How do I find out when I am financially independent?
In this post I will dive a little into a question that I see quite often. Namely, how much one needs to be financially free, or financially independent. I would often like to respond to all of these posts. However, it often ends up that I start and then do not have time to write everything I want in response (because I often sit on a bus or go to and from the coffee machine at work;)) and then it does not turn into anything. I think it’s because the answer fits better with a blog post than a comment 🙂 So here I will try to elaborate on what I mean by the answer is not so easy and straightforward.
When are YOU financially independent?
The answer to the question is very subjective. It is about how YOU live your life, what expenses do YOU have today and are these the same expenses you want in the future? Some people tighten their budget a lot to be able to save up – but is that the same budget they will live on when they reach “financial independence”? Only there can one begin to count on it. Let me show you with an example:
What are your expenses?
In 2018, the average salary for a Dane was USD 53259.97 before tax, which corresponds to USD 4438.33 a month and approximately USD 2750.96 after tax. Let us then assume that your budget and the level of expenditure you want to keep is made on the basis of the DKK 2750.96 a month. If you also expect to save 10% of your salary today (= USD 275.10) then your real expenditure level is DKK 2750.96 – 275.10 = USD 2475.87.
In addition to these expenses, you may also want to travel, which is why you should add USD 3255.58. per year. This gives USD 2475.87 + (3255.58 / 12) = USD 2745.59.
Your expense level = USD 2745.59 per month = USD 32947.11 per year
How much much to live off the dividends?
There is usually a direct return of 3-4% for a company on the major stock exchanges, so let’s expect a direct return of 3.5% in your portfolio (for comparison, for example, the Swedish index OMXS30 had 3.86% in direct returns in 2017 and I would think OMXC25 is at about the same level).
To manage an expense level of USD 32947.11 per year with a direct return of 3.82%, you must save approx. USD 927.840 (USD 32947.11 / 3.5% = DKK 927.840). But in this calculation I have not yet deducted the tax.
With the current rules, we have to pay 27% of the first 9001.68 USD (2020, OBS double for spouses) and after this 42%. If, to make it easy (for me;)), we calculate with 42%, then we actually need a little more than the USD 927.000. Then the calculation looks like this:
x * 0.58 = USD 32947.11 / 0.58 = USD 56805.30 per year (before tax)
Then you need a portfolio size of USD 1.622.906 with a direct return of 3.5% to have USD 2745 per month.
NOTE. This is if you only look at dividends and do not expect to be able to sell shares / funds along the way, for example. There are some who do this, for example by following the so-called 4% rule -> that you can sell 4% of your holdings every year. ->
“Experts consider the 4% withdrawal rate to be safe, as the withdrawals will consist primarily of interest and dividends.”.
I personally am more of a fan of living off dividends where I do not have to sell out of my shares on an ongoing basis.