FI Explained

Last Updated: Feb 8, 2022

So what is FI? FI = Financial Independence. Gotta love acronyms. But what exactly does “Financial Independence” mean?

A pretty common definition is that you’re no longer financially dependent on your parents or some other caregiver. So basically when you’ve moved out and you’re earning money on your own – enough to pay for all your expenses. That also means you aren’t racking up credit card balances!

While this level of financial independence is an important first step, on this site we’ll be talking about something MUCH bigger. So what DO we mean?

Our FI definition: you no longer need to work for a living. At all. Ever again. You have saved and invested enough money that the income from those investments covers all your expenses.

You may be thinking: “Ha, only people who make ridiculously high salaries or win the lottery could do that. And doing it before you turn 40!?! Yeah right. Maybe if you slave away at a startup in your 20’s or 30’s and then get lucky enough to be bought by a giant tech company. And even if you get a million dollars, you’ll still probably run out of money when you’re older if you just quit when you’re 30.”

Guess what? I had those exact thoughts too. And guess what? I was totally wrong.

Changing Your Mindset

To make FI a possibility in your life, a vital shift in mindset is needed first and foremost. Most folks have the following math in their head:

How much I earn – A little bit of savings (or none) = How much I can (and do) spend

That is terrible math though. That math ensures you’ll be doing mandatory work until you’re quite old (or dead). Much better math is needed.

Lets try this math instead:

How much I spend = Amount necessary to maximize happiness / Frugality Muscle Factor

It turns out that once your income (with the assumption that you’re spending all your income) passes around $75K (give or take $10K to $20K, depending on the study), your happiness level will either flatten out or actually go down!

Notice something critical in this new equation: there is no mention of your income. Now obviously you must ensure your income is greater than your spending – you can’t spend $75K/year if you earn $35K/year (though some people do their best to try, with disastrous results). But once your income does pass the maximum happiness threshold, you really should not tie your spending to your income at all. I know that sounds insane if you’re new to this FI community, but it is so critically important to understand and implement in your own life if you want to be much happier and wealthier. Turns out that nobody got rich by spending all their money!

So let’s say you’re spending $75K a year in order to maximize that sweet spot for general life happiness. That’s still a good chunk of change. Fortunately there’s a great way to reduce that number while actually INCREASING your happiness. It has to do with what I (and many others) call Frugality Muscle. So if you have a Frugality Muscle Factor (FMF) of 2, you cut your spending in half! Woo-hoo!

FMF is really just a measure of how skilled you are at living efficiently. As you build those skills at the Frugality gym, many of which we’ll be discussing on this site, you’ll find that something bizarre and wonderful happens: your expenses start to drop like flies and your life satisfaction somehow goes UP. This process continues in a virtuous spiral upward to financial freedom.

After a while, learning how to reduce your spending without feeling any sacrifice becomes a fantastically fun optimization game. When you find a new cell phone service that cuts your bill in half while also increasing your data allotment, or you fix your own toilet for the first time and save the $100 to $200 it would cost to call out a plumber in the middle of the night, it is absolutely thrilling!

That leads to a major theme in the FI community: an incredibly positive attitude towards reducing spending and saving large amounts of money. Which I think is vital, because humans respond much better in the long term to carrots than sticks. And achieving FI is definitely more of a marathon than a sprint for the vast majority of folks, so it’s vital to use positive motivation (carrots) far more than “you should just be a responsible adult and save money” scolding (sticks).

I can tell you with 100% confidence that despite being a natural saver, it wasn’t until I found the FI community that I became highly motivated to save as much money as possible (without sacrificing happiness). Prior to that, dealing with personal finance tasks was more of an important chore: they needed to be done, but I didn’t really derive any joy from working on them. Now those same tasks are super fun optimization activities.

I also find that in the FI community, our “street cred” goes the opposite direction of mainstream society: we “brag” about how little money we spend on our lifestyle, including travel and stuff we use/buy. (Well, not really brag, but tell each other about how much fun it is.) So obviously “travel hacking” is big in this community, which allows you to spend orders of magnitude less than others to travel the world – future post!

A personal example: it’s a big point of pride to me that I drove a 1996 Honda Civic from 2004 to 2012 (8 to 16 years old) and then drove a 2004 Toyota Camry from 2012 to 2021 (8 to 17 years old), despite the fact that my wife and I could have easily purchased a much more expensive car in cash for most of those years*. During the last couple years I drove the Camry, I liked to brag about how my car was now old enough to get a drivers license, so it should be driving me around! 🙂 That’s how autonomous cars will work, right?

More points of pride for me (you may notice an electronics theme):

• The latest video game console in our house is the N64, which I bought when I was a teenager.
• Our TV is now 11 years old and still working great.
• I put together a new blazing fast desktop computer for less than $600, and maybe a few hours of (fun) work, by buying a computer (on sale of course) on Amazon that had a large slow hard drive, buying and installing a new solid state drive, and then installing Linux (Ubuntu). The result feels equivalent to a machine 3 to 5 times more expensive (that runs Windows of course).
• My wife and I got two $1000 smartphones for free – future post!

Socrates would have fit in perfectly in the FI community: “The secret of happiness, you see, is not found in seeking more, but in developing the capacity to enjoy less.”

Three Things You Can Buy

Now you may have noticed I wrote something contradictory above: I claimed that not only can you reduce your expenses by building your frugality muscles, you can also increase your happiness. But didn’t that National Academy of Sciences publication already state you achieve maximum happiness at $75K? How can you go beyond this max?

Well, I think it’s because the NAS (and most others) refer to traditional happiness metrics:

• How reliably you can put a roof on your head, food on the table, and clothes on your back, and keep you and your family safe in general
• How much and what quality “fun” stuff you can buy for yourself
• How many and what quality trips and vacations and experiences you can afford

And very often in the personal finance literature (especially in the minimalist community) you’ll find folks espousing how much more happiness can be gained by buying experiences rather than things – which in general I agree with. 

But there is a THIRD major thing you can buy, beyond more stuff and experiences: Freedom. And I would argue that after you have a roof over your head, food on the table, and clothes on your back, FREEDOM is what gives you the most happiness bang for your buck. Because even if you have a super high paying job that provides all the luxuries you can ever dream of and yet you hate your job (which you’re trapped in because you spend all your income), you’ll still be miserable nearly all the time. Even on the weekends and vacations, you’ll probably spend most of it thinking about how awful it will be when you get back to the office. 

So, as you build up those frugality muscles, you will start to save more money AND require less money in the end to fund your lifestyle. Which means you accelerate your timeline to FREEDOM. THAT is the major reason in my mind why you will likely see big happiness gains. And I believe this holds true even if you LOVE your job – because having the freedom to walk away from your job if it ever does turn bad is an insanely valuable thing to have for anyone and everyone. 

Another (secondary) reason you’ll probably increase your base happiness level by increasing your frugality strength is the satisfaction of being a more self sufficient and capable person in general. You’ll be the bad-ass who knows how to fix the sink when you’re at a friend’s house party, or who can cook amazing meals for your family for very little money, or who can travel the world for a small fraction of what most people spend on trips.

FI vs FIRE

So I think most people can get onboard with buying their freedom. Where a lot of people get hung up is the idea of full “retirement”, where you never do any work again, especially any paid work. What if you enjoy your job? What about all the studies showing that people who work longer also live longer?

You may have seen the acronym FIRE in a news article somewhere, which stands for “Financial Independence, Retire Early”. I think this acronym caught on for a couple reasons: 1) FIRE in all caps is inherently attention grabbing, and 2) the words “Retire Early” are more captivating to the general population than “Financial Independence”. 

Problem is: I don’t think anyone should fully “retire” in the traditional sense (doing nothing productive with your life at all), at ANY age. Young or old. Of course I assume you do not have a physical condition that prevents you from working – though many of those conditions are a result of sedentary lifestyle choices that can be reversed. 

Why though? Why should everyone “work” until the day they die? Especially if they easily have enough money to never need to work again (i.e. FI)?

Again it all comes back to happiness. Humans did not evolve to be unproductive for long periods of time – we really need meaningful work to achieve maximum levels of happiness. Even (and especially?) when we are older. All other factors equal, those who contribute to society in positive and impactful ways are happier than those who do not. Whether you are helping a single person with a minor project or changing the lives of millions for the better, just doing positive work leads to a far happier (and likely longer) life.

BUT, do we all need to work 60+ hours a week our entire lives? Definitely not. Achieving optimal balance of work and rest is also critical for balance. 

The problem? The standard model for working in the U.S. (and much of the rest of the world) is far closer to that 60 hour number than it should be. And yet despite these long hours, the average savings rate in the U.S. was just 7.6 percent in 2019. So people remain trapped in jobs they dislike and/or work far too many hours for.

FI provides the freedom and confidence to do not only different kinds of work that you find meaningful, but also less work if you choose. Many in the FI community regard part time work as the optimal work-life balance.

One very common refrain you’ll also hear within the FI community: even if you decide to keep working full time and for the same employer, the confidence you gain as you get closer to and then achieve FI means that you can push for doing much more of the work that you enjoy, and far less (or none) of the work you don’t enjoy. Being able to walk away if an employer is unwilling to accommodate such requests provides tremendous bargaining power: jokingly (and sometimes not so jokingly) called “F-You” money by many folks in the FI world. The vast majority of folks I’ve heard of doing this were completely successful as well – usually they work for reasonable employers that want to keep their most productive people happy, and those employers very likely realize that those people will be the most productive when doing work they love.

Two specific examples: my wife and I. My wife continues to work for a fantastic employer that gives her tremendous freedom to work on interesting projects that she finds very engaging and make use of the skills and talents she’s honed over the years. That was also true for me in the years leading up to FI and for about a year after we hit FI, at which point I left to explore a more entrepreneurial path [future post]. 

Finally, a note about social safety nets. In some countries around the world, taxes are high and social safety nets are strong. Very few people will live in poverty, but it’s also significantly harder to amass a large fortune. But here in the U.S. and many other countries, the dominant culture is one of low taxes and minimal safety nets. For example, here in the extremely wealthy state of Texas, 20.9% of people under age 65 did not have medical insurance in 2019, a statistic that I’m sure blows the minds of those living in countries with universal healthcare. The reason? Texas legislators refused to expand medicaid in the state and thus turned down billions in federal aid (for reasons I will not attempt to explain here, but I believe involve the possibility of facing slightly higher taxes down the road). Texas is also one of the lowest cost of living states in the country, and has no state income tax. My main point: if you live somewhere that has low taxes and poor social safety nets, it is even more important for you to take advantage of those low taxes to build your own safety net. Though some folks are clever and work in a low tax rate / poor safety net location while young to save a ton of money and then move somewhere with a higher tax rate / better safety net when they are earning less later in life.

In summary:

• Financial Independence does not equal Early Retirement – I believe you should do meaningful work your entire life for optimal happiness
• FI enables you to pursue work you care much more about, and to achieve better work-life balance through reduced hours if desired
• FI is even more important in states/countries with poor social safety nets, and is made easier with the low taxes that often accompany the lack of safety nets

How Much Money You Actually Need

Now let’s get back to the nuts and bolts of FI. So why all this emphasis on how much you spend? Well, it turns out that how much money you need to save for FI depends on how much money you spend! Crazy, huh?

Yet despite how obvious that conclusion is, the vast majority of the traditional retirement savings advice out there doesn’t ask you about your spending at all. The reason: they assume you spend nearly all of your income. So what do they ask for? Your highest or average income for the last X years of your working career. They assume you’ll be spending almost this exact amount each year of your retirement, for the rest of your life, despite extensive evidence to the contrary. So of course you need to save an insanely large amount of money and do mandatory work well into your late 60’s or early 70’s.

But what if we break with this ridiculous assumption that you need to spend nearly all of your income? How much money do you REALLY need to make work optional the rest of your life? Here’s another nice equation for you:

How much money you need to make work optional the rest of your life = 25 times the amount you spend each year

Now where in the world does this 25 number come from? Is that really a reliable amount? Did I just pull that number out of my butt?

Fortunately the answer is no to the butt question. Also commonly known as the “4% rule”, it states you can safely withdraw 4% of your portfolio each year (adjusted upwards a bit each year for inflation), with extremely low risk of ever running out of money (and most likely ending up with far MORE money than you started with). So if you can safely withdraw 4% each year, that means you need to have saved up 25 times what you actually spend each year (1 / 0.04 = 25). This 4% number is also called the Safe Withdrawal Rate (SWR), which you’ll find everywhere in FI and retirement literature. The original source of this 4% value is from a study done in 1998 called the Trinity Study. Obviously a ton of research regarding SWR’s has been done since then, but the 4% value has held its ground pretty well since then.

However, most folks in the FI community would agree that the “4% rule” is more of a guideline or rule of thumb than an iron clad law. There are many, MANY articles and books and videos and podcasts (and on and on) about the 4% rule, with a wide range of opinions on how “good” this rule is. Some of my favorite references:

• Mr. Money Mustache: “The 4% Rule: The Easy Answer to “How Much Do I Need for Retirement?””
• Mad Fientist: “Safe Withdrawal Rate for Early Retirees”, and his interview with Michael Kitces
• Early Retirement Now’s “Safe Withdrawal Rate” series, which dives into a ridiculously awesome amount of math regarding the SWR

In this list you’ll find a nice spectrum of attitudes towards the 4% rule, from the most positive and optimistic in Mr. Money Mustache to the most conservative and pessimistic at Early Retirement Now. Mad Fientist and Michael Kitces I think strike a nice balance between the two extremes. I myself gravitate towards the more optimistic interpretations and assumptions, for a wide variety of reasons we’ll get into in future articles.

And of course I make a giant assumption here, which I probably should have mentioned earlier: you must first know how much you spend each year! You need that number before you can multiply it by 25. So your first step on the journey to FI is track every penny you spend.

Another big caveat: your annual expenses may change significantly after FI, especially if you leave your current job to do something different. For example, if you want to focus on raising your kids, your commute and childcare costs could drop dramatically. Or if you want to travel more or start a business and know it will take a bit of money to do those things (more on how to keep those costs to a minimum in a future post though), then your expenses may increase. So actually your 25x FI number is based on a best estimate of your expected spending (with some margin of safety built in).

What if I don’t make $75K a year?

According to the US census bureau, the median household income for 2019 was $68,703. And of course 2020 brought massive layoffs and record-setting levels of unemployment with the coronavirus global pandemic. So that means there are many millions of households in the U.S. making FAR less than the $75K number I use above. And of course billions more around the world. So what does all this discussion of FI mean for them? Is it even possible?

I’m not gonna sugar coat the answer: yes, it’s definitely still possible, but it will probably be much harder for you. Unless you can increase your income (and there are MANY ways to do that), saving enough for FI early in life will obviously be much harder for you than a family clearing $200K a year. No doubt. I certainly had many years as a college and then graduate school student where I did not make much money at all – probably barely above the official poverty level actually. And I definitely did not save much money as a result – though I did find ways to save a little bit.

Assuming you have not gone into terrible debt to fund a lavish lifestyle you can’t afford (as millions of people do, even among high earners), no doubt you’ve actually been forced to find frugal solutions for a lot of life’s necessities. But again I recommend a big mindset shift to a more positive light: instead of seeing your life as just deprived of nice things, be proud of the likely extensive frugality skills you’ve honed in your life. Instead of being stuck with a cell phone that is cheaper than the more expensive model all your friends have, you’re actually just living a more efficient lifestyle than your friends.

And guess what? All those frugality skills you were forced to develop will become extremely valuable as you find ways to increase your income, assuming you’re smart and disciplined enough to keep using those skills. You will find your savings rate starts to soar, and you will find your way to FI rapidly (and most likely decades before your friends driving around in luxury cars).

Summary

Overall, the benefits of both pursuing and then achieving FI are incredibly powerful and far-reaching into every corner of your life. You will experience a significant happiness and confidence boost in both your personal and professional spheres, as your frugality and asset strength builds. I cannot recommend it enough, for everyone on this planet.

To sum up this very high level overview of FI, here are the core tenets in my opinion:

• Change your mindset: lowering your expenses is a fun optimization game that builds your frugality muscles; and once your income passes the “max happiness threshold”, decouple in your mind how much you spend from how much you earn
• Remember what buys the most happiness, above toys or vacations: Freedom
• Achieving FI does not mean you retire and never do work again – I believe you should do meaningful work your entire life
• Use the 4% rule as a guide: save 25 times what you spend each year, and you’re done with mandatory work
• To know your FI number, first you must know exactly how much you spend each year, or rather your best estimate of what your expenses will be after FI if you make significant changes (e.g. retiring)
• If you don’t make much money now, be grateful for the frugality skills you’ve been forced to learn, as they will come in handy when you start increasing your income

I know, a lot of what I wrote above will sound wildly unrealistic and ridiculous to many (most?) people. That’s OK. Exposure to what is possible I think is critical to planting seeds of hope, which hopefully will blossom later on when you’re ready. Especially for younger folks who have the opportunity to shave decades off their mandatory work career and pursue their passions for the majority of their adult lives. 

I’ve also completely skipped over numerous other ways to FI: real estate (very popular in the FI community), side hustles and passive income sources from businesses (also very popular), etc. But I think we can all agree that this post is long enough already. Future posts!

* Update about Cars, Feb 2022:

I must admit that my thinking on cars has changed a little since I first wrote this post. In general, I now think that if (and only if) you are well down the path towards FI and have enough money, getting an EV or at least a hella efficient hybrid to replace a traditional ICE vehicle is a strong health choice, for both your family’s lungs and the health of the planet. It feels more like a responsible thing to do as a result, rather than a totally irresponsible waste of money. Kind of like replacing an energy guzzling ancient refrigerator with a modern much more efficient model. Hell, even Mr. Money Mustache got an EV back in 2016 [https://www.mrmoneymustache.com/2016/10/04/so-i-bought-an-electric-car/]. 

Now does that mean you should buy a top of the line Tesla as soon as you have enough money in your bank account to buy it? No. Unless you’re a multi-millionaire, I strongly recommend finding a lower cost EV/hybrid. The Mrs and I are now driving a 2020 Kia Niro plug-in hybrid (which we only fill with gas after long road trips) and a 2020 Kia Niro EV (same color and trim and everything, it’s weird). These are exceedingly fancy vehicles for us, but we still didn’t go crazy and buy two new Teslas (which would have cost 2x to 3x more). We even bought the previous year models for additional savings (though given the chip/vehicle shortage, we had far less selection as well). Beyond preventing our kids from regularly breathing exhaust and helping the atmosphere, we also needed more space with our second kiddo (TWO giant car seats now), we wanted many of the modern safety features like back-up cameras, and we wanted to make sure we could take full advantage of the non-refundable federal tax credits of both cars (since I left my job in 2021, and we may not make enough in 2022 to pay enough taxes to get the full credit).

And I must say that the longer I’ve driven our EV and PHEV (which rarely uses gas), the more disturbing and obnoxious I find the horrendous crap pouring out of ICE cars. I’ll likely write a future post to rant more fully about this topic.