What is financial independence and how can you achieve it? | Fidelity (2024)

* Financial Independence Planner Methodology

Learn more about the methodology of the financial independence planner.

Limitations of the financial independence planner
The financial independence planner (“FI Planner”) is not intended to project or predict the present or future value of an actual asset allocation or actual investments. Also, the planner should not be used as the primary basis for any investment, savings, or tax-planning decisions. The planner estimates an effective tax rate based on your total income, account contributions and take-home pay. The Financial Independence Number presented in Chapter 2 is generated through Monte Carlo simulations. These simulations are based on analysis of historical market data. The analysis considers the probability of returns that certain asset mixes might experience under different market conditions. Stocks are represented by the Dow Jones Total Market Index from March 1987 to latest calendar year. From 1926 to February 1987, stocks are represented by the Standard & Poor's 500® Index (S&P 500® Index). The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. Bonds are represented by the Barclays U.S. Aggregate Bond Index from January 1976 to the latest calendar year. The Barclays U.S. Aggregate Bond Index is a market value-weighted index of investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of one year or more. From 1926 to December 1975, bonds are represented by the U.S. Intermediate Government Bond Index, which is an unmanaged index that includes the reinvestment of interest income. Short-term instruments are represented by U.S. Treasury bills, which are backed by the full faith and credit of the U.S. government. Monthly returns assume the reinvestment of interest and dividends. It is not possible to invest directly in an index. All indices include reinvestment of dividends and interest income. All calculations are purely hypothetical and will not affect your actual accounts. Remember, past performance is no guarantee of future results. Performance returns for actual investments will generally be reduced by expenses, which may be different from those used in these hypothetical illustrations. Returns also will generally be reduced by taxes. Data entered in the FI Planner will not be shared with other Fidelity tools and will not update or override any information previously provided to Fidelity. If your financial situation has changed, you should update your information accordingly.

IMPORTANT: The projections or other information generated by the FI Planner regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use, and over time.

Chapter 1 – Savings Rate Calculation

The savings rate calculation is intended to provide an estimated percentage of your current savings rate to your total income. The FI planner assumes all contributions customers indicate they are currently making to their accounts are for savings, and that money is not used for essential or discretionary expenses. The calculation uses inputs such as current salary, other income, account contributions, takehome pay, and pay frequency to estimate an effective tax rate. First, the calculator estimates your taxes by deducting from your take-home pay and all pre-tax deferrals you might have (traditional 401(k), traditional IRA and HSA). It then divides the remaining amount with your salary. This effective tax rate is then applied throughout the calculation to gross up any after-tax contributions and/or payments made to debt, so that the calculation can correctly factor in taxes when allocating your cash flow. The savings rate calculation then collects additional inputs to identify the current accounts you have, and to determine if you are eligible for a 401(k)/403(b) and a Health Savings Account. The FI planner also asks you to provide your employer match information for your 401(k)/403(b) if you are eligible. A current limitation is the planner only takes a single-tiered match and does not account for multi-tiered match structure or non-elective contributions. Your employer match information will be used in a later chapter to allocate your cash flow. Based on your recurring contributions and frequency of contributions to all your accounts, the savings rate calculation estimates your total savings rate as the ratio of the total amount of savings in pre-tax terms to the total pre-tax income (salary and other income).

Chapter 2 – Financial Independence (FI) Number

The FI number is intended to provide a projected age at which the desired level of spending may be achieved with 90% confidence throughout the retirement time horizon (age 96). The FI number calculation takes your current age, current savings and planned contributions, and your desired retirement expenses expressed in today’s dollars (net of any retirement income) as inputs. Your monthly expenses are estimated as the difference between your income and your current savings indicated in Chapter 1. Any dollars not saved are assumed to be dedicated towards essential and discretionary expenses. Fidelity estimates that the average person will spend 15% less per month in retirement. However, if you plan to move somewhere more expensive or travel a lot, you may want to estimate 15% to 30% more. For more detail, visit Fidelity’s viewpoint. The future expenses indicated in the tool are used as inputs for the FI number and years to FI calculation. The calculated FI number then tests every year whether the estimated combined savings and contribution growth is sufficient to cover the desired expenses. Assets and contributions are grown using straight line growth rate calculations from a reference table derived with Monte Carlo simulations; the FI Planner itself is not running any simulations. Instead, the returns used to project any given year have been derived by determining the rate of return over the planning horizon with 90% confidence out of 250 Monte Carlo simulations. Fidelity uses the corresponding figure based on your planning horizon so as to err on the side of a more conservative estimate of future market performance. The simulations used to generate returns are based on a historical performance analysis of asset class returns, including a range of potential returns for each asset class, volatility, and correlation. Asset classes are represented by benchmark return data from Morningstar, Inc., not actual investments.1

  • Stocks (Domestic and Foreign) are represented by the S&P 500® Index from the year 1926 through 1986 and the Dow Jones U.S. Total Market IndexSM from 1987 through the last calendar year.2

  • Bonds are represented by U.S. intermediate-term bonds from 1926 through 1975 and the Bloomberg Barclays U.S. Aggregate Bond Index from 1976 through the last calendar year.3

  • Short-Term investments are represented by 4-week U.S. Treasury bill rates from 1926 through the last calendar year.

1. Morningstar, Inc., is an independent provider of financial information. Morningstar does not endorse any broker-dealer, financial planner, insurance company, or mutual fund company.

2. S&P 500® Index is an unmanaged market capitalization-weighted index of common stocks. S&P 500® is a registered service mark of Standard & Poor’s Financial Services LLC. Dow Jones U.S. Total Market IndexSM is an unmanaged market capitalization-weighted index of over 5,000 U.S. equity securities which contains all actively traded common stocks with readily available price data.

3. Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market capitalization-weighted index of U.S. dollar-denominated investment-grade fixed-rate debt issues, including government, corporate, asset-backed and mortgage-backed securities with maturities of at least one year.

A sustainable withdrawal rate of 3% is used to determine if the projected balance can meet your planned expenses. This rate is sustainable for withdrawal horizons up to 55 years in retirement with various investment mixes. This amount is also determined via Monte Carlo simulations to be sustainable with 90% confidence out of 250 simulations. A 90% confidence level represents underperforming market conditions, in which 9 out of 10 market scenarios the hypothetical portfolio performed at least as well as historical market averages, while 1 out of 10 times the hypothetical portfolio failed to perform as well as historical market averages. The FI number is the projected balance at 90% confidence level that is enough to cover your estimated expenses through age 96, given the 3% sustainable withdrawal rate. Balances at that age are reported in today’s dollars. The assumption of a hypothetical investment mix of 70% stocks, 25% bonds and 5% short term investments is used throughout the experience and rebalanced monthly to this stated allocation. The investment mix is for educational purpose only and does not represent actual investment performance. If you have a different investment mix, your actual results may differ. The calculator assumes you will cover estimated expenses with your savings only. Social Security or guaranteed income sources are not included in the calculation. Non-qualified distributions may be subject to taxes and penalty.

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Now, let's dive into the concepts mentioned in the article "Financial Independence Planner Methodology" and provide information related to each concept.

Financial Independence Planner Methodology

The Financial Independence Planner (FI Planner) is a tool designed to help individuals estimate their financial independence and plan for retirement. It is important to note that the FI Planner has certain limitations and should not be used as the primary basis for investment, savings, or tax-planning decisions.

The FI Planner utilizes Monte Carlo simulations to estimate an effective tax rate based on total income, account contributions, and take-home pay. It also generates a Financial Independence Number, which represents the projected age at which the desired level of spending may be achieved with 90% confidence throughout the retirement time horizon.

Savings Rate Calculation

The savings rate calculation in the FI Planner provides an estimated percentage of an individual's current savings rate to their total income. It assumes that all contributions indicated by the user are for savings and not used for essential or discretionary expenses. The calculation takes into account current salary, other income, account contributions, take-home pay, and pay frequency to estimate an effective tax rate. This tax rate is then applied throughout the calculation to allocate cash flow and factor in taxes.

Financial Independence (FI) Number

The FI Number is a projected balance that represents the amount needed to cover estimated expenses through age 96 with 90% confidence. It is calculated based on an individual's current age, current savings, planned contributions, and desired retirement expenses. The FI Planner uses straight-line growth rate calculations derived from Monte Carlo simulations to project the growth of assets and contributions. The assumed investment mix is 70% stocks, 25% bonds, and 5% short-term investments. The FI Number is determined using a sustainable withdrawal rate of 3% and is reported in today's dollars.

Limitations and Assumptions

It is important to note that the FI Planner's projections and information are hypothetical in nature and do not reflect actual investment results. Results may vary with each use and over time. The planner assumes that estimated expenses will be covered by savings only and does not include Social Security or guaranteed income sources. The planner also assumes a hypothetical investment mix and does not represent actual investment performance. Non-qualified distributions may be subject to taxes and penalties.

In conclusion, the Financial Independence Planner Methodology utilizes Monte Carlo simulations to estimate an effective tax rate, calculate a savings rate, and generate a Financial Independence Number. However, it is important to consider the limitations and assumptions of the planner when using it for financial planning purposes.

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What is financial independence and how can you achieve it?  | Fidelity (2024)


What is financial independence and how can you achieve it? | Fidelity? ›

Financial independence is based on key principles which involve spending less than you earn, saving regularly, and making smart investments. To save money effectively, it's crucial to get rid of or reduce any debts you might have, decide on specific savings targets, and pay yourself first before making any expenses.

How is financial independence achieved? ›

Make a budget to cover all your financial needs and stick to it. Pay off credit cards in full, carry as little debt as possible, and keep an eye on your credit score. Create automatic savings by setting up an emergency fund and contributing to your employer's retirement plan.

What do you mean by financial independence? ›

The talk page may contain suggestions. ( November 2013) Financial independence is a state where an individual or household has accumulated sufficient financial resources to cover its living expenses without having to depend on active employment or work to earn money in order to maintain its current lifestyle.

What can I do to become financially independent? ›

Create a budget and accordingly plan your financial journey. Start building your credit score to ensure that you have credibility in front of lenders. Make safe as well as high-return investments. Create sources of passive income for yourself.

How do you achieve financial success? ›

  1. Choose Carefully.
  2. Invest In Yourself.
  3. Plan Your Spending.
  4. Save, Save More, and. Keep Saving.
  5. Put Yourself on a Budget.
  6. Learn to Invest.
  7. Credit Can Be Your Friend. or Enemy.
  8. Nothing is Ever Free.

When can you achieve financial freedom? ›

Avoid impulse buying and unnecessary debts, and always strive to save a portion of your income, no matter how small. The golden rule is to first save and then spend rather than spend first and save later. By saving at least 10-20 per cent of your salary you can take the right step towards financial freedom.

What does financial independence look like? ›

But financial independence can have various meanings. One popular definition is having enough money to be able to stop working. A more attainable interpretation is that you don't have to rely on someone else, such as your parents or a spouse, for money.

Why is financial independence so important? ›

It also requires responsible management and control of one's finances, making informed decisions about spending, saving, and investing.” The biggest advantage offered by financial independence is that you can control the things that matter most in your life. You're beholden to no one.

How to achieve financial freedom in 5 years? ›

  1. Set Clear Financial Goals: The first step towards achieving financial freedom is to set clear and specific goals. ...
  2. Create a Budget and Track Expenses: Developing a budget is crucial for managing your finances effectively. ...
  3. Reduce Debt and Increase Savings: ...
  4. Invest Wisely: ...
  5. Increase Your Income:
Sep 27, 2023

How do you grow wealth? ›

Strategies for building wealth
  1. Create a financial plan. Building wealth starts with creating a solid financial plan. ...
  2. Start budgeting. Making a budget is essential to building wealth. ...
  3. Maximize your savings. ...
  4. Manage debt. ...
  5. Invest. ...
  6. Understand tax impacts. ...
  7. Insure your wealth.
Oct 6, 2023

Why is it hard to be financially independent? ›

It really starts with something as simple as a budget. This can be an obstacle for many. Unless you know what it costs for you to live, you won't be able to determine how much income you will need to generate to become financially independent. Your expenses, therefore, give you an income target to shoot for.

What are 10 steps to financial freedom? ›

10 Steps to Achieve Financial Freedom
  • Understand Where You Are At. You can't gain financial freedom if you do not have a starting point. ...
  • View Money Positively. ...
  • Pay Yourself First. ...
  • Spend Less. ...
  • Buy Experiences Not Things. ...
  • Pay Off Debt. ...
  • Create Additional Sources of Income. ...
  • Invest in Your Future.

What could make financially independent life easier? ›

In general, if you want to achieve financial independence, you must change your lifestyle. It may mean spending less on frivolous things, eating out less, driving a cheaper vehicle, or working a second job.

What are the 5 steps to financial freedom? ›

In order to achieve financial freedom, it is best to break down the tasks into smaller steps:
  • 1) Define your personal financial freedom goal. ...
  • 2) Create an emergency savings fund. ...
  • 3) Pay down credit card and other debt. ...
  • 4) Pay yourself first. ...
  • 5) Create and maintain a workable budget.

What is the 4 rule for financial freedom? ›

The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.

What is the 50 30 20 rule? ›

The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.


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