Financial Independence Illustrated

By Pinyo, on August 31, 2007

In “Are you wealthy? Here’s a test,” I defined financial independence as: “when income from my assets can cover all my family living expenses and a few luxuries”. These words were never clear in my mind until I read Your Money or Your Life by Dominguez and Robin and saw the illustration. The authors called this the “Crossover Point.” Perhaps, this was the best graphical representation of the word financial independence.

Take for instance the graphic above. If my income (green line) is less than my expenses (red line), I can quickly accumulate debt (black line below $0). However, if I am diligent at reducing my expenses and improving my income, I can climb my way out of debt, and build assets (black line above $0) that appreciate in value and generate income. If the earnings from my investments (blue line) exceed my expenses, then I have achieved basic financial independence (the first crossover point). If it exceeds my current income, then I have achieved a more secure financial independence (the second crossover point).

Although this was simplified, it did demonstrate key ingredients of wealth building:

• Living beyond your means (i.e., income is less than expenses) create debt
• Even small amount of debt can grow quickly out of control
• Debt steals time, the most valuable component of wealth building
• Reducing expenses is the most effective way to eliminate debt and build wealth
• Effective investment strategy can help achieve financial independence quicker

Here is a look at a more realistic illustration:

There are many life events that can delay financial independence. In this illustration, I factored in key events like home purchase, marriage, and childbirths in the 30s. In the 50s, I built in additional expenses for kids’ college expenses. There are also several spikes for car purchases. I also factored in a few pay cuts which are represented by the 2 dips in income. Here, you see that both crossover points are further out.

If you are interested, here is the Financial Independence Illustrated Excel Workbook. Note that I did not separate out taxes, it was bundled into expenses. I also made some assumptions (1) debt grows at 20%, (2) assets grow at 10%, (3) income and expenses grow at 2-4%, and (4) safe withdrawal rate is 5%.

Here are a few links about Financial Independence and Crossover Point:

• When Your Income From Investments Covers Your Living Expenses: The “Crossover Point”, The Simple Dollar
• An Introduction to the Crossover Point, Get Rich Slowly
• Your Money or Your Life: Transforming Your Relationship with Money and Achieving Financial Independence, It’s Your Money

This article was featured in the 2nd Carnival of Everything Finance hosted by Everything Finance.

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Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

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