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Monday 1 July 2019

What's Your Financial Freedom Percentage?

A cheesy retirement stock photo. 
Whilst early retirement may not be for everyone, financial freedom is something we are all going to have to achieve.

Unless your retirement plan consists of living off your children, or seeing how many cans of baked beans you can buy with a SASSA grant (the answer is around 150), you are going to need to become financially free by the time you stop working.

Eventually the salary tap will be turned off, and you will need to find other ways to water your expense garden.

It therefore stands to reason that, one of the most important things to track with regards to our finances is our financial freedom percentage. In other words, we should all be tracking how much of our expenses our current investments would be able to cover (and I would suggest keeping a close eye on that number as you continue along your career path).

It's one of the things I track monthly on my journey towards early retirement and financial freedom. And while I do like to keep an eye on how my actual journey is playing out against my plan, my favourite chart is the the one which shows how much of my planned retirement expenses could be covered by the income my current investments could generate.

As of end June 2019, the chart looks as follows.

Using the 4% Rule, my current investments would be able to generate me a monthly income of around R4,788, whilst my retirement expenses are currently estimated at around R28,069/month.

That means, at this point in time, I am 17.1% financially free (more on this a little later).

This may leave you wondering what your financial freedom percentage looks like? Fear not, I have you covered!

The Financial Freedom Calculator

Fortunately you can calculate your financial freedom percentage quite easily, all you need is two numbers:
  1. The total value of your current investments (don’t include the house you live in)
  2. Your total monthly expenses (don’t include any amounts going towards investing or extra debt repayments)
Once you have those two values, drop them into the calculator below, and it will spit out a value indicating how financially free you are. (More detail on how the calculation works a later on.)

Total Value Of Your Investments(R):

Your Total Monthly Expenses(R)*:

You are % Financially Free
* Your current monthly expenses excluding any retirement contributions and extra debt payments
** This is the amount of monthly income your investment could generate using the 4% Rule
Share this calculator

Two Ways To Use The Calculator

Something which I think I should address a little more thoroughly, with regards to the above calculator, is what we consider our “Total Monthly Expenses” to be?

As we are plodding along at the grindstone, on our way to retirement, we may pick up things like home loans, a (usually lengthy) commute, and children (man, don’t you hate those!) These things could form a part of your current total expenses and so you will likely include them when using the calculator.

That means that, if you are one of those with a home loan, commute, and children (my hand is raised), then your current monthly expenses are, let's call it, somewhat expanded. Using these expanded expenses means the calculator will give you an answer which represents your financial freedom percentage as your situation currently stands. And this is perfectly fine – the percentage you get does accurately reflect how financially free you are according to all your current expenses at the current point in time. But it can also mean that the value you get out is a little disheartening – but fear not! Your current expenses may not accurately reflect what your actual expenses in retirement will be.

If you still have some years to go at the grindstone, many of your current expenses will become irrelevant as the years tick by. Home loans get crushed, commutes disappear, and kids get booted out the house start their own lives. So your monthly expenses once you hit retirement may look very different to when you are still grinding it out. (On the flip side don't forget that there may be additional retirement expenses like travel and hobbies which you also need to think about).

And so I encourage you to run a second set of numbers through the calculator. Re-look at your current expenses, and have a stab at imagining what they will be like once you are actually financially free. Then use that value for the total expense input of the calculator. Hopefully the number is more encouraging!

Out of interest, our current financial freedom percentage (excluding all income and expenses from our rental property) is 13.76%. That's quite a bit lower than the 17.1% figure I mentioned at the beginning of the article (which uses our estimated retirement expenses) because, among other things, I don't expect to have a bond repayment once I retire, and so our retirement expenses should be lower than what they are now.

The Maths Behind The Calculator

The financial freedom percentage calculation is actually pretty straightforward, and that’s thanks to the simplicity of the 4% Rule (a.k.a. the Rule of 300). This rule says that the amount you need in order to be financial free is 300 multiplied by your monthly expenses in retirement.

In other words, the amount of potential monthly income your current investments could give you is simply your total investment value divided by 300.

Then, to get the percentage of your expenses this income covers (i.e. to answer the question “how financially free are you?”), you just take your current investments potential income and divide it by your current expenses, then multiply all that by 100.

Like this:

That calculation is a little messy, so let's move some stuff around so that in the next step we can simplify it. So put the 100 into the top numerator and rewrite the Monthly Expenses as a fraction over 1.

Like this:

Now we can divide the 100 by the 300, which leaves a 3 in the denominator of the top fraction, and if you recall your High School Maths, we can move the bottom fraction to the top as long as we switch it around.

All that leaves us with a really simple calculation:

And that's it - the simplicity is beautiful! Your financial freedom percentage is simply the value of your current investments divided by 3 times your monthly expenses.

How To Improve Your Financial Freedom Number

In the final equation above, you will see there are only two levers to pull with regards to your financial freedom percentage. To get a higher financial freedom percentage, you can:
  1. Increase your current investment value
  2. Decrease your monthly expenses
I will admit that increasing the value of your investments seems like the far sexier way of improving your financial freedom percentage, but I want to encourage focus on the second option instead. 

Because by focusing on your expenses you can attack financial freedom from both directions!

Less expenses will immediately improve your financial freedom percentage the very next time you run the calculation. But in addition to this, less monthly expenses also means you will have more money available to invest every month, which in turn means that your current investment value will tick up faster.

So by reducing your expenses you get to pull both levers at the same time!

And then finally, because I am really nosy, I am going to ask what your numbers look like?

Anyone bumping up close to 100% (or even over 100%)?
Anyone just starting out?
Anyone half way?

I would love to hear about it - I think it will make for some interesting discussion!

Till next time, Stay Stealthy!
 - ~ - ~

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