Note: This is part 4 of a 5-part introduction to financial independence and understanding. Make sure to read the whole series to really grasp what Money Tofu is all about!
Being financially independent sounds great, and you may identify with 1 or more of the 3 reasons to achieve FI. But you might also be thinking that you need to make too many sacrifices to actually achieve it.
Research has shown that people generally find it difficult to wait for delayed gratification — the act of sacrificing an immediate reward so that you can get a greater reward in the future. In the Stanford marshmallow experiment, children were given a choice between a small treat immediately, or two treats if they waited for about 15 minutes. About one-third of participants were able to defer gratification long enough to get the second treat.
More importantly, follow-up studies “found that children who were able to wait longer for the preferred rewards tended to have better life outcomes, as measured by SAT scores, educational attainment, body mass index (BMI), and other life measures.”
It is human nature, so it is perfectly natural to think that you may not want to save an exorbitant amount of money by living miserly for many years for the purpose of being able to spend it only when you are much older (and possibly less able).
I’d like you to think about 2 different things before discarding FI completely, however.
Sacrificing Happiness Now vs Later
Firstly, I’ve heard the following argument: Life is short and unpredictable. If you don’t enjoy it while you are young, you are wasting years of your youth and can’t fully enjoy life by the time you can actually retire. And who know if you will even live that long?
These are questions I’ve considered about, and I would like to turn this line of thinking on its head.
While it is true that achieving FI means you should save money, and thus sacrifice immediate pleasures compared to spending that money, by no means should achieving FI cause you to live miserably. There is a brilliant reddit post that says you should build the life you want, then achieve FI.
Essentially, your goal should be “sacrifice” only the parts of your spending that are not actually contributing much to your happiness. If you look at it this way, you aren’t sacrificing so much as streamlining or optimizing what you spend your hard-earned money on (a topic further explored in the next part of this series).
Let’s think about the premise that life is unpredictable, and we don’t know when we will ultimately die. If you truly believe this and take it to the extreme, you would do no planning for the future whatsoever (you wouldn’t even think about what you will have for dinner today). I’d wager that you probably aren’t that extreme, and actually do plan for the future. The question then, is simply one of timeframe.
We won’t know when we will die, but unless you have been diagnosed with an unfortunate medical issue, you can expect that you will live to the average life expectancy. In the United States, life expectancy ranges approximately from 75-80. Even if you are a bit conservative with the estimate, you should at least expect to live into your 60’s or 70’s.
Let’s take 75 as an example. If you work until “normal retirement” age (62-67), you essentially have only 10 years left to live a life where you have the freedom to set your own schedule.
If you took the route of extreme “sacrifice” to achieve FI within, let’s say, 10 years of entering the working world at age 20, you would have a whopping 75-30 = 45 years of living in freedom! That’s 4 and a half times longer!
If you take a softer approach and sacrifice less, you might achieve FI with 20 years of working instead, being able to retire at age 40. That’s still 75-40 = 35 years of freedom!
If we look at an earlier age limit, such as 50, the results are even more staggering. If you were to die at 50, you would not be able to retire normally at all. Compare that with planning for being FI, which would allow you 20 years (under the fast route above) or 10 years (under the slow route) of living freely.
If you really don’t know what the future holds, shouldn’t you want to maximize the chance that you can experience truly free living?
Levels of Financial Independence
Secondly, financial independence is not necessarily all or nothing. There are multiple levels of FI, which can grant you different level of freedom. The first 2 are terms that have been established, while I made up a label for the 3rd one. The 4 levels I categorize FI with are:
- FatFIRE – This is the highest level of FI, allowing you to Retire Early (RE) with enough wealth to have extravagant levels of spending (generally greater than $100,000/year). It also takes the longest to actually achieve, requiring high sources of income and/or extremely low levels of spending.
- FIRE – This is what I think of as the traditional level of FI that still enables someone to retire. There is enough wealth accumulated to allow a moderate level of spending that you can comfortably live on.
- LeanFIRE – This is a low spending level that allows you to still retire. According to the reddit r/leanfire community, this is less than $40,000/year of spending. Due to the lower threshold, you should be able to reach this level much quicker than the above 2.
- PartialFI – Not having enough to fully retire, but having a sizeable amount saved up to handle all sorts of emergencies and provide some freedom in not having to worry if you lose your job. This is the first level that you should reach on the way up the ladder, but can also be an alternative to LeanFIRE if retiring with a low spending amount doesn’t entice you.
Determining the difference between Fat, Regular, or Lean FIRE is not really important. Nor is an actual intention to return. In each of the FIRE stages, you have enough wealth such that you could retire if you wanted to, regardless of your willingness to do so. Those stages embody the concept of being FI — one is only truly FI if they are free to retire from working if they so choose.
The PartialFI stage is different. If you are not yet FI or have no desire to FI, I would at least encourage you to think about reaching PartialFI. If we boil it down, there are essentially 3 states to really care about:
- Living Paycheck-to-Paycheck – If you are spending every dollar you make as soon as you make it, you are living paycheck to paycheck. A single bad event, such as a job loss or emergency expense, will make your life extremely difficult. You may have to take out loans on such occasions, which take time and interest to pay back, further putting you into debt.
- Emergency Fund – Having an emergency fund, a stash large enough to cover 3 to 6 months of living expenses (I would recommend 6 months to be safer), lets you weather emergency expenses and income losses without incurring additional debt or causing you headaches. This is a much better position to be in, and those living paycheck-to-paycheck should strive to save up at least an emergency fund.
- Years of Savings (or PartialFI) – If you are able to save up an emergency fund, you are not spending all of your income. Continuing to apply the same saving methods should eventually get you to multiple years of savings over time, achieving what is essentially partial financial independence. At this point, you have far less worries about money, yet can continue to work and live as normal. The feeling of not having financial troubles is great.
With all of these levels of financial independence, reaching each one requires far different amounts of “sacrifice.” Hopefully you can see that there are benefits to having an emergency fund and even several years of savings, and that you can achieve some of the freedom that being PartialFI can bring you without needing to go all the way.
Even if you have no intent to actually achieve full financial independence, merely having the goal in the back of your mind is also extremely beneficial. An alternate way to look at it is to focus on the parts of FI that provide you with financial understanding and the ability to make smart choices to maximize your happiness. That is precisely the topic of the next and final part of this introductory series.