. The emotional burden of having debt should be gone and you can take a breath of relief. Congratulations!
2. Building an emergency fund
Once you have a positive net worth, your next goal should be to build an emergency fund. This is money that you have set aside to pay for any kind of emergency which comes your way.
An emergency form is basically an account where you have between 3 to 6 months of living expense on the side in cash. In case of an emergency, you need this cash on hand immediately. If it is invested then, it might take you 2-3 days to get access to the funds and you might be forced to pull it out at a low level.
In our example, the monthly expenses represent CHF 3’333 (CHF 40’000 divided by 12). Therefore, reaching this milestone would mean that between CHF 10’000 and CHF 20’000 on the side.
3-6 months of living expenses on the side in cash and immediately available and you have reached the second millstone on your path towards FI.
3. F-You Money
This is my favorite milestone of all and I believe it is one of the most important.
F-You Money is the level where you have enough money on the where you are comfortable enough to quit your job, without falling on financial hardship for a considerable amount of time.
This is more of an emotional level, rather than a financial level. For some people it might be already after having 6 months’ worth of expenses on the side, for others it might be somewhere around three years.
Personally, I put this level at 2 years which would represent 8% of my FI number. If I did not like my job, this is the level of net worth I would have to have to quit my job. I would basically have two full years to look for a new job (or build up a successful side hustle) without having to decrease my standard of living.
In Tom’s case, he would pass this milestone the moment his net worth reaches a level of CHF 80’000.
4. Quarter FI
Simply explained, it is the moment you reach 25% of your FI number. There are two reasons why I consider this a milestone on the path towards FI:
The first reason is because the step between milestone number 3 (F-You Money, 8% of your FI number) and milestone number 5 (Half FI, 50% of your FI number) is huge. I need that extra milestone in-between to give me that “happiness hit” and keep me motivated.
The second is that I allow myself to think differently about the way I generate money from this moment on. How and why?
When you have a low net worth, then your increase in net worth will mainly come from you saving money. For example, if Tom has a net worth of CHF 100’000 (10% of his FI number), then every CHF 1’000 saved, will help him increase his net worth by 1%.
If his net worth were at CHF 250’000, then every CHF 1’000 saved would increase his net worth only by 0.4%.
At the same time, your invested money is generating returns. The lower your net worth is, the lower your return in CHF value will be. And vice versa.
Assuming an annual return of 7%, a net worth of CHF 100’000 will give Tom CHF 7’000 per year. A net worth of CHF 250’000 will give him CHF 17’500 per year.
At the level of 25% I consider the snowball of FI to be taking up real speed. From 0% to 25% my snowball is rolling down the hill at a low pace and the only way for me to make it faster is by adding more snow (and therefore weight to it). Once it reaches 25%, it is so heavy that it will pick up so by itself and get into a real whirlwind.
This is where compound interest starts really kicking in.
5. Half FI
Half FI is reached when you are at 50% of your FI number. Congratulations on getting this far.
To put it in the words of Joel: If you have a spouse, then one of you is at FI.
The second thing to consider is that you may have reached 50% of your FI number, but you have much less than half of the time remaining to reach FI.
Again, we go back to the concept of compound interest. When you started your journey to get to 50% of FI, you had no net worth and therefore were not profiting from compound interest on your net worth.
You are starting the second 50% with a considerable net worth which will generate significant interest for you from the beginning. Therefore it will take much less time getting from 0% to 50%, than getting from 50% to 100%.
6. Lean FI
Separate your essentials and your discretionary living expenses. Discretionary expenses are all expenses which are not essential for your survival. For example, expenses related to TV, sports, restaurants, make-up would fall within this category.
Essentials are all remaining costs. Basically anything which you would not be able to cut in the most dire of situations. Basic food, housing and the most basic cosmetic products would belong to the essentials.
Lean FI is achieved when you have 25 times your essential expenses. To paraphrase Joel: lean FI is when you have an infinite emergency fund.
If you were willing to cut your life down to the bare bones, then you would alredy be financially independent at lean FI.
In both Joel’s and my case, discretionary spending represents roughly 30% of our total expenses, therefore Lean FI would have been reached at 70% of our FI number.
In Tom’s case this would be CHF 700’000.
Boom! You are officially financially independent. You have put enough money on the side to cover your living expenses infinitely. Well done!
Many people who have read “The Milestones of FI” on FI180, will now be asking themselves where “Flex FI” and “Fat FI” went.
The concept of Flex FI is when you reach 20 times your annual expenses (i.e. expenses are 5% of your net worth) and basically describes the state where you can consider yourself to be financially independent, if you are ready to be flexible and adjust your spending rate to 3% if necessary.
Fat FI is when your net worth represents 30 times your annual expenses and is the level where you are financially independent if you want to be conservative.
I am not a big fan of these two concepts. Firstly, because they imply that you have different types of financial independence.
Personally, I believe this misses the point. At the beginning, you need to choose your FI number based on your risk profile and your annual expenses. If you are more of a risk taker and flexible with going back to work or moving to a cheaper location, then your FI number will be 20 times your annual expenses.
If you are conservative or you do not consider it an option to go back to work, even in times of hardship, then you would take 30 times your annual expenses as your FI number.
Therefore, personally I feel that there is no such thing as Flex FI, Normal FI and Fat FI. It is all just FI. But this is up to everyone themselves to decide.
Milestones Based On Your Passive Income
The main problem that I see with the milestones based on your absolute FI number is that it does not put things into context. This means that you do not have a sense of time and it does not consider different forms of work, such as part-time work.
The concept of setting milestones based on passive income addresses this last point. The concept is rather simple:
1. Based on your net worth, calculate how much money you could withdraw every year based on the 4% rule, if you retired today.
For example, if Tom had a net worth of CHF 300’000, he would be able to withdraw CHF 12’000 per year without his net worth every going to 0.
Given his annual expenses of CHF 40’000 per year, he would still have to generate CHF 28’000 per year (in after tax money) for the rest of his life, in order to survive and never go bankrupt.
At a net worth of CHF 600’000, the 4% withdrawal would give him CHF 24’000 per year and he would only have to generate income of CHF 16’000 for the rest of his life. And so forth.
Until at some point Tom would reach the level where his 4% withdrawal rate would reach the same level as his annual expenses and he would not have to work another day in his life if he did not want to.
Of course, if you are more flexible, then you can use 5% instead of the usual 4%. If you are more of a conservative person, use 3.25%. Or any other number which you have identified for yourself.
The way you would set up the milestones are either in CHF 5’000 or CHF 10’000 steps. For example, Tom could set milestones at:
- CHF 40’000 in remaining income has to be generated
- CHF 30’000 in remaining income has to be generated
- CHF 20’000 in remaining income has to be generated
- CHF 10’000 in remaining income has to be generated
- Financially independent
Basically, at the point of financial independence, your passive income through investing your net worth, is generating enough to cover your full annual expenses.
Why do I really like this approach?
Mainly because it tells you how much after-tax income you have to generate at minimum if you decided to quit your full-time job and take on a part-time gig. Or how much your side-hustle would have to bring in ever year, for you to consider early retirement.
From a mind-set point of view I think it is much more powerful than the milestones based on your absolute FI number. It basically puts better into context how risky it is to quit your job right now. Respectively, it highlights how much money you still have to generate year-over-year given your net worth.
There is no correct approach to defining your milestones towards FI. Everyone will put different milestones based on their preferences.
Personally, I track both of the methods above. The first one give me the motivation to reach for that next target, the second helps me put everything into perspective in case I consider pursuing a different path than my current job.
The last two points I want to make is that it is important to celebrate those milestones. A pat on the shoulder is both good for you and your significant other to keep the process going.
And as a last point: Reaching FI is not the ultimate goal. The ultimate goal is to do something that gives you purpose and meaning in life.
If you expect that your life will dramatically change when you reach FI, then you are mistaken. Make sure to know what you enjoy, what you get value from and what you want to do with your life.
You need to know this no matter where you are in your FI journey. At negative net worth, at FI and after reaching FI.
- Calculate where you are in the Milestones based on your Absolute FI Number
- Calculate where you are in the Milestones based on Passive Income
- Celebrate any milestones passed
Where are you in the milestones on your path to FI? Which approach do you prefer? Is there any milestone you think should be included?
Let me know in the comments or send me an e-mail at firstname.lastname@example.org. Any questions, concerns, feedback and constructive criticism is highly appreciated.