[Editor's Note: The following post by WCI Network partner Passive Income MD discusses how to figure out what “your number” is. The truth is the “retirement” is not an age, it's a number, and it can be calculated. PIMD shows you how to do it here.]
The concept of financial freedom is foreign to most physicians. After all, we’re used to seeing patients and billing to create income. Simply put, we trade time for money – if we don’t go to work, we don’t get paid. In fact, most people would be surprised to find out that many physicians actually live paycheck to paycheck.
Throughout our academic lives, we’re taught that if we study hard in college and medical school, work hard in residency and fellowship, and then get a good job, we’ll be set and happy for the rest of our lives. That’s all well and good until we face the realities of medicine today: declining reimbursements, decreased autonomy, and significant numbers of physician burnout. Even job security in medicine isn’t what it used to be.
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That’s why I feel that, as physicians, the concept of pursuing financial freedom is more important today than it’s ever been. Many physicians have felt the burnout that seems to come for us all, but they feel they have no choice but to continue running on the hamster wheel at a furious pace.
What’s the Solution?
The solution to all of this is multifactorial. But there’s no doubt in my mind that becoming financially free solves a good number of these problems. If you’re not reliant on your day job for income and it doesn’t dictate the daily financial choices you make, then you can choose to practice how you want, where you want, and for whatever reason you want.
For many, the idea of financial freedom is abstract. So how do we actually make it happen? Well again, there isn’t only one way, but from my own experience, I’ve found that what works for many physicians is to create multiple streams of passive income. This can be done through real estate, businesses, etc.
In order to achieve financial freedom, one of the most important things you can do is to set a concrete, attainable goal. You need to know where you are in your journey and how soon you can realistically attain it. One way to set this goal is by calculating your Financial Freedom Number (FFN).
What Does Your Financial Freedom Number mean?
Your Financial Freedom Number is the point at which your passive income is equal to or exceeds your expenses of living. Once you’ve reached this number, again your day job (being a physician) becomes optional and along with that freedom comes the ability to make your own choices as to how you work and live.
How To Figure Out Your Financial Freedom Number
It simply takes two steps:
1) Figure out all your expenditures for the last 12 months
Some people like to use the last 3-6 months time frame, but I like to use the last 12 months. I believe this creates a better picture of your overall expenditures and evens out the seasonal fluctuations.
I use Personal Capital and it’s all automated for me and broken down by categories. However, I know some people like using YNAB or Mint.com. Others like to do it old school and put everything on a spreadsheet.
Make sure to take a look across all of your bank and credit card statements, and account for large cash purchases as well (if you can remember them).
2) Add up all these expenses and simply divide by 12
Doing this will give you your average monthly expenses. This number is also your Financial Freedom Number. If you can hit this number or exceed it with monthly passive income, then you can consider yourself financially free.
Sounds simple… because it is. But what’s amazing is that most people don’t know what their personal number actually is.
It’ll probably take you about an hour to get this done if you’re doing it by hand. But trust me, it’ll be one of the most effective hours of your life.
Again, we need to know what our goal is. Aimless running doesn’t help. Having a clear vision of the number you want to reach is the best and most effective way to make it happen.
What is the 4% Rule?
After figuring out your Financial Freedom Number, some like to use the “4% Rule” to determine what size portfolio will allow you to be financially free.
The “4% Rule” states that you can withdraw 4% of your portfolio value each year (adjusted for inflation), and depending on your allocation, but it should last 30 years with over 95% certainty. The idea is based on the often-referenced Trinity Study. Another way to calculate this is to take your yearly expenses and multiply by 25.
For example, if your expenses add up to $100,000 a year, you simply multiply that by 25, and that tells you that the size of your portfolio needs to be $2,500,000 for you to be considered financially free.
What I Do With My Financial Freedom Number
Well, I invest most of my assets in real estate so the 4% Rule doesn’t really apply to me. I also like to build up cash-flowing businesses, like this blog and Curbside Real Estate, and that’s not something you can plug into that rule as well.
So in terms of my Financial Freedom Number, the most important thing I measure is the amount of monthly cash flow I receive from streams of income outside of medicine. When that amount of cash flow eventually reached my FFN, I knew that I was financially independent from medicine.
Achieving Financial Freedom
The next step to achieving financial freedom is to take your Financial Freedom Number and determine when you want to hit that goal. The important thing is to make your goal time-bound. When do you want to “retire”?
I’ve found it’s easier if you break things up into smaller bite-sized chunks. For example, let’s say your goal is to be financially free in 15 years. If your FFN is $15,000/month, then that means by Year 5 you should aim to hit a third of that, or $5,000/month. That seems much more doable – and it could happen much faster than that.
Now that you have your short-term and long-term goals, you have to figure out how to actually reach those milestones.
As an example, let’s say you decide to use real estate as the vehicle to get you there. Assuming you’re able to get a very conservative cash flow of $250/unit per month, you divide your five-year goal ($5,000) by $250, and you’ll get 20. That’s how many rental units you need to hit your short-term goal.
5000/250 = 20 Units
Can you accumulate 20 units in 5 years? Absolutely. In fact, I’ve met people who’ve done that in 1-2 years using a combination of single-family homes to apartment buildings.
Can Your Financial Freedom Number change?
Oh yes, it can definitely change with time. What if you wanted to move to an area with a higher cost of living? Well, your FFN would have to be adjusted higher. What about the cost of education for your children? I always try to account for that when calculating my FFN.
The good news is that your passive income isn’t static as well. The income you receive should also continue to increase with time if you’ve made smart investments. For example, if you have mortgages on properties, and you continue to let your tenants pay them off, at some point those mortgages will be paid, and your income will (almost definitely) multiply.
Not only that, but the underlying assets (like real estate) will continue to increase in value as well, providing more security and comfort. In this way, you’ll be set for life.
Conclusion
If given the freedom of choice, I have the suspicion that many of you would still continue to work as physicians – but on your own terms. Maybe you’d continue to work full-time because you love it. Some physicians might go part-time and gradually retire as I’ve started to do. Others might quit altogether and pursue other passions. Whatever you decide to do, the fact that you are able to make those choices means that you’ve already succeeded.
Starting with the end goal in mind helps to set the course and allows you to correct along the way. Figuring out your Financial Freedom Number makes that goal even more specific, and gives you a concrete metric to achieve. But you also need to set a timeline for when you want to make that happen. Break it up into chunks and set shorter-term goals.
Of course, none of this will do any good if you put it off. Ultimately, the key is to get started as soon as possible. It may seem like a long journey, but it all begins with a single step.
Have you calculated your financial freedom number? Why or why not? Comment below!
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My current yearly expenses are dominated by taxes (about $100,000 including property taxes), retirement savings ($90,000), private school and college expenses ($40,000) and all the expenses of living in a big house in a posh subdivision ($50,000 with utilities on a 15 yr mortgage). Three out of four dollars that I make go to these large pots.
I set a retirement age goal of 55 and missed this. Looks like 58 for me now. I will then vest at work in their 5% 401A match (worth $100,000) and allow my youngest daughter to finish high school where she is a sophomore this year.
My expenses then dwindle to MUCH lower numbers as I have chosen to downsize our life in order to go to part time locum (vacation coverage) for a few years to cover our “freedom budget”.
My taxes drop an amazing amount making only $120,000 a year of which one fourth comes from a pension. My retirement savings will become a solo 401 or SEP, so they drop a huge amount also. The mortgage will be gone (and the retirement home paid off with equity). My private school and college expenses will be zero as college funds will have been saved. The reduction in expenses is a very large amount.
Of course, “we make plans and God laughs.” I look forward to seeing how much of this plan actually works out…
Since I am looking to be free young but not that young, I find it helpful to also calculate the number for when my kids are gone. No more 529s or tuition payments, much smaller food budget, and by then the mortgage is paid off so only covering property taxes, no more retirement savings, etc. Takes my expenses almost down to an average US household. If I can stomach lasting that long, that would also be about the time I’d have that ultimate in passive income, a military pension…
Sounds a lot like my situation, KFM.
The taxes, retirement savings, 529 plans and tuition, and mortgage are huge expenses that drop out along with disability insurance and life insurance (another $4000 gone).
I am at the beginning of my career, and I am having a difficult time calculating how much I will need to save in the context of inflation, since I plan to work for another 20-30 years. My financial freedom number now will be much higher in the future due to inflation. So if I adjust my financial freedom number upwards for inflation, how do I calculate my financial freedom number in the same context?
For example, let’s guess my annual expenditures will be $120,000 (today’s dollars). Adjusted for inflation, that number will be $222,000 in 25 years, assuming 2.5% inflation. The financial freedom number in this scenario would be $5,550,000. Assuming a net worth of zero at the outset, that means I would need to save $8,430 per month to reach this number. However, my wages now will most certainly (hopefully) be less than my wages in 20 years. Therefore, if the same proportion of income is invested now compared to 20 years from now, the amount that could be saved would increase (due to the rising wages post-inflation). How do I account for this in the calculation of how much to save?
I just always use after-tax numbers. So instead of using 8% nominal, I run my projections with 5% real.
Not gonna lie, this read like a blog-recipe-meets-generic-finance-YouTuber-meets-r/financialindependence wiki.
1) scroll past the 60% “original content fluff” that’s games the google algorithm before getting to the recipe
2) look how much I made in real estate after the housing crisis!
3) Ps follow the 4% rule!
WCI is right personal finance is kinda boring once you have the core principles down. The rest is just variations on a theme. Jim I really appreciate your truly original content over the years even if I disagree with some of your opinions on taxes.
I understand the theory behind the SWR, as well as how most people arrive at approximately 4%. It seems to be a great tool for setting goals and expectations for both one’s career and retirement.
My question is, how should I plan for taxes in retirement? What fraction of the 4% SWR would they consume? I’m sure it is different for different investment vehicles, but I rarely see taxes taken into account. If a person had a $1 million portfolio, which I’m 40,000 per year, how should they plan for taxes?
Thanks!!
They should plan to pay any taxes due out of that $40K. How much tax they owe depends on how much of that $40K comes from tax-deferred, tax-free, basis, LTCGs/qualified dividends, and ordinary income as well as other taxable income sources. Very individual. But if you were living in retirement on ONLY $40K, you’d pay hardly anything in taxes. A more likely scenario for a reader of this blog might be living on $100K and paying $10K in taxes.
I would argue the example of 20 units in 5 years is basically turning in the stethoscope to be a full time property manger.
Having managed my rental unit for the past 5 years and now on our third set of tenants the work is definitely worth the payoff. But I could not imagine expanding that workload by 20 without significantly impacting the effort required to manage the properties.
Passive income should be just that passive. Managing 20 rental units, writing and maintaining a blog are not passive activities you are basically trading in one profession for a different one.
You have very useful information for someone like me who just finished residency and plans to invest in rental properties. Could you clarify if I can use my rental property depreciation towards my W2 for tax deduction? or can the depreciation only be applied to income earned from businesses?
Hi Rameez,
You can deduct up to 25K of passive losses from you income if your adjusted gross is <100K. If your income is greater than 100K you can still carry that loss over every year. My property is still negative on the taxable income but generates a significant positive cash flow each year. As my mortgage interest drops and the rental income continues to rise I will be crossing the threshold soon and will then be able to utilize the passive losses I accumulated.\
Home that helps,
Lee
Good point that you can for lower earners.
Only toward the income from that property as I understand it, but I’d have to double check to see if it can be used against another property’s income.
If my spouse can qualify as a real estate professional, I heard that I can deduct all rental property losses against my physician income, W2. There are specific requirements to be qualified a real estate professional but this would mean big savings in taxes. Does anyone know more about this topic? or have experience using this ?
Sure, it works, but it’s a pretty high hurdle. 750 hours a year. I mean, managing one little rental property isn’t going to cut it.