Financial Independence (FI) means having enough income to pay for your expenses for the rest of your life – without relying on a 9-to-5 job. A financially independent person generally lives on the income generated from investments. In this article, we will cover the six basic steps for how to become financially independent in 5 years or less.
Five years is a very short amount of time to achieve financial independence. That said, if your finances are already in a good place, it’s certainly not impossible or unheard of.
1. Examine Your Finances in Detail
In order to reach FI, you need to spend less than you make. You’ll need to know exactly what you are earning and what you are spending. Take time to examine your finances in detail. Create a way to track expenses and review your spending.
2. Work to Pay Off Debt
In order to find financial freedom in 5 years, you’ll need to get rid of your consumer debt. This means paying off student loans, credit card debt, and even your car loan. By paying off debt, you’ll reduce your monthly expenses while freeing up funds to save for financial independence.
3. Cut Your Expenses
Since you’re working in an accelerated time frame to reach FI, it’s wise to cut certain expenses so you can save (or invest) even more money. Start small by cutting out impulse buys and subscriptions you don’t use. Then, work your way toward cutting down on the major expenses like groceries, bills, and even housing costs.
4. Increase Your Income
Saving and investing enough money for financial independence likely won’t happen just from cutting expenses and living a frugal life. You should consider ways you can increase your income in these 5 years to financial independence. This could look like a second job, starting a side hustle, or asking for a raise at your current job.
5. Invest Strategically
Financial independence in 5 years won’t be possible unless you invest strategically. Focus on finding the best investments to generate powerful passive streams of income over the long run. You will likely decide to max out several investment accounts each year – from your 401k to an IRA.
The FI community swears by both real estate investing and index funds as paths to generating wealth. Do your own research and develop a strategy that works for your time frame. If you need assistance, consult a financial advisor who has worked with clients that want to be financially independent and retire early.
6. Try Saving 80% of Your Income
If you want to reach financial independence in 5 years or less, your savings rate is going to need to be astronomically high (up to 80%). If you follow the steps above and truly live frugally while increasing your income, this is possible to obtain. If you can wait a few more years, then you won’t need such a high savings rate which is not realistic for many households.
Below, we will take a closer look at how we arrived at this number.
The Math Behind Financial Freedom
Reaching financial independence by a specific date all depends on your savings rate. Your savings rate is the percentage of your total income you're able to save (assuming that you need the rest of the income to pay the bills).
It’s important to note that FI relies on some major assumptions about your investments, like you’ll earn about 5% each year you’re invested (after inflation) and that you’ll only withdraw based on the 4% safe withdrawal rate. Take note that this withdrawal rate does carry risk and you may decide to pursue a more conservative number for your own FIRE journey.
How to Calculate Your Savings Rate
In order to find out what your savings rate is, you can use the following formula:
Example of Using FI Formulas
Assume you have a job that pays $50,000 a year. You've cut your expenses by so much that you only need $20,000 a year to live comfortably.
Your savings rate is ($50,000 - $20,000) / $50,000 = 60%.
Once you have your savings rate figured out, use the fast track financial independence formula below to calculate how long it will take you to achieve financial independence.
Number of Years to FI = (1-Savings Rate) / (Rate of Return on Investments)
Assuming a 5% return on investment (post-taxes), you can achieve financial freedom in:
13.3 years if you save 60% of your income;
8.6 years if you save 70% of your income; and
5 years if you save 80% of your income
Remember: This formula assumes that you're on the fast track to financial independence in 5, 7 or 10 years. As you can see from the formula, it takes an extreme savings rate to achieve financial independence in 5 years or less. (Note this is not a linear formula)
If you're on a slower, more traditional path to financial independence (e.g. 20, 30 years), it's more appropriate to use a formula that takes long-term compounding (i.e. earning interest on your interest) into account.
Our Simple Savings Calculator will tell you how long it will take to meet those financial goals.
A Word of Caution on the 5-Year Financial Freedom Plan
An 80% savings rate is not doable for most people, especially lower-income families. The 5-year financial independence plan pushes the boundaries of reality: You need to keep your well-being – and the well-being of your family – in mind.
You Still Need to Live Your Life
Often, the fast track to financial independence leads to a “scarcity” mindset. Unless you’re a single individual with no dependents or partners, you can’t always make saving for the future more of a priority than living in the present. Balance is essential.
Your Investments Need Time to Grow
Remember that your investments need time to provide returns. You want to invest in stocks or funds that you can buy and hold for 5-10 years.