Ready To Retire By 40? 4 Steps To Financial Independence On $40K


Ignore all of the noise and fancy words like tax-loss harvesting and geo-arbitrage. They can be off-putting and make things sound more complex than they need to be.

I’m going to show you in four steps how it can be possible to reach financial independence by the time you’re 40 years old while earning $40K a year.

This is the ultimate beginner’s guide to financial independence!

FIRE has a PR problem

But first, let’s take a step back.

There is this thing called “FIRE” that’s been mentioned in some mainstream media outlets lately. This is happening both in the US where it originates from and also across the pond in the UK. It’s actually spreading quickly and there is now a global FIRE community. 

So what is FIRE?

“FIRE” stands Financial Independence, Retire Early. However, there are those who prefer Financial Independence, Recreational Employment instead. 

Surely this is a good thing. Knowledge is spreading that there is another way to live the life you want. People can learn to improve their finances. They can provide in the present whilst also preparing for the future. Great right?  

Not so fast.

The reception towards the FIRE community has so far has been mixed, to put it mildly. Just check out most of the comment sections and you’ll see what I mean.

The reasons people can be annoyed with the concept vary. Sometimes, they are literally keyboard SHOUTING as they vent their frustration. 

It has been labeled too upper middle-class, to male, too white, too unrealistic, too impractical, and even selfish. That’s right. Selfish. How dare people withdraw themselves from the workforce at such an early age! 

Truth is, I’m part of the FIRE community and I believe it has a PR problem. 

I try to avoid the term and I dare not utter the words ‘retire early’ when talking to colleagues or family. It’s as if there is a degree of shame attached to it.  

“FI” and “RE” are two different things. FI being the enabler and the RE being one of many different options you could pursue. The problem is that they are lumped together and to anyone new to the idea, it can be a massive turn-off.

I think it’s time the acronym ‘FIRE’ took early retirement.

It did its job by being catchy. It ignites the imagination and provides a hook for people to be intrigued. 

We now need to be able to relate to the average Joe. Those who might not want to retire early. Those not earning six-figure salaries. People who might have children and childcare costs to contend with

This article will do just that. It will show you in four steps how you can have the option to retire by 40 while starting on $40K a year. 

Bear with me here. $40K is not a small change. I get that. However, it is far from six figures and a more realistic figure to aim for as a starting salary for most. The reason why I want to just get that point made now is so that you can read the rest of the post with an open mind.

Since I live in the UK, I will compare the numbers between the US and the UK.

The Four Steps To Financial Independence Are: 

  1. Earn
  2. Budget
  3. Protect
  4. Invest

Step 1 – Earn

Aim: Maximize your earnings and develop multiple income streams.

Here’s the situation then. Let me introduce to you Amy and Adam. They are 25 years old and both earning an after-tax income $40K a year. Amy lives in the US and Adam lives in the UK. 

They have a student loan debt balance of $40K. 

For the first few years out of university they were getting themselves settled. They managed to pay off all their credit card debts, bought a used car for cash and lived with parents to save some money. 

Amy and Adam both annihilated their consumer debts by using the ‘debt snowball’ method.

They don’t start their financial independence journey until 25 years old with an after-tax income of $40K.

Amy and Adam clearly had parents who taught them how to manage money and not to take on too much debt. 

Amy Adam
Location US UK
Age 25 25
Student Loans Debt $40,000 £40,000
After-tax Annual Income $40,000 £40,000
After-tax Monthly Income $3,333 £3,333

It’s safe to say, they are far from rich, but not poor. 

How did they secure such an income?

Action – Preparing to get a job

They both placed themselves in the best position to be employable in a competitive job market. This does not always mean getting a degree, although for some trades that’s a necessity. 

I wouldn’t want someone to do brain surgery on me by learning through Youtube videos!

You could seek out internship programs, volunteer your time to shadow someone who works in an area you’re interested in, read and go on training courses. 

The list is endless. 

It is about self-development and improving yourself so that you have skill that are in demand. 

Skills which someone is willing to pay for.

“Make sure you have a very particular set of skills. Skills you have acquired over a very long time. Skills that make you invaluable to employers.”

That last part sound familiar?

Action – Getting A Job

This is the traditional route to earning money. A contract between yourself and your employer; you sell your time and effort in exchange for money. It’s a straight forward transaction.

However, this first step can feel disheartening at times. Be prepared for the rejection letters or never hearing back after you send your resume (CV) off. 

Remember, you only need one job out of the millions out there. Don’t give up!

After finishing university and waiting to join the Police, I needed a job to tie me over. I applied to lots! I even got turned down for a job as a binman (garbage collector). A large part of why I kept getting rejected for jobs was because I didn’t tailor each resume to the job I was applying for. 

Why would a graduate of finance want a job as a refuse collector?  Surely this person isn’t serious or there is something wrong with him. 

Looking back, I can completely understand why I got rejected so much. 

Amy and Adam were smarter than me. They were better prepared and practiced the art of crafting a resume. They knew they had to stand out from the crowd and were confident and comfortable doing so.

Once they were happy with their main resume, they went out on the job hunt. I use the word ‘hunt’ deliberately. 

Unless their skills were highly in demand and they already created a solid reputation for themselves, they knew that sitting at home in their sweatpants just wasn’t going to work. 

A job was not going to look for them. They were far too inexperienced to be head-hunted. 

They got out there. Networked, used social media, let friends and family know they were looking for work. They were being proactive and intentional about. 

They were hungry for a job!

Once they found a job that could be the right fit, they researched the company. They tailored their resume to be specific to that particular job and that particular company. 

They did this for every job they applied for.

Once they got offered an interview, they did more research. Joined forums, found people who were already with the company, got to understand the company culture and found out about the individuals who were likely to be interviewing them.

This helped them to be better prepared and be confident at the interview.

Amy and Adam clearly put in the work, smashed it out the park and got offered their jobs.

Action – Do Some Overtime, Get Promoted Or A Pay Raise

Many people on the path toward financial independence can quickly become distracted with new money making ideas. The reality is that our ‘job’ is likely going to be the source of most of our income for a while.

One other thing Amy and Adam weren’t shy about was working when there was paid overtime on offer. They were doing their employer a favor and not only were they getting more money, they were storing away goodwill for when the next promotion or performance review came up. 

Not all jobs offer paid overtime, but if they are available, they are a great starting point to earn extra income. 

They also adopted a growth mindset. A strive for continual personal and professional development. This way, when it came to the annual performance review, both Amy and Adam were in a much better position to ask for that pay raise or promotion. 

It is not about doing the minimum required and generally coasting along. If they can demonstrate that the value they add exceeds the amount that is paid to them, then it greatly improves their odds at the annual review. It places them in a much stronger negotiating position for a pay raise. 

It seems so straightforward, but I see people everyday expecting a pay raise just for turning up to work on time.

Action – Never Turn Down Free Money!

Amy and Adam understood the terms and benefits of their employer pension scheme. Yawn! Yeah, it’s downright boring! 

However, they wanted to make sure that they were not missing out on any free money from employer matching. For example, Amy put 5% of her salary into her company pension and her employer did the same. The exact percentages vary between employers and pension schemes.

If they’re in the public sector, then the amount that is contributed by their employer is likely to be even more generous compared to the private sector. 

When faced with the choice of opting out of a company pension scheme; Amy and Adam thought about it very carefully. 

They were both very tempted to opt out of the scheme because it meant more money in their bank account at the end of each month. After a momentary weakness, they snapped out of it and said to themselves: 

“I’d be stupid to turn away free money!”

They didn’t want to get used to the extra money because they knew what they would be like. They’d no longer be able to go without it and the chances of them joining the pension scheme later on would be pretty much zero. 

They started contributing from day one and learnt to live with slightly less money each month in exchange for much more money in the future. 

Action – Generate A Second Income (a.k.a The Side Hustle)

Amy and Adam were killing it at work. They were getting pay raises and contributing into their pension schemes. 

However, they were young and there was only so much Netflix they could handle before their brains turned to mush. They decide to start looking for a second income. 

Amy decided to find a flatmate and started to make some pretty good money from it

Adam on the other hand was a bit of an introvert and couldn’t stand the idea of having a stranger living with him. Instead, he started to look for a side hustle that would allow him to work from home. He’d actually become somewhat of an ebay expert

As a result, once they were in their 30s, they were both making an extra 20% on top of their salary. This was in the form of paid overtime, bonuses and side hustles

They might even decide to charge their kids rent later on in life!

Summary of Step 1

  1. Prepare well to get the job you want.
  2. Get a job.
  3. Stand out from the crowd.
  4. Maximize your salary through sales commission, bonuses, overtime, pay raise or promotion.
  5. Understand your pension scheme and take advantage of the benefits.
  6. Diversify your income through other business interests (a.k.a the ‘Side Hustle’).

Step 2 – Budget

Aim: Reduce your expenses, optimize your taxes and increase your savings rate.

From my experience, the word ‘budget’ can send shivers down many people. People see it as:

1) too restricting. We all work so hard, who wants to live life constrained? 

2) too boring. I’m weird and love spreadsheets. Most people hate them.

3) too time-consuming. Life is busy enough as it is. Sitting down once a month to go through the budget?  Ain’t no one got time for that!

4) too honest. We like to bury our heads in the sand. Ignorance allows us to continue spending. Tracking our expenses is such a buzz kill!

5) too difficult. The truth is, budgeting is a skill which needs to be taught and practiced. 

Action – Spend with intention

Every time Amy and Adam spent their money, they do so intentionally. There were no accidental or spur of the moment purchases. They had an idea of how much they spent on average each month for different things. 

It looks like this:

Type of Expense Amy (US $) Adam (UK £)
Transportation 150 150
Rent / Mortgage 700 700
Utilities 225 225
Home Repairs 50 50
Communication 50 50
Groceries 240 240
Household Goods 50 50
Clothing 25 25
Eating Out 50 50
Recreation 75 75
Healthcare 450 0
Student Loans 425 180
Monthly Total 2,490 1,795
Annual Total 29,880 21,540

Amy and Adam’s expenses are low compared to the typical American or Brit. But typical people do not have the option to retire by 40. 

Amy and Adam sure as hell don’t want to be typical! 

They intend to avoid lifestyle inflation. So as soon as they get that bonus or pay raise, most of it is immediately invested. 

Lifestyle inflation is when spending increases with income. Before you know it, the food bill is over $1k a month for a single person and you’re buying a new car every few years!

Action – Giving Money A Clear Job Description

They both budget to ensure that they do not take on any more debt. 

Amy uses YNAB (You Need a Budget). It’s a budgeting app which I’ve personally used myself and recommend when first starting out.

Adam on the other hand made his own spreadsheet which at first he updated on a weekly basis, but over time found he only needed to refer to it once a month. 

The process of keeping a budget is especially vital in the early stages of building wealth. Amy and Adam are effectively giving the money they earn a performance review.

They treat money like an employee. They make sure every pound or dollar earned is working hard to create value with minimal waste.

To come up with the above budget, they had thought about what they ‘need’ and what they ‘want’. 

Needs are things like a roof over your head; food on the table, electricity and so on.

Wants are things like eating out, socializing and holidays.

The goal in setting a budget is to strip away all the noise; all the wants. Then slowly add them back in one by one until they have reached a balance that is right for them. 

Interestingly, it would appear that Adam has the upperhand by living in the UK due to zero medical costs and lower student loans repayments. This is because student loans debt in the UK is repaid based on the amount a graduate earns. In fact, 83% of graduates never repay their loans before it is written-off by the government.

Action – Tax Optimization

With their income maximized and expenses minimized to a level they are comfortable with; that alone is not enough. Amy and Adam makes use of all the tax-efficient accounts.

For Amy, they are accounts such as ROTH IRA and 401(k).

For Adam, they are account such as ISA, LISA, and SIPP.

Once they begin to accumulate assets and their net-worth starts to grow, they will be considering the implications of inheritance tax and estate planning

Action – Staying Out Of Debt

Like Amy and Adam, I don’t prescribe to the notion of ‘good’ debt vs. ‘bad’ debt. I am of the view that debt carries a certain degree of riskiness, from low risk to ridiculously crazy risk of losing money.

Getting a car on finance would be classed as being ridiculously crazy when framed this way. As soon as someone drives that car out of the forecourt, they have instantly lost money. 

Getting rid of the idea of there being such a thing as ‘good’ debt from their mindset has helped Amy and Adam make better spending decisions.

Be careful of using the term “it’s an investment” to self justify a spending decision that is a “want” and is a depreciating asset. It’s okay to want something and to buy it. Just do it intentionally. 

Action – Geo-Arbitrage

It’s a fancy word which basically means move somewhere else that’s cheaper to live. Amy and Adam have decided to do just that. They live in a LCOL (low cost of living) area. For some, this could also mean moving abroad. Here are a few highlights when it comes to geo-arbitrage:

  • Housing Costs – this is the main cost for most. This is about moving to an area or country where accommodation is cheaper. It could also mean moving in with parents for a few years even if they charge a bit of rent.
  • Taxes – in some countries and states, you simply don’t get taxed as much. Of course, this might mean public services aren’t as good but that’s not always the case. It would depend on what you’re used to since everything is relative.
  • Childcare Costs – these costs can truly delay early financial independence dreams. But it doesn’t have to be that way. A country or state which subsidize childcare costs or even moving closer to family who can help with childcare can save thousands.
  • Education – it is an unfortunate reality that the quality of teaching can differ widely depending on the school and area. When contemplating private education, it is worth bearing in mind that they rarely provide value for money. It also holds true that education in many LCOL countries are actually much better than in the US or UK.
  • Medical – the US is infamous for its medical costs. I’m based in the UK and consider myself very lucky to not need to worry about this cost. It definitely makes reaching financial independence less complicated. The UK is not alone here; there are many countries with universal health care
  • Safety – a LCOL area does not have to mean danger. It’s about striking a balance. Moving to a country that is on the government black list is not something I would consider no matter how low the cost of living is. It’s about finding the right balance for you and your family. 
  • Earning – sometimes geo-arbitraging to a LCOL area can actually result in earning more. My point earlier about standing out and providing value to an employer can give immense leverage. Picture this. Earning a city salary, but able to work from home in the countryside, or move to the far east. 
  • Quality of life – what is important to you and your family?  Are there public parks nearby? Will geo-arbitrate result in less time spent commuting?  Is the air quality good? Is there a community spirit?

Action – Turbo Charge Savings Rate

The ‘savings rate’ is a number that provides a snapshot of how much someone saves as a proportion of their income. The higher the rate, the less they spend relative to their income and the quicker they will reach financial independence. 

Due to Amy’s health insurance and student loan repayment, her savings rate is much lower than Adam. This is a clear example of geo-arbitrage in action. If Amy moved to the UK for work or through marriage, she could eliminate her medical costs. 

Amy (US $) Adam (UK £)
Age 25 25
Monthly Total 2,490 1,795
Annual Total 29,880 21,540
Monthly Total 843 1,538
Annual Total 10,120 18,460

Summary of Step 2

  1. Be intentional with your spending – don’t be typical.
  2. Budget – give your money a clear job description.
  3. Be tax efficient – keep more money in your pocket!
  4. No such thing as ‘good’ debt.
  5. Geo-arbitrage your way to financial freedom.
  6. Maximize your savings rate.

Step 3 – Protect

Aim: Protect your path to financial independence with an emergency fund and insurance. 

This step is often neglected or missed out altogether. Amy and Adam learnt from their parents that having adequate protection is important to safeguard their path to financial independence. 

As a Police Officer, we are taught to have multiple contingency plans. In other words: what’s your backup plan to your backup plan? 

The last thing Amy and Adam wants is to start making good financial progress only for it to come crashing to a halt, or worse go back to square one because something unexpected happens. Unfortunate events in life such as losing a job and a sudden long-term family illness not only drastically increase your stress levels, but could seriously scupper plans for financial independence.

There are a number of ways to mitigate against some of these risks.

Action – The Emergency Fund

Start off with an emergency fund worth three months of expenses before overpaying on any debt. This gives Amy and Adam an invaluable safety net for surprise expenses without the need to take on any more debt. 

Once that’s done, consider increasing it to six months worth of expenses. This will help cover for larger unexpected expenses such as a period of unemployment. 

The money saved needs to be what is called “liquid”. This means it can be easily accessible. If it isn’t then it’s not much use in an emergency. 

Don’t get back into debt because of an emergency!

Action – The Freedom Fund, a.k.a The FU Fund

The Brit in me prefers the more toned down terminology of the Freedom Fund as opposed to the F U Fund. For me, this is one or two year’s worth of expenses saved. 

This is when Amy and Adam can start to feel truly liberated. A boss not giving you the time off to be with your family?  Company won’t give you a sabbatical to care for an elderly relative?  

Say hello to the freedom fund. 

It gives you the power to hand in your notice. It’s amazing how differently employers treat valuable staff who they know are willing to walk away. They will do all they can to keep them. 

There is no such thing as idle threats with a freedom fund. They can sense it in your confidence and body language. Having a freedom fund can completely change your outlook on life.

Action – Ignore The Insurance Myths

There are some in personal finance who are against insurance. Their reasons are many, but it mainly boils down to the following points:

  1. Myth 1 – Money down the drain if a claim is not made.
  2. Myth 2  – Better to self-insure by having an emergency fund and a freedom fund.
  3. Myth 3 – All policies are expensive and provide poor value.
  4. Myth 4 – Insurance companies can’t be trusted – they will try to avoid paying out by referring to tiny clauses hidden somewhere in the terms and conditions. 

Let’s quickly tackle each of these myths.

Myth 1 – remember that insurance is not an investment or a savings plan. There are certain hybrid products which try to do a bit of both, but they are generally poor value for money. Understanding what the product is aiming to achieve will help you come to terms with the fact that if you don’t claim, it has still done its job. It was there to cover you in the event of a disaster. Be grateful that you didn’t have one. Don’t wish for one! 

Myth 2 – what would you do if you had a young family and your partner was struck down with a long-term illness or worse?  What size of emergency fund or freedom fund would you need to cover such an event? Six figures at least. That money should ideally be liquid, but even if it was invested, you would be at the mercy of the markets. Maybe forced to sell during a crash. 

Myth 3 – certain policies certainly cost more than others. That’s because they cover more eventualities and therefore increases the probability of paying out. For some, it might be totally worth getting a policy that is more expensive because their circumstances are more unpredictable than most. Someone who goes skydiving every weekend will have a more expensive insurance policy. A policy that costs more than others does not necessarily mean it will always provide poor value. For some, a policy might be over-insuring whilst for others it could be just right.

Myth 4 – everyone will have heard stories about how someone had their insurance claims denied. For the most part, the story has been sold by the claimant to the news outlet. Chances are, they either failed to be truthful on their application or did not read the terms. The insurance company cannot defend themselves in the article because the information is confidential. 

How many people do you know go to the press to tell them about that time they made a successful insurance claim?  Stories about insurance claims are biased and unreliable. 

Even if a claim has been unfairly turned down, there are appeals procedures and they are rare. 

Action – Get Life Insurance

This is the main protection so I will go into a bit more detail about it. This type of insurance pays out in the event the person insured dies. 

You can go for a term level policy which pays out a set amount if you die within a certain period of time for a set premium. 

There are increasing term policies which increase the potential payout each year in line with inflation. However, your premiums will go up by at least the same percentage. 

There are decreasing term policies, which are usually taken out with a mortgage. This is when the life insurance pays out just enough to pay for the outstanding balance of your mortgage.

Finally, there is also something called whole life police. As the name implies, they are guaranteed to pay out because it covers the whole of your life until you die. These are generally poor value for money and should be avoided. They tend to be used to cover any potential inheritance tax, but there are other avenues to explore first because this is considered. 

Once you have decided on the type of policy you want: 1) Term Level; 2) Increasing Term; and 3) Decreasing Term, you then need to decide on how long you would like the insurance to run for. 

Longer term policies are more expensive. This is because as you get older, the chances of you dying increases due to ill health.

Unless you are choosing a decreasing term policy to cover a mortgage, you will then need to decide how much you want to be insured for. This is the amount that will be paid out. 

There is no set rule to decide on this, but a general loose guide is 10 times the main earner’s income. You need to decide for yourself what amount would help your family get through what would be an already difficult time. A few points to help:

  1. Cover mortgage debt.
  2. Cover other debts
  3. Cover dependent expenses, such as children until they are adults
  4. Cover education expenses for kids
  5. Cover loss of income

When taking out a life insurance policy, there are so many add-ons. These include:

Indexation – this is when you choose to have the amount of cover that increases every year based on inflation. By choosing this option, your premiums will increase by at least the same percentage as your cover increases. Any life policy with an indexation option is also called an ‘increasing term’ policy.

Waiver of Premium – this allows you to stop paying your insurance premium if you become seriously ill or disabled. In other words, you continue to be covered by the life insurance even when you cannot work.

Guaranteed vs Reviewable Premiums – guaranteed premiums mean that the premium you pay will not change for the entire duration of the policy (unless you select indexation). Reviewable premiums mean the insurance company reserves the right to review your policy every few years and adjusts the premiums you pay. Reviewable premiums tend to start off lower than guaranteed premiums but can increase significantly. It may be suited if you are currently very price sensitive but expect your income to rise significantly in the future.

When taking out insurance as couple, the natural tendency is to take out a joint policy. This is a policy which insures two lives, for example for yourself and your partner. 

However, this type of policy will only pay out once. So, in the event one of you dies, the policy pays out once and then terminates. However, when taking out single life policies instead, it means that each person being insured have their own policy. So, in the event your partner dies, the insurance pays out, but your life remains insured. This is perhaps useful if you have children. 

What I have found is that getting two single life policies works out just the same as a joint policy. 

On occasions, it has even been cheaper!

Action – Consider Critical Illness Insurance

This is a type of insurance which pays out when you fall very ill. 

What does very ill mean?  

They call is a critical illness. 

The list of critical illness changes quite regularly based on medical advances, but think of it as a very serious medical condition. An add-on you can have to this type of cover is called ‘Total and Permanent Disability’ cover. This means the insurance company will pay out if you are unable to work in an occupation which you are suited due to training, education or experience.

Action – Consider Income Protection Insurance

This is a type of insurance provides a regular payout until you retire, die or return to work in the event you become too ill to work. There are several differences between income protection and critical illness. The three main ones being:

  1. Critical illness payout a lump sum whereas income protection provides a regular income.
  2. Critical illness is usually a permanent illness whereas income protection will pay out even if the illness is recoverable. 
  3. Critical illness cover will allow one claim whereas income protection can continue even after a claim. 

Action – Consider an insurance broker

I used to think insurance brokers do not work in their client’s best interest. Surely, their interests are aligned to whoever provides the best commission. 

Whilst this can be true, it is up to you how you manage this relationship to your advantage. You would want to look for an all of market broker or a fee only broker (does not work on commission). 

I used an insurance broker when we were arranging protection for our family. 

I did my research and asked prospective brokers questions. If they stumbled on any of them, I knew they weren’t the broker for me. The terms above will hopefully give you a good head start. 

Remember that if you are interested in any of the add-ons, to ask about them. I found adding them on did not affect my premiums but every provider is different. Check!

They can also secure deals even cheaper than going direct. It was significantly cheaper for me, so much so the underwriter was surprised they offered me such a price. I negotiated hard! 

They can also liaise with underwriters directly to resolve any problems. If you find that you will be ‘rated’ (industry term for policies involving an individual with medical conditions requiring much higher premiums), your broker will explain everything to you and tweak your policy to make it affordable.

A broker is worth their weight in gold by ensuring that the policy taken out is suitable for you and will pay out in the event of a genuine claim.

Finally, if your insurance broker does not talk about a Trust, then find another. A trust is treated as a separate legal entity. Life insurance policies in the UK can be written into a Trust so that it remains outside your estate. This means it is not be subject to inheritance tax calculations. It is free to do with most big providers if you ask. 

This alone can potentially save your family thousands in tax should you need to make a claim in the future. 

If your employer provides insurance as part of your compensation package, or your pension has a ‘death benefit’ make sure you know the details. You don’t want to over-insure. However, it is worth remembering that the older you get, the more it costs to insure. So if you leave the company and go to one that no longer provides a similar level of benefit, then adding more cover onto your private policy will cost much more as you age. 

Summary of Step 3

  1. Have an emergency fund
  2. Save for a freedom fund / F U fund
  3. Ignore the insurance myths
  4. Get life insurance
  5. Consider critical illness cover
  6. Consider income protection cover
  7. Consider using an insurance broker

Step 4 – Invest

Aim: Invest wisely and with minimal fees.

Now we get to the really juicy bit. Some people skip the earlier steps and jump straight to here. 

That would be a bad move! 

Amy and Adam understood the importance of getting their financial house in order and having a solid foundation before they even considered investing. 

FI Life Stages

To achieve financial independence, Amy and Adam needed to look at life as two distinct periods (FI Life Stages):

  • Period 1 – time period when work is a necessity.
  • Period 2 – time period when work becomes optional.

Period 1 is the wealth accumulation phase of life.

To be FI, Amy and Adam will need to have net-worth of at least 25 times their annual expenses. This net-worth number is also called the FI number

The number 25 comes from what is referred to as the 4% rule of thumb. This percentage is also known as the retirement withdrawal rate, sometimes referred to as the ‘safe’ withdrawal rate. The idea is that they have invested enough so that they can spend at the withdrawal rate and not run out of money. 

Net-worth is calculated by taking to value of total assets minus total liabilities (debt). 

The number 25 is a loose guide and acts as a starting point. The number required for each individual will depend on a number of factors such as:

  1. Asset allocation (the mix of assets that make up their net-worth)
  2. The types of assets owned
  3. Length of retirement
  4. Investment costs
  5. Taxes
  6. Risk tolerance

Once someone has accumulated enough wealth by reaching their FI number, they are considered to have reached Period 2 of their life and is financially independent. 

Action – Where are you on the path to FI?

The FI Life Stage could be broken down further in 18 checkpoints. This provides an opportunity for Amy and Adam to celebrate smaller milestones and to keep themselves motivated.

See where you are and track your progress towards financial independence by taking the FI Score Test [FIST].

Action – Understanding risk

There will always be an element of risk when investing. Risk is the probability of sustaining a loss.

The return Amy and Adam get from an investment is the reward for the risk they were willing to accept. Some types of assets are riskier than others. 

The riskier the asset, the greater the potential for higher returns and losses

This is the risk and reward trade-off. 

When talking about risk, there are two components to consider. The first is something called risk tolerance and the second is risk capacity

Risk tolerance is the emotional ability to remain calm and stay the course during periods of falling prices. It is how someone copes with the ups and the downs of investing. 

I consider investments to be medium to long-term. I don’t invest expecting a return in one year.

Both the stock and property market goes through cycles of highs and lows. Knowing and expecting a crash at some point in the future helps to psychologically prepare for when it happens. 

Someone’s tolerance for risk will determine their investment portfolio. If they are risk averse (someone who think they will lose sleep at night and sell at the slightest dip), then they should own relatively less volatile assets (they that don’t fluctuate in price much). 

The cycle is inevitable and it happens because of human behavior. 

To understand why that is, I encourage you to watch the video by Ray Dalio – How the Economic Machine Works

Risk capacity is someone’s financial ability to survive an investment loss. Being able to tolerate a loss but not having the capacity (having enough money) will only result in financial ruin. A proper understanding of both tolerance and capacity are absolutely essential before anyone begins their investment journey.

So how does risk differ from volatility?  

It is really easy to conflate the two things and even I am guilty of sometimes using volatility as a proxy for risk.

Risk is the likelihood of you losing your investment because you sell at a loss. One of the main controllers over risk is you. A loss is only ever realized if you sell. 

Volatility, on the other hand, is a measure of how often and how much the price or value varies over time. 

A stock or fund can be very volatile but not that risky once time horizon is factored in. This is the benefit of investing for the long-term and having an emergency fund. You are not forced to sell when market conditions are against you. 

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” – Warren Buffett

Action – The art of simplicity

Some of the best things in life are simple. 

Introducing complexity comes with it increased costs, time and stress. 

Amy and Adam don’t own any individual shares. If they changed their minds in the future, any individual stocks they own would only form a tiny portion of their net-worth.  It’s what they call their ‘fun money’ to invest with. Money they can afford to lose. 

Even veteran fund managers do not outperform the market in the long term. For the average person, we do not have the time, nor the knowledge to choose the right company and buy it at the right price. 

So what does Amy and Adam invest in?

They invest in funds that track the performance of the entire world’s stock markets. They own the world.

It is like buying a tiny piece of every major company in the world. 

Funds which track the performance of the world’s stock market are called index tracker funds. They are passive rather than actively managed. That’s because they aim to copy the performance of a particular index or indices using predominantly computer software and algorithms. 

Active investments on the other hand use teams of people to actively manage the fund. They spend time researching, use forecasting models and their own judgement to try and deliver higher than average returns. 

As a result, active investments are much more expensive compared to passive investments. Half a percent may not seem like much, but when compounded over time; it makes a huge difference. 

“There seems to be some perverse human characteristic that likes to make easy things difficult.” – Warren Buffett

Action – Diversification: spreading your money

Amy and Adam are investing in the stock market through an index fund. This tracks the world markets so they are engaging in diversification. It means they are reducing their risk by not putting all your eggs in one basket. 

In other words, the impact of one company going bankrupt or a country going through political turmoil will only likely make a negligible effect on their overall performance. . 

They could apply this same principle by investing in other types of assets on top of the stock market, such as property, bonds or building their own business. 

This way, their wealth is not entirely reliant on one particular asset class. 

Now that I have mentioned bonds, it may benefit to briefly explain what they are. 

Bonds are like an “I O U”; a debt obligation. The return on bonds is generally much lower than stocks and shares because there is less risk. 

Bonds can be issued by companies or by governments. The more stable and trustworthy a company or government, the safer the bond will be. The safer the bond, the lower the return. 

Remember the risk and reward trade-off I mentioned earlier. 

As people approach retirement, it is not unusual to see them allocating a greater proportion of their wealth towards bonds. That is because the returns are much less volatile. 

Once retired, people tend to need the stability of not waking up the next day with 50% of their investments wiped out and having to return to work because they no longer have enough money. 

They do not have the luxury of time to wait for recovery phase of the cycle.

Action – Minimize Costs

Compound interest can work for or against you. 

No matter what you decide to invest in, keeping the initial and ongoing costs to the minimum will ensure that you do not erode any future returns. Just a 2% difference in cost can reduce your return by six figures

“The trick is not to pick the right company, the trick is to essentially buy all the big companies and to do it consistently and to do it in a very, very low cost way” – Warren Buffett

Action – Review Your Investments

Amy and Adam reviews their investments at least once a year to see how they are performing. They don’t do it everyday, because the idea is to ‘set it and forget it’. 

Two main considerations when reviewing their investments: 1) costs changes; 2) market changes. 

The first is self-explanatory. The platform they’re using may have increased their fees or the funds they are buying into are charging more. This could mean there could be better value alternatives out there. One thing to bear in mind are any exit and set-up costs.

The second element relates to rebalancing their portfolio of investments. The process of rebalancing involves buying or selling assets to get back to their preferred level of asset allocation.

This is important to ensure that the overall desired risk has not changed. 

For example, imagine they had a 40/40/20 asset allocation, 40% stocks, 40% property and 20% bonds at the start of the year. 

By the end of the year, the value of stocks have increased and the value of properties have also increased. This will mean that the percentage value of the bonds proportion would fall because of the gains made in the stocks and properties. Your new asset allocation could end being something like 45/45/10. 

As a result, their overall portfolio would be riskier than it was a year ago. They would need to either buy more bonds or sell some stocks or properties to bring their portfolio back to the original desired level.

Action – Don’t Time The Market

Don’t try to time the market. This is when someone makes a decision to buy or sell based on trying to predict the future market price of an asset (such as stocks or property). When this happens, what they are doing is speculating. They are effectively saying that they know something that the market does not already know. 

Lets say Amy and Adam receive an inheritance or have a large lump sum to invest. What would they do with it?  

  1. Keep hold of it as cash and wait for a crash to buy?  
  2. Invest a smaller fixed amount on a monthly basis (also called Dollar / Pound Cost Average)?
  3. Do they invest the whole lump sum?

Option 1 – I believe that most investors are not experts, and even experts cannot predict the future (heck, they struggle to predict the weather a few hours ahead of time!). This is not a strategy I would recommend. If they invest for the long term, even by investing at the peak would still provide healthy returns based on historical data. Time in the market is better than timing the market.

Option 2 – this strategy is called Dollar / Pound Cost Averaging. There are benefits and drawbacks to it. Investing a large sum of money all in one go requires Amy and Adam to overcome a psychological barrier: the fear that the price will drop soon and they could have bought it for cheaper. 

Instead, they split the lump sum up into say 6 or 12 equal amounts and invest on a monthly basis.

The idea is that should the markets fall over the next few months, they would have only invested a portion of your lump sum instead of all of it. 

Option 3 – whilst Option 2 has its main benefit of overcoming a psychological barrier, it is not the mathematically optimum strategy. That is because studies have shown that on a month by month basis, the market is more likely to go up than go down. As a result, the best financial decision here is to invest the whole amount in one go. Only hindsight will tell you if that was the perfect time; but in the long term, it doesn’t really matter. 

Summary of Step 4

  1. Track your progress towards financial independence
  2. Understand your risk profile
  3. Keep things simple
  4. Diversify
  5. Review your investments
  6. Don’t time the market

How Amy and Adam Can Retire By 40

Using all the above principles, this is how Amy and Adam can retire by 40 or reach financial independence really early. 

Assumptions for both Amy and Adam

Age Starting FI Journey 25
Annual After Tax Starting Household Income 40,000
Annual Income Increase 5.0%
Age Start Earning Side Hustle Income 30
Percentage Value of Side Hustle Income Compared to Base Income 20%
Inflation 2.0%
Investment Growth Rate 8.0%
Withdrawal Rate 3.5%

You’ll notice that I’ve used a conservative withdrawal rate of 3.5% instead of 4% to factor in a potentially longer period of retirement. 


Amy reaches financial independence at 40 years old with a net-worth of almost one million. Her average savings rate during this period was 49%.

Adam reaches financial independence at 38 years old with a net-worth of almost 900k. By the time he is 40, he has nearly 1.2 million. His average savings rate during this period was 60%.

Adam could afford to spend more and still reach FI by 40 if he chooses to. 

The reason for the drastic difference between Amy and Adam are due to medical costs and student loans debt. Although they had the same amount, Adam was lucky due to the way student loans are repaid in the UK.

Final Thoughts – A Life Worth Living

The individual steps to reach financial independence are easy. What’s hard is having the perseverance and patience to complete the journey. 

Earn: Maximize your earnings and develop multiple income streams.

Budget: Reduce your expenses, optimize your taxes and increase your savings rate.

Protect: Protect your path to financial independence with an emergency fund and insurance. 

Invest: Invest wisely and with minimal fees.

Following these four steps consistently and over a long period of time will pretty much guarantee a comfortable retirement.

Whether or not this will be early will depend on when you start. You can be sure of one thing though: starting now will ensure an earlier retirement then not starting at all!

We could spend all day debating the expenses and assumptions used for Amy and Adam. They are not living a life of luxury, nor would anyone consider them to be living in poverty with those expenses.

For anyone earning more or in a dual income household, then it certainly makes the journey easier. 

Remember, Amy and Adam are used to this low level of spending. They haven’t succumbed to lifestyle inflation

Our expenses are also around 20k a year despite now earning much more. I’m so used to living on our current expenses that it does not feel like deprivation at all. Every time I got a pay raise, work overtime or get some extra income, I immediately put the money to work. 

Getting to this mindset will take time and practice. I promise you, it will be worth it!

The whole point of the exercise was this:

  1. Introduce the main concepts which could allow many people to reach financial independence earlier than originally planned. 
  2. If on a low income, the principles here can still help build wealth slowly over time. Just because I can’t run a marathon, it doesn’t mean I don’t try to keep fit!
  3. You don’t have to aim for FI by 40. Choose a savings rate which you are most comfortable with. 

Time is precious. I hope the article provides you with a solid foundation to kick start your journey towards financial independence. 

No one said this would be easy. If it were, everyone would be doing it. It’s really important that you decide for yourself why you want it and your plans beyond FI.

Don’t end up with regrets that you spent too much time at work instead of spending time with the people you love. 

It’s your life, your money and your time. It’s your choice to make work optional sooner, rather than later. 

Retire by 40 Calculator

Have a play with the numbers yourself to see how you too can retire by 40. Change the fields in white.

This article originally appeared on The Money Mix and has been republished with permission.