Percent of Financial Freedom: the FI Ratio

Basics Oct 01, 2020

Closely related to the vaunted savings rate is the Financial Independence (FI) Ratio. It is a measure of how close you are to achieving your financial independence goal. To make progress towards your FI goal and eventual freedom, you need a positive savings rate. The higher your savings rate, the faster you achieve FI. Once you get over 100% on your FI Ratio, you're ready to retire – or move onto whatever big project you've been saving for independence.

There are two main ways of calculating your FI Ratio.
The simplest is to take your current net worth and divide it by your target net worth. However, I find this to be fraught with misunderstanding as net worth is a lying metric that muddies matters.
The second way is to divide your passive income by your expenses. This is more accurate, but requires a more thorough financial system than most people are comfortable enacting.
For example, if you make 1,500 USD/mo in stock dividends and 1,000 USD/mo in rental income on average, you have 2,500 USD in passive income per month. If your average monthly expenses are 3,000 USD a month, then your FI Ratio is 2,500/3,000 = 5/6 or ~83.3%

We use a variant of the first method in our finances: total investments divided by our target FI investment goal. We came up with this goal using the 4% safe withdrawal rate, our approximate expenses, and some hand waving for a safety factor. However, this is only our first revision of our goal. As we draw nearer to the goal we will need to revisit our target amount with exacting precision.

Precision is more important when you have a properly diversified portfolio with investments such as rental properties and business ventures, rather than when you're just starting off with a single asset type. Dialling in your target goal is also important so that you don't waste time waiting to pull the cord to bail on working for money.

Jumping
Photo by Ricardo Gomez Angel / Unsplash

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Mistress

Mistress of the Home, responsible for all matters financial. A loving Domme tempered with ambition and attention to detail.