The pursuit of Financial Freedom is often criticized by financial pundits as somewhat of a pipe dream for the vast majority. That realistically it is only attainable to those with a high annual income. Meanwhile many people in the Financial Independence arena maintain that it truly is available to anyone who wants it badly enough.
So which is it? Can ANYONE really achieve Financial Freedom, or do you need to be earning six figures in order to make this a reality.
There are many factors involved in reaching Financial Freedom, but the most important number, and the one that will dictate if FF is even a viable option, has a lot less to do with your annual income, and a lot more to do with the difference between your annual income and your annual cost of living. That’s what it really all boils down to.
If the difference between those two numbers is small or non-existent, you can adhere to a strict savings plan, diligently track all expenses, live frugally, eliminate debt, and implement a myriad of financial strategies, and still not achieve true financial freedom.
For example, if John Smith has an annual cost of living of $23,000, and brings home an annual income of $25,000 (after taxes), even if John saves every penny of his extra $2000, that savings rate is simply not going to achieve early retirement. He’s just not saving enough money.
But if John considers relocating to a lower cost of living area, where he can reduce those costs to $12,500 (yes this can be done, even in the US and Canada!), while still maintaining a modest annual income of $25,000, than FF suddenly becomes a very viable option. Making some pretty conservative investment and withdrawal rate assumptions, at an expense to savings ratio of 50/50, John can expect to retire with sufficient savings in about 16 years. That’s nothing to sneeze at.
Similarly, if you are making $175,000 a year but racking up an annual cost of living of $150,000, FF isn’t in the cards anytime soon for you either. Reduce that cost of living number to a more than generous $50,000 while maintaining that income, an expense to savings ratio of about 28/72, with those same investment/withdrawal rate assumptions, FF becomes a reality in about 8 years.
All of that is why the answer to the question is not as simple as yes or no. And it’s definitely not decided by whether or not you make $75,000+ annually. It’s decided by the answer to a follow-up question, being are willing to change your lifestyle?
The quickest path to FF is to reduce your cost of living. It’s the best first step anyone can take to improve their financial situation. And generally speaking, it’s the absolute last thing most people have any interest in doing.
Which is exactly why the vast majority will never achieve FF. Not because they are failing to earn a high income, but because their desire to achieve FF simply doesn’t outweigh their resistance to change or “sacrifice” their lifestyle.
But for those who are willing, reducing your COL does two things for your overall plan.
In the short term, it widens the gap between your annual income and COL, allowing you to save more, faster.
In the long term, if you can maintain that low COL, it means you will have to save a smaller total amount of money over your working years in order to meet your retirement COL via passive income.
The second biggest move you can make is to increase your income. Yet again, it widens the gap between those two numbers allowing you to up your savings rate and build your proverbial nest egg that much faster.
If you can reduce your COL and increase your income simultaneously, until your expense to savings ratio is about 20/80 or better, those are the kind of moves that can make FF a reality within 5 years or less.
All of which sounds incredibly daunting, but when you start to evaluate your life based on your actual needs and what brings you value, living off 20% of your annual income isn’t actually such a “sacrifice”.
So if you are prepared to adjust your lifestyle to reduce your cost of living to equate to 50-80+% of your annual income, than the answer to the question of can anyone achieve FF, is an absolute resounding yes. It’s just that most people aren’t willing to do that.
[…] And what if you are barely hitting the middle class scale in your area? Well, honestly speaking if you are making a total family income that is on the low end of the middle class threshold, I won’t go so far as to say that you can’t achieve FF, but it will take much longer. This is simply because there’s a threshold for what you require to live reasonably whether you make $30,000 or $300,000. If you live in an area where a reasonable lifestyle costs $30,000 annually, and you only make $50,000 per year, it’s going to take you a long time to save enough money to generate the required income to sustain a $30,000 lifestyle in retirement. If that’s you, and FF is where you want to go, you need to start heavily analyzing how you can increase your income (which we’ll talk about in the next post). […]