Want to get a fight going? Challenge people to define financial independence.
A week ago, I estimated that a ticket out of wage slavery would cost roughly $4.5-million for a Canadian couple. This outraged some readers. They argued people can retire successfully on far, far less.
Well, sure. But I'm talking about financial independence, not retirement readiness.
Financial freedom doesn't depend on age. It also doesn't hinge on the vagaries of the economy: You're not truly independent if a couple of bad years in the market can send you scurrying back to work.
To be a stickler about it, genuine financial freedom consists of being able to live solely on dividends and interest payments – to be what the French call a rentier.
My $4.5-million estimate applies to a couple whether they're 25 or 65. It's the amount you and your spouse would need to generate the median Canadian household income by using only the dividends and interest payments generated by a low risk portfolio.
It is, of course, unrealistic for most of us to aspire to a $4.5-million portfolio. So why dwell on what I call the Financial Independence Index? Let me offer three reasons:
It's a signpost
Many investors don't realize how much the market has shifted. Ten or 20 years ago, it was possible to reap solid payoffs from bonds, even after adjusting for inflation's bite.
Not so these days. Falling bond yields have raised the cost of financial freedom to nosebleed heights.
My calculations assume you split your money equally between Canadian stocks and Canadian government five-year bonds, and live solely on dividends and interest payments. A couple who did so would have required only about $1.4-million in today's dollars to have generated a median income back in 1994. By 2004, the sweet spot had risen to about $2.5-million (again, in today's dollars).
Today, the figure stands at $4.5-million. That is one whopping change.
The Financial Independence Index provides one easy way to track the market shift. I hope we'll soon start to see the index move in the opposite direction, indicating that financial freedom is becoming cheaper.
It's a baseline
Unless my wife has been planning a truly sweet surprise for my birthday, I don't have $4.5-million quite yet. Chances are you don't either. But you can adjust the index to reflect your own circumstances, especially if you're on the verge of retirement.
For instance, if you and your spouse both worked and are retiring in your mid-60s, you will probably collect a combined total of $25,000 to $30,000 a year in government transfers such as Canada Pension Plan and Old Age Security. That gets you roughly a third of the way to the median household income I've assumed, and reduces your savings needs accordingly.
You might also conclude you can live on less than the median household income in retirement, since many big expenses, such as paying for your house and raising kids, are things of the past. Living on, say, 25 per cent less than the median means you require 25 per cent less savings.
Finally, there's a crucial distinction between true financial independence and retirement readiness: A rentier wants to have enough money to live off his or her capital indefinitely; most retirees are concerned with making their money last for no more than 30 years.
Market history suggests that withdrawing no more than an inflation-adjusted 4 per cent of your portfolio each year should ensure your money lasts three decades.
Depending on exactly how one twiddles the variables, a middle-class couple retiring in their mid-60s look to be absolutely fine with financial assets of $1-million or so. Just remember, though: That's not quite the same as being a rentier.
It puts a price on work
The Financial Independence Index tell us that it's rarely been more expensive to quit work. But the converse is also true: Working has rarely been more valuable.
Even a modest part-time job can replace the income you could expect from a sizable bond portfolio. At a time when financial freedom is expensive, your most valuable asset may be a job you actually enjoy.