3 Keys to Achieve Financial IndependenceSubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on June 3rd, 2016
What does it mean to be financially independent? To me, it means your assets can produce enough predictable income to support your lifestyle, even as prices and taxes continue to rise. At that point, you’re beholden to no one but yourself and your family.
Even if you enjoy your career, this type of freedom is extremely rewarding. You can work because you want to, not because you have to.
This article covers three keys to reaching this lofty and worthwhile goal.
Know How Much Money You Need to Retire Comfortably
These days many Baby Boomers choose to continue working after the traditional retirement age. Instead of riding off into the sunset at age 65, many are working second careers for less money, with less stress, often doing something they really enjoy. Others stay in their careers well into their 70s and even their 80s.
Even if this is your plan, it’s advisable to prepare for retirement and aim for complete financial independence. It's nice to have the option to change your mind.
Do you know how much money you’ll need to retire comfortably and stay retired? Knowing the answer to this question is critical for planning purposes.
To arrive at a ballpark number, find out how much money you and your spouse can expect to receive in Social Security and pension benefits each year in retirement. This is your guaranteed income. You’ll probably need investment income to cover the gap between your guaranteed income and your lifestyle needs.
Assume you can spend no more than 4% of your investment portfolio each year. So, multiply the gap between your guaranteed income and your lifestyle needs by 25, and that’s a ballpark number of how much money you’ll need in your portfolio to retire.
If you need $20,000 in investment income to support your lifestyle, you need a $500,000 portfolio; for $40,000 in annual investment income, you need $1,000,000; and so on.
Please note this is intended to give you an estimate; I recommend consulting with an advisor you trust to determine exactly how money much you need to achieve financial independence.
Know Your Spending Speed Limit – and Stay Within It
Once you know how much money you’ll need to be truly financially independent, it’s important to establish a spending speed limit. Your speed limit is how much money you can safely spend each year without sacrificing your long-term goals.
When you’re in the prime of your career and your annual income is climbing, it’s easy to exceed this speed limit. Your next paycheck replaces the money you spent, you continue to live your lifestyle, and it's not always clear how this can impact your financial independence. However, when you exceed your speed limit, you’re not investing as much as you should, and you lose some of the magic of compounding interest.
Spend no more than 80% to 85% of your income and invest the remaining 15% to 20% so that your money can grow and outpace the ravages of rising prices and taxes. Invest wisely, and you’ll build considerable wealth before retirement age.
Manage Your Return on Behavior as an Investor
Having a plan to hit your financial objectives isn’t enough. You have to stick with the plan to make it count! That’s often harder than it sounds.
According to Dalbar’s Quantitative Analysis of Investor Behavior 2015 Edition, the average equity fund investor earned 8% less than the S&P 500 index over a 12-month period.
The primary reason? According to Dalbar, poor returns for investors is not necessarily due to poor selection of investments. It’s investors’ behavior when it comes to buy-sell decisions that does the most long-term damage.
As we’ve written about before and illustrated in our infographic on Investor Behavior 2016, even sophisticated investors can be influenced by psychological triggers such as fear of loss, media response, regret, and herding. These natural tendencies cause people to go in and out of investments at less-than-optimal times during a market cycle.
Does your advisor proactively communicate with you on the “why” of your investment strategy, how current events may (or may not) affect your short- and long-term gains, and how to capitalize on the investment mistakes of others? If not, it’s hard to be a rational investor times of fear and market euphoria.
If you would like advice on how to achieve financial independence, contact Reby Advisors today by sending an email to email@example.com or calling (203) 790-4949!