You will be able to explain how a financial independence number is built from yearly spending and a withdrawal rate.
Ask people what their financial independence number is and you often hear a round figure: a million dollars, two million, whatever a forum post or a friend once said. A round number is easy to remember. It is also built on someone else's spending, someone else's country and someone else's pension system, so for you it is almost certainly wrong, either too high or too low.
Your number has a simple definition. Your financial independence number is the amount of invested money whose sustainable yearly withdrawals would cover your yearly spending. Two inputs decide it: how much you spend in a year, and how much you can safely take out of your investments each year without running out. The second input is the subject of the next module. This lesson is about the first.
Notice what is missing from that definition: income. Two people earning the same salary can have very different numbers, because one spends most of it and the other spends half. Income matters for how fast you get there, because it decides how much you can save. It does not decide where there is. Spending does.
This is why the number is so sensitive to spending. Suppose, as a made-up example, you plan to withdraw 4% a year. Then every 1,000 dollars of yearly spending needs 25,000 dollars invested to support it. Cut a 3,000-dollar yearly subscription and phone bill habit and you have lowered your number by 75,000 dollars. No pay rise does that as cheaply. The same maths works against you: a lifestyle that grows by 10,000 dollars a year adds a quarter of a million to the target.
That is also why a guess is not good enough. Most people underestimate their spending, because the items they remember are the regular ones: rent or mortgage, food, transport, phone. The items they forget are the lumpy ones: a wedding gift, a car repair, a holiday, a new laptop, an insurance premium paid once a year. Those can add up to a large share of the true total, and they will not stop when you stop working.
So the first step is to find out what you actually spent over the last twelve months. Your bank and card statements already hold the answer. Total them up, include anything paid from cash or another account, and compare the result with the figure you guessed first. The gap between the two is useful information in itself.
You will not use that figure as it stands. Over the rest of this module you will split it into essential and flexible spending, because the two are treated differently in a plan. Essential spending has to be covered every year, whatever markets do. Flexible spending can be trimmed in a bad year, and that flexibility is one of the strongest protections a plan can have. You will also adjust it for life after full-time work, because some costs fall when you stop working and others rise.
In Singapore a few of those adjustments are large. Your salary stops, and so do the CPF contributions and income tax that come with it. Employer group insurance ends, so medical cover becomes a cost you pay yourself. Insurance premiums rise with age. And CPF LIFE will eventually pay you a monthly income, which reduces what your own investments must cover later on. Module 3 shows how to build that into the number.
By the end of the module you will have a spending base you can defend, at today's prices, and a first number that is yours rather than borrowed.
Your task: write down your best guess of what you spent in the last twelve months. Then total your actual spending from your bank and card statements, and write both figures side by side.
Write down your best guess of what you spent in the last twelve months, then check it against your bank and card statements.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).