On the journey to Financial Independence, we gradually build up our invested assets which provide us an ever increasing stream of passive income. Dollar by Dollar, this passive income grows to eventually cover an increasing amount of our cost of living.
It is an incredible revelation when we discover that our passive income begins to cover certain living expenses; our groceries, our phone bill, automotive costs or even one of the biggest expenses: our accommodation. These milestones are incredibly motivating to see reached, and help us make our journey to Financial Independence more sustainable.
Personally, I have been very satisfied to see my passive income from my ETF and LIC investments slowly start to cover my living costs. I simply use the 4% rule and multiply my annual recurring expense by 25 to determine how much I need invested to cover it. Although we know the return from stocks is on average 10% per year, we need to tuck away the remaining 6% to account for the erosive effect of inflation and the ‘down-years’ when the market crashes.
Personally I started with my smaller expenses first, as the psychological benefit is parallel to the paying off debt using the debt snowball approach (use the smallest expenses or debts first). This way you see all the ‘little wins’ and they all add up to a massive psychological boost!
During my accumulation (working phase) leading up to Financial Independence, my costs are as follows;
- Drivers licence renewal fee ($500/10 years) = $1,250 invested
- Mobile phone bill: $150 annually = $3,750 – invested
- Car insurance: $200 annually = $5000 – invested
- Car registration: $700 annually = $17,500 – invested
- Grocery bill: $1800 annually = $45,500 – invested
- Rent cost: $28,600 annually = $702,000 – 182/702 = 26% of the way!
Before you ask, yes I am serious and yes these are my basic living expenses. As a single bloke in his twenties with no kids, this is easily doable. My electricity, gas, water and internet are packaged into my rent, and I grow about a third of my food on my balcony ‘frugal’ garden of 100 pots in a 7 square meter strip along the railing.
I do use my car occasionally, but mostly for inter-state trips to visit family, (95% of my mileage is spent on highways) or when I’m sick or lazy and its raining outside and I need to be at work for early flights. I try to offset my petrol usage by my side hustles such as ‘flipping items’, and also use this money to buy spare parts and consumables such as oil and do all the maintenance myself.
Accommodation in the working phase
I understand it is incredibly wasteful and luxurious to have an entire expensive apartment to myself and live alone at the moment (albeit it is a fairly small one bedroom affair!). However I truly value my independence and privacy after spending almost my entire working career to date in communal accommodation like university dorms or sharing in regional / rural areas.
I acknowledge I could be much more efficient with my accommodation and use house hacking principles to cut this cost or even make my living arrangement profitable – such as getting house mates or putting empty rooms up on Air BnB.
However, I currently need somewhere private to recover from the high stresses of my job, as well as work from home on projects. I value this ‘zen’ space more than I do reaching Financial Independence 6 months quicker. Ultimately, this is what being frugal is about – focusing on spending our life energy on what really matters – and this is what matters to me at the moment.
Further, as a single bloke looking to find his future wife, I think communal or sloppy ‘Bachelor pad’ living arrangements aren’t exactly conducive to dating. I want to be able to show a woman I am capable of providing and supporting a nice house-hold, which is an awesome place to relax, enjoy ourselves and base our adventures from.
Accommodation during the Retirement phase
Of course, the earlier numbers are based on the working phase and this is just a fun little game I like to play on my journey to Financial Independence.
My real FI/RE number is based on my projected costs in my retirement or ‘draw down’ phase – which certainly doesn’t include paying rent in one of the most expensive cities in the world!
Rather than my current $550 per week rental bill, I am estimating a much more reasonable $250 per week bill during my draw down.
Renting during retirement
A $250 a week accommodation allowance is more than enough to cover the rent for a very comfortable place to live in a heap of places across Australia, but of course my focus is on regional centers, and away from the bustling metropolis of inner Sydney or Melbourne.
Buying during retirement
Without sacrificing the golden goose of your index funds and buying a property outright, $250 a week is actually enough to currently service a mortgage of around $260,000, which with a typical 20% deposit ($65,000) affords a $325,000 property.
If you look around Australia, $325,000 can buy you a heck of a lot of house in the right areas. In most regional centers and even capital city suburbs, this will get you a decent 4 bedroom home on a large block; but you are probably going to need to add some ‘sweat equity’ and do some renovations to slowly bring it up to a luxury standard of living.
Further afield when looking at rural properties, even in productive areas not too far from regional centers, $325,000 can buy you up to 5 hectares (around 10 acres or 40,000 square meters) of land. This is a huge chunk of land and enough to really do whatever you want! I have seen permaculture enthusiasts able to make one acre of land (4000 square meters) productive enough to support the food needs of 25 families, without resorting to commercial growing tactics or chemical fertiliser!
House hacking during retirement
These scenarios assume I do not use ‘house-hacking’ to further reduce the cost of accommodation (or even turn it into a profitable en-devour). Simply taking on a house-mate can almost halve the bill, and it would be reasonable to assume when it came time to live with your girlfriend or partner that they would contribute their half – your joint finances are much more powerful than they would be as two individuals, and you benefit from the economy of scale and sharing.
Journey to free rent in the accumulation phase
Nevertheless, I am currently living in a posh apartment in Sydney, and its costing me a pretty penny. It is ‘sort of’ a requirement for work since I wanted to live relatively close (within easy commuting range) but if I was smarter I would have initially chosen to live closer to the airport anyway.
Since I am lazy and don’t want to move all of my stuff again, enjoy the parks, shops and sports facilities at my doorstep, and have good relationships my neighbors, and want to bring a girl into my life and be able to be romantic without the mood killer of housemates, I am happy to stay here.
I can come up with plenty of more excuses…. I am commuting on a bicycle now anyway, which is saving me a decent chunk of money that I was previously wasting doing a ‘clown car’ commute, and this helps offset the high cost of living here.
To be able to generate enough to live here using a 4% safe withdrawal rate, I need to earn and invest another $570,000. That’s a pretty big chunk of ETFs, and to be honest I will reach Financial Independence based off my optimised retirement living conditions long before I hit this number.
Therein lies the power of geographic arbitrage – even within a country or within a state! It is often said that the three golden rules of property are: Location, Location, Location!
I am currently saving and investing around $3,000 per fortnight into ETF and LICs. Starting from zero, assuming the standard 10% long term rate of return on equities, and reinvesting the dividends, it would take me just over 5 years to reach this goal.
However, when factoring in my current investments and their effect on compounding (since only about 10-20% of my total income is used to support my current living arrangement) this time-frame comes down to about 4 years, or around 20% progress per year on average.
Of course, due to the exponential nature of this compound growth, its not like a standard 20% chunk is progressed each year. Without doing the complex math, the progress could be look something more like;
- 14% in year one
- 21% in year two
- 28% in year three
- 37% in year four
Yes these numbers are pretty much irrelevant, but the concept is important. Don’t give up on your journey to Financial Independence just because you aren’t seeing massive gains within the first 6, 12 or 18 months. The power of compound interest and gains on your investments is incredible, but just like the mighty oak tree needs time to grow from an acorn, your first few years will most likely be very boring and slow progress. Your investments need time to grow.
Financial Independence progression is not linear
But thats the key; a millionaire is made $10 at a time, and finance should be slow and boring. Consistently living below your means is the key to generating long term wealth, and it is only when you get toward the end of your journey to FI will you see the massive lifting done by your portfolio; until then the hard work has to be done by you living below your means and investing aggressively!
Don’t let the Net Worth gain reports of people more established than you on their journey to FI scare you. We all started from zero, and it takes time for that portfolio to begin producing hefty returns and accelerating the journey to FI. It is not a linear process, so don’t try to track it linearly!
Realistically, in terms of optimised Financial Independence and my actual FIRE number, I use a 7% draw down as per my three-stage retirement system. With an estimated cost of living of around $1700 per month in retirement or $20,400 annually, this translates to a number of around $300K invested in ETF and LICs.
When I look at it this way, this really only means I have 19 paydays left until reaching Financial Independence; a lot sooner than the 4 years should I continue my current living arrangements!
I don’t include the equity in my investment property (or future properties) in this calculation since it is difficult to extract and live off this equity. I plan to refinance to use this equity to afford additional properties, and this is a parallel ‘backup’ plan to my dividend index stock investing. I do this to diversify my investments and as a backup retirement scheme. Over time, as inflation devalues our currency, the rents rise whilst the mortgage stays the same – this means they gradually become more cash flow positive as well as appreciate in capital value. Sometimes, a mortgage is called a ‘hedge against inflation’ for this reason.
Investing and seeing the dividend yield cover an increasing portion of your cost of living is incredibly rewarding. It can be a fun game to see just how many of your line expenses can be covered by your dividend yields, and this keeps you motivated to keep investing aggressively and keep your cost of living as low as possible on your Journey to Financial Independence.
Of course, during the working (accumulation) phase, we are still earning income from our jobs, businesses and side hustles. This should ideally cover our cost of living (which should be as low as possible) with a huge margin enabling you to aggressively invest as much of your savings as possible, as well as reinvesting any dividend yields to maximise the benefits of compound interests.