This is the third of a three part series detailing our journey to financial independence. Part One covered how we have done to date and what has gotten us there. Part Two explored where we go from here, including the impact of potential actions we are considering with our finances. Part Three will review the workings of a downloadable Excel model you can use to calculate your own progress towards Financial Independence. Enjoy!
My prior two posts in this series include lot of charts and graphs showing how spending, savings and investments all interact to achieve financial independence. While the numbers reflected my own progress, you can easily calculate with your own numbers as well.
Refresher on Financial Independence Calculations
Before we get into the component pieces of the model, let’s review how the math works.
How to Calculate Percent to FI
For purposes of calculating how close one is to achieving FI, you only need to to know two numbers from your finances:
- Current investment portfolio balance
- Amount of annual expenses (budgeted, prior twelve months, etc.)
In addition, you’ll have to pick an assumed withdrawal rate from your portfolio. I’d suggest using one of the following:
- 2% withdrawal rate to be very conservative. It implies you will have saved 50 years of expenses in your portfolio.
- 3% withdrawal rate to still be conservative, but not quite as much. It implies 33.3 years of expenses saved.
- 4% as a reasonable baseline. It’s not too aggressive and in line with the standard advice for retirement planning. It implies 25 years of expenses saved.
To calculate, simply multiply your portfolio value by the assumed withdrawal rate. Then, divide your annual expenses by the result. Voila! What you get is how close you are to achieving financial independence expressed as a percent.
How to Calculate Years to FI
With a little extra information, you can transform the % to FI calculation into the number of years it will take you to get to 100%. You will need:
- Amount of annual savings (budgeted, prior twelve months, etc.)
- Assumption for real (after inflation) returns on your investment portfolio.
To calculate, you can use the NPER (number of periods) function in Excel, which is what I’ve done for you in the downloadable model we’ll review in Part Three. What this function does is calculate how long it will take your portfolio to grow to support your annual expenses, based on how much you’ll add each year through savings and how much it will grow through returns.
FI Model Review – Simple Analysis
Now that you’ve got an overview of the math, let’s dive into the model. The first tab is a simple analysis which shows the FI calculations at a single point in time. For a given set of assumptions, it will calculate your current % to FI and how long it will take you to get here.
Here is what you should see for assumptions when you open the model. Cells highlighted in gray with blue font are the ones you can edit.
There are four key assumptions you will need to input:
- Current annual savings (budgeted or prior 12 months)
- Real return on investments (return after inflation)
- Current annual spending (budgeted or prior 12 months)
- Current investment portfolio
In addition, you have the ability to make additional adjustments to the following:
- Birthdate (this will allow you to know your age when you will reach FI)
- Current spending (to remove one-time expenses, for example)
- Current investment portfolio (I back out 529 college savings balances in my analysis since that money technically belongs to my kids)
Lastly, I’ve included a section where you can test how potential changes to spending, savings and assets impact your FI metrics. You have to have each one set to “Y” to see the impact. Simply put in the impact to saving, spending or assets that each potential change would entail and the model will calculate a before and after impact.
There are two main output sections: one that shows the results in table form, and the other graphically. The results are the same in both. I’ve used a 2%, 3% and 4% withdrawal rate for the output, but you can change to anything you want to.
I haven’t turned on any of the potential adjustments I put in as placeholders, so none of the outputs show any change. The Portfolio Payout shows how much your portfolio would distribute for a given withdrawal percentage. The % to FI shows how much annual spending the portfolio payout will support. The Years to FI and Age at FI show long long it will take % to FI to reach 100%, based on your assumptions for real rate of return and savings. % to FI and Years to FI are also shown graphically
Since the math relies on various assumptions and estimates, I’ve also included the ability to see how different assumptions impact years to FI. The following shows how different assumptions produce different results. There are graphs showing these results as well, with how much years to FI changes from the original assumptions.
FI Model Review – Detailed Analysis
The second tab is a more detailed version of the simple analysis, where you can vary each of the key assumptions by year. The simple analysis implicitly assumes that any changes will occur for all future years, which may not be the case. This allows you to select both the year a given change would start to occur, as well as it’s duration.
Using one of my prior examples, let’s say you have a new baby this year and expect to have childcare expenses until they go to kindergarten. You could select the amount of extra spending, when it would start and how long it will occur. You basically just have a lot more flexibility for inputting various assumptions.
One other note on assumptions: since the detailed analysis allows you to track spending, portfolio balances, etc. over time. Make sure you’re treating inflation consistently throughout. In the template model, I started spending at $60,000 per year, but then assumed it would grow 2% a year with inflation. As a result, I will need to make sure my portfolio return assumption is nominal (real + inflation). If your spending assumption doesn’t include an increase for inflation, make sure you use real returns to keep the math consistent.
Since the detailed analysis shows how things vary over time, the output is updated to show how % to FI changes in response to different assumptions. The dotted line represents the 100% target finish line. Also included are graphs showing how your investment portfolio and annual spending change as well.
I hope you find this model useful for analyzing your current financial situation and evaluating actions you might take to improve your financial standing. Did the model help you get a better understanding of you finances? How close or far away from financial independence does it say you are versus what you thought?
John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.
He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.