Financial independence is an enticing concept, that spawned a popular movement with its own jungle of lifestyle possibilities, methods and acronyms. It is based on the perception that the traditional working life as an employee, often characterized by dependency and consumerism, ending with retirement at 65 (or thereabouts) is very suboptimal for many people. It also often implies that happiness comes automatically when reaching a magical number of assets (your FIRE number), that will enable you to leave it all behind and completely change your life from one day to the next – be financially free and never look back. To reach this point you either need to save and invest an enormous amount of money or change your lifestyle to dramatically reduce your spending – or a combination of both.
This approach can be quite extreme, especially if you want to reach your goal quickly and increase your savings rate while cutting your spending by an amount north of 50%. A lot of people may dream about it, but few actually put it into practice as it means being very different from your peers and to live very frugally or at least way below your means, which is very hard to do.
While I understand the attraction of the idea and share a lot of the values it is based on, I don´t see it in such a black and white fashion. I think the all-or-nothing approach has reasons that are largely structural and I will describe how I try to find some workarounds to be able to incorporate a lot of the concepts in my everyday life – gradually over time.
Inflexible Structures
In its classic form, whether by society´s conventions (retirement) or by your own design (financial independence), an abrupt change in states from working life to retirement is happening from one day to the next. This structure almost implies that one is unhappy with either one or the other, or (mal)content with both.
To visualize this, I look at it as a scale where one starts at working to cover one´s spending and debt plus saving for retirement. In the graph below this translates as earning about 125% of what you actually need to cover your cost of living, as, for example, an average European employee´s financial situation might look like, where the deposit into the state pension system amounts to roughly 20% of income and 5% are saved.
Actual financial independence is zero at the beginning of your working life and you have to continue working full time. This is buffered slightly by personal savings, but only with a much higher savings rate would they actually provide a way out.
At age 65 (or thereabouts) the scale jumps to 100% of your spending being covered by retirement income – which might mean cutting your spending, because retirement income often falls short of what you earned before (and it implies that the pension system of the country you live in is still solvent by that time).
Jumping from full employment to retirement from one day to the next
To speed up the process you can ramp up the percentage of money you save; for example you could earn twice as much (or more) as you actually use; save and invest 50% and be financially independent in about 17 years. This is a faster track for a young person, but the jump from one side of the scale to the other is essentially the same. During the process you could feel like you´re in a real slog or be highly motivated to reach your goal – in any case you are not where you actually want to be for all that time.
A much better solution for me personally would be to gradually move along the scale from left to right, reaching small goal after small goal, to find an equilibrium that is very positive or even optimal at any given time. The process of becoming ever more independent is in itself the source of great satisfaction and fulfillment comes from implementing changes continuously. By looking at the process as a goal in itself, it´s possible to stay flexible and follow whichever serendipitous path opens up – as ideas and goals about life are not fixed.
The next graph shows my personal goal – the golden middle of semi- financial independence. It would incorporate about 90% of what is valuable about the concept to me. The most important are: the freedom to pursue anything of interest; independently valuing pursuits for their own sakes (not by their compensation) – whether it is time spent with family and friends, learning, new ventures, social commitment, travel, „useless“ ideas etc. – being open to new paths in life; the freedom to say no…
The goal is never to retire at all, but rather continue working indefinitely on all the things that I´m interested in – with monetary compensation as a motivational factor, but not a necessity.
In practice implementing financial independence gradually may be quite difficult to do in many employment situations as it is hard to communicate to a boss that you have saved a good amount and are ready to switch to a 9/10th job now, for example. But I can see this rigidity changing around me (e.g. a teacher at my son´s school took several years of 5/6th pay to go on a one year travel sabbatical) and I have a hunch that the structure of employment and working life will go through fundamental changes in the near future. How to use these changes for your benefit (rather than being afraid of them) is what the next part is about.
My path
I want to explore the possibilities to align different models of a working life with my personal ideal for living – rather than setting the goal at not having to work for a living at all.
Whether by luck or design I´m not sure, but I have to admit I have never had a job (except a paper route as a teenager) nor a boss, but have always been working as a self-employed photographer. While that is not the easiest path to take and I probably make a lot less money than many of my friends who have entered and risen in the corporate world, it has enabled me to model my own business to align with my interests – constrained, of course, by my family´s financial needs.
Being creative, traveling the world to take breathtaking pictures, that sounds like a perfect goal already, doesn’t it?
Well, of course the reality of running a photography business is a bit different – what you actually are is a creative service provider. While you don´t have to share office space with a boss, in the end you still depend on your clients. To be sure, I love the essence of my work, but I don´t think clients or even a commercial orientation are necessarily very conducive to visual creativity, nor will it likely result in the highest quality work – a lot of the focus is on whether it sells not if it is actually creative.
A dearth of jobs during the financial crisis and a greatly reduced appetite for creative risk on the client side that you can still feel today (translating into more superficial work), nudged me and my partner quite unwittingly onto the road towards greater independence.
We completely changed our business model and became independent creators of creative content, utilizing a royalty model to sell our work, produced at our own risk, through different agencies. We transformed our working reality from dependence to increased self-reliance and creativity, with new possibilities (and need) for development opening up. Instead of trading time for money, we created an income stream that continuously works in the background, leaving us free to create content on our own terms – scalable according to our financial needs.
We completely changed our business model and became independent creators of creative content, utilizing a royalty model to sell our work, produced at our own risk, through different agencies. We transformed our working reality from dependence to increased self-reliance and creativity, with new possibilities (and need) for development opening up. Instead of trading time for money, we created an income stream that continuously works in the background, leaving us free to create content on our own terms – scalable according to our financial needs.
Study – Work cycle
What if we live much longer than previous generations, for example through new medical technologies? We would need a model that accounts for an indefinitely long retirement time and rethink the course of our working life. These are thoughts that I find very endearing, because they open up so many invigorating possibilities and ways to think out of the box that are beneficial – even if reality turns out to be less utopian.
Instead of the classic linear model: study – work – retire, we could look at it it as a cyclical process of life-long learning and earning: study – work – study new stuff – work – study – work. Or even better: do both simultaneously and go into whichever direction our interests carry us. This requires a lot of flexibility, but would also be super exciting. It also poses new questions as to how to structure work itself and also how to finance our lives with a lot of financially unproductive downtime.
From New York to Hollywood
In our work as photographers we often assemble temporary teams to work together on a project basis, a concept I have since come across as a model an ever greater part of the economy is shifting towards – dubbed the „Hollywood Model“:
A team is assembled for a unique project and works together as long as is needed to complete the task, then the team disbands. This project-based business structure is an alternative to the classic „ New York“ corporate model, in which capital is spent up front to build a business, which then hires workers for long-term, open-ended jobs that last for years.
This model enables us to structure our working life around short-term, project-based teams rather than fixed jobs. We can change our expertise over time, even radically so, if we wish.
Not doing so might even turn out to be a dead end – depending on what you do. Here is an interesting app to estimate the chances of your job being automated away soon. (plugging in “photographer” it came up with only a 2,1% chance of being taken over by robots – pretty save, not? Unfortunately it doesn’t account for the amount of de-professionalization going on in the space. I can´t tell you how often I have recently come across the „talented colleague“ within the client´s company perfectly adequate to do my job! A large part of the photography business has essentially become commoditized through advances in technology, that are continuously lowering the barriers to entry.)
Not doing so might even turn out to be a dead end – depending on what you do. Here is an interesting app to estimate the chances of your job being automated away soon. (plugging in “photographer” it came up with only a 2,1% chance of being taken over by robots – pretty save, not? Unfortunately it doesn’t account for the amount of de-professionalization going on in the space. I can´t tell you how often I have recently come across the „talented colleague“ within the client´s company perfectly adequate to do my job! A large part of the photography business has essentially become commoditized through advances in technology, that are continuously lowering the barriers to entry.)
The Hollywood model has the great advantage of enabling us to flexibly scale the amount of money we earn and work we do, according to our needs and to easily make time to branch of into new areas of engagement and learning – something that is often hard to do within a classic job structure.
Personally, I have recently split my efforts into two fairly equal parts: running my photography business (which, after several years spent building it up, cruises along on its royalty model fairly smoothly) and professionalizing my investment activity – an area I have found immensely interesting and challenging for a long time. I spend about half my working hours on this endeavor, researching and implementing systematic investment & trading strategies, as well as writing about the process.
Role of Investing
This naturally leads me to take a much more active approach to investing, than is usually the case when looking at financial independence models. In all honesty, it is also as time consuming and demanding as a second job.
I don´t depend on my savings to finance my retirement for the rest of my life, because I see other areas of income as a permanent (and motivating) part of my life. Also I am able to scale my earnings up and down according to my needs and can therefore be much more aggressive as an investor without fearing large drawdowns as being devastating to my financial health.
At the same time I see acquiring extensive investment skills as a long-term value – something my photography skills might not be (everyone takes great pictures nowadays, right?).
How much money do you actually need?
The classic rule to achieve financial independence is to save 25-30 times your annual spending requirements, invest in a classic stock / bond (e.g. 60 / 40) portfolio and live of the proceeds at a 4% inflation adjusted withdrawal rate (3% to build in an additional safety net).
This is quite a conservative assumption as it is likely to work over 95% of the time (taking history as a guide) and you don´t ever have to earn another penny. In fact a laddered, 100%-TIPS (inflation protected bonds) portfolio yielding 3% real (if we ever reach that level again) would sustain a 5% safe withdrawal rate over a 30-year period with much less volatility.
The greatest danger, that I can see, is that you are most likely to reach the coveted FIRE number in the run up towards the end of a bull market (because your invested assets gain a lot of value), exactly when asset prices are inflated and expected returns are at a low point (like right NOW for instance). Living through an extended drawdown right after jumping the gun might proof to be quite traumatic and possibly jeopardize a well thought out plan. Better to wait and see a little bit longer and add a cushion to your savings until your investments survived the first bear market (S&P 500 down more than 30% as a rule of thumb).
Changing two parameters could dramatically alter the equation
The first is easy: What if things don´t go as planned and I will have to earn an additional penny or two – so what? I think it is actually preferable to still earn a part of your income actively well beyond your 60´s and pursuing new interests is likely to lead to new earning possibilities as well.
You can plug in your preferred numbers into a retirement calculator. For example, if you have saved 10 times your annual expenses, you can switch to a half-time, half-pay job (or even less as you can reduce saving) and you won´t have to ramp up the amount you earn ever again with a probability of over 60%. If you start doing this during a prolonged bear market, the chances that your assets will grow considerably are actually pretty high.
You can plug in your preferred numbers into a retirement calculator. For example, if you have saved 10 times your annual expenses, you can switch to a half-time, half-pay job (or even less as you can reduce saving) and you won´t have to ramp up the amount you earn ever again with a probability of over 60%. If you start doing this during a prolonged bear market, the chances that your assets will grow considerably are actually pretty high.
The second is harder, but doable: invest intelligently with extra skill (acquired through thorough learning and research) to increase your risk-adjusted returns, which will influence the outcome immensely.
- A relatively straight forward approach would be to diversify your asset allocation globally across all asset classes. Taking history as a guide, this should add an extra percentage point or two to your returns on average while reducing portfolio volatility even more – boosting risk-adjusted returns by about 50% – with only a yearly rebalancing effort. This could increase your sustainable withdrawal rate and therefore reduce the necessary capital by about 25% (I´m using half the increase of risk-adjusted returns as a rule of thumb, as the 4% withdrawal rule equals about half the long- term annual return of a 60 / 40 portfolio).
- A more active approach could add return enhancing factors to the mix (value and momentum preferably) and use a trend- following overlay on a global portfolio to increase returns and, most of all, achieve bond-like low volatility. If the future does indeed rhyme with the past and you are able to avoid mistakes, this approach could double your risk- adjusted returns and make withdrawal rates of 6% achievable – cutting the capital base you need by 1/3rd to about 17 – 20 times annual cost of living. (A thorough analysis of momentum effects in the context of retirement withdrawals by Blue Sky Asset Management supports this view).
Pushing it to the limit
As I really love all that investment stuff, I take it one step further. I invest in a portfolio of systematic strategies, adding additional elements and a small amount of leverage to the approach described above. This is an aggressive, high risk approach (you can even call it a lot of work) – quite the opposite of the conservative financial independence idea – but it would make withdrawal rates of 8% a realistic chance.
This leads to a minimum capital base of 12,5 times annual spending to reach financial independence – or just half that for the semi-retirement, I think is optimal.
This leads to a minimum capital base of 12,5 times annual spending to reach financial independence – or just half that for the semi-retirement, I think is optimal.
This may sound crazy to some, but well below an achievable limit for others – there are a lot of very extreme (unrealistic?) return expectations touted out there. These numbers are what I distilled from my research and there are plenty of (professional) examples where it was actually done over decades.
In practice, to build in a margin of safety and retain growth potential, I would aim at 12,5 times annual spending saved as a capital base to support semi-retirement. Half the investment returns would be dedicated to consumption, the other half to grow my investment capital.
And if that fails? Well, I guess I will produce more beautiful pictures and create additional streams of income….