For many, financial independence is the holy grail of personal finance. Although financial independence is a little different for everyone, basically you can consider yourself financially independent when you’re not dependent on any employment income to meet your needs. Some go a little further and define it as meeting all your needs strictly with passive income- or income that you don’t have to work for. Either way, it means that you at least have the ability to quit or retire from ‘regular’ work whenever you wish, if you haven’t already.
When you’re aiming for financial independence, trimming expenses goes a long way. Especially if those expenses are ones that you don’t really value. The problem is that expenses have a tendency to pop up like weeds. So periodically you need to pull out your financial weed whacker, and whack those expenses out. (Anybody else going crazy from the dandelions this time of year).
Why Trim Expenses?
So why is trimming (whacking) expenses so important to reaching financial independence? Two reasons: eliminating expenses allows you to save towards financial independence quicker, and cutting out expenses means that you need less to become financially independent.
A huge part of becoming financially independent is typically building up a passive income stream from investments. Over time you build up investments that pay out regular dividends or that allow you to cash out portions while maintaining your principle.
Cutting out an expense means you can invest more in these funds. Furthermore, if you’re cutting out a regular expense, you can now save that amount not only once, but every month going forward. For example, if you cut out your $80 cable bill (since the cable bill is everyone’s favorite punching bag), you can now stash an extra $80 towards financial independence every single month. Or $960 every year. Add compound interest or dividend reinvestment to that and it’s even more.
When you cut out an expense, that’s now one less expense that you need to fund with your independent income. Back to the cable bill example- not only were you able to save an extra $960 (plus growth) each year, you also now need $960 less each year to consider yourself financially independent.
If you’re funding your financial independence primarily by investments, this is huge! Investments typically return passive income at a rate of 2-4% per year. Even at the 4% rate, to get an additional $960 per year in extra income, you’d need an extra $24,000 in investments. Or to put it another way, you’d need to save $24,000 to fund your cable bill for the rest of your life.
Putting the Two Together
Let’s keep running with the cable bill example and plug it into the bigger picture. Say you’re earning $2000/month after taxes. Including your cable bill, your expenses total $1600 (including short-term savings such as emergency and car savings funds). This means you’re saving $400/month towards financial independence. To become financially independent, you need to be able to cover $1600/month or $19,200/ year. Based on the 4% ‘safe withdrawal rate,’ you’d need $480,000 saved up to consistently provide you with this amount per year.
Below is a chart showing how long it would take you to reach financial independence, assuming a 7% growth rate while saving. The red line is the $480,000 you need, and the blue line is your growing financial independence fund. Without eliminating any expenses, you reach financial independence after 30 years.
But how will eliminating your cable bill affect the numbers? Since your cable bill was $80, you’re now able to stash $480 away each month. Your expenses have also shrunk to $1,520/mo or $18,240/year. This means you now only need $456,000 to become financially independent. Below is an updated chart. Now you reach financial independence in only 27 years- 3 years earlier. And if just a cable bill can do that, imagine the possibilities when you start slashing larger expenses!
One thing that I left out of my saving models is income increases. Few people will continue to receive the same income for the rest of their lives. Presumably, as you get better at your job and pick up new skills, your income will rise accordingly. It’s easy to let lifestyle inflation consume all your increased income. A better alternative might be to redirect at least some of your raises to savings. If you’re used to living on $1,520/month, don’t let a raise change that. Instead, consider using the raise to speed your way to financial independence.
My point isn’t necessarily that you should cut out every expense in your life so that you can reach financial independence as quickly as possible, although this might be right for some people. Rather, prioritize expenses and goals in your life. Evaluate how much you’re getting out of an expense, and how much you want financial independence. In the case of your cable bill, decide whether having cable service is worth depending on employment income for an extra 3 years of your life. If not, whack it out!
If not having to depend on employment income is your top priority, then go crazy and cut out every possible expense. But if you really enjoy some of the things you’re spending money on in the here and now, perhaps keeping them in your life is worth delaying financial independence by several years. Just be aware of the effect that extra expenses have on your route to financial independence.
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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.