While we talk a lot about financial independence (FI), why we want it, and how we live frugally as a means of getting there, we haven’t talked much about what it is and the logistics of how to achieve it. This post will be the first of several in our FI series that will give you the ins and outs of financial independence. If you have any questions after this post, make sure to drop us a line and we’ll make sure to answer your question in future posts.
Simply put, financial independence means that you are not reliant on a job to pay for your expenses and can live on passive income instead. There are several ways to achieve FI. Some people invest in real estate, some in the stock market (specifically boring ETFs), and others create a business, hire the right people, and have it mostly run without their help. The goal is to create an investment portfolio that will create enough passive monthly income to live on. While we may decide to invest in real estate at some point in the future, for now our investments are almost all in the stock market, with a bit of peer-to-peer loans on the side.
How do you do this and how long does it take? And most importantly, is it even possible?
Let’s answer the questions in reverse order, from the simplest to most complex.
Yes, it is possible. Many people have achieved it and many others are well on their way. The journey to FI is an exercise in persistence and delayed gratification. As we all know, get-rich-quick schemes are almost always too good to be true. But the journey to FI is a well-planned and strategized get-rich-slowly plan. That’s why we call it the snail’s path to wealth.
As for how long it takes, it depends. Depending on your investments, the stock market, your savings rate and your financial situation at the beginning of your journey, it could take you several years or several decades to reach financial independence. Our goal is to reach it by the time we turn 50 – over a decade from now.
And now – how to do it. The traditional stock market based financial independence model maintains that once you have accumulated 25 times your annual expenses – or 300 times your monthly expenses, you will have reached financial independence. The logic is fairly simple. On average, the stock market grows 7-10% per year. This means that in theory, you should be able to pull 4% each year and live on that, while the rest continues to grow and compound. This means that you no longer need to work to live and are free to pursue other activities – if you choose.
25 times your annual living expenses is a lot! How do you expect to reach that?
Lucky for us, we have two significant phenomena working in our favor – and you do too, especially if you are Israeli. Those two things are compound interest and the Israeli pension (and keren hishtalmut) system.
The magic of compound interest makes the road to FI more like a snowball rolling down a mountain and less like a piggy bank. Although it may be slow-going at first, it goes faster and faster the farther along your journey you are, as larger sums of money generate more money. While we currently stand at 20% of our FI number, we are more than one fifth of the way to our goal, thanks to the magic of compound interest.
And here in Israel, we are fortunate that Israeli employers not only match your own pension contributions, but triple them, meaning that a whopping 18-20% of the value of your gross income is getting invested each month. If you are lucky enough to have a keren hishtalmut, that number goes up to 28-30% of your monthly gross salary. For example, if you earn 10,000 shekels per month and have a pension and keren hishtalmut, you are investing 3,000 shekels per month without even investing anything extra on your own. That alone, is incredible and a huge investment in your future. In addition to our pensions and kranot hishtalmut, we invest an additional 30% of our net income, totalling a savings rate* of 44%. This means that we invest almost as much as we spend per month. Next year when both kids are in public school, we hope to pass the 50% mark.
Do you actually plan to retire at 50? What are your plans for after you achieve FI?
There’s a reason we prefer the term FI (financial independence) over FIRE (financial independence, retire early). From what we’ve seen, most people don’t actually retire upon hitting FI, as endless vacation becomes boring. We likely will continue to work part time because we enjoy it, but knowing that we are work-optional and able to choose the hours and capacity of our work is priceless.
The journey to FI is exciting and definitely is possible. We love sharing our journey with you.
* To calculate your savings rate including employee and employer contributions, you need to add these numbers to both the numerator and denominator in your calculations.
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