This Is How Much You Need Earn on Your Investments for 'True' Financial Independence, Says Graham Stephan

Financial independence might be closer than you think.

Financial independence is the buzz phrase at the center of online communities, discussion boards, and even headlines. But what does the term actually mean? According to real estate investor Graham Stephan, the meaning of "true" financial independence is a little different from what others will tell you. Learn more about Stephan's idea of financial independence and how to calculate your FI number below.

'True' financial independence

According to a recent tweet from Stephan, your financial independence number is more than a safe rate of withdrawal. However, perspectives differ on how to calculate your financial independence number.

When it comes to the math on financial independence, some will point to the 4% rule, stating you can retire when your expenses are 4% of your total portfolio. Others will explain that you need to invest in "safe" bonds to cover your expenses.

"True" financial independence is about budgeting and returns to Stephan. He states that financial independence is "when your day-to-day expenses are covered by what your investments make."

Calculating Graham's FI number

So, how do you figure out if your situation qualifies as financial independence by Stephan's standard? A quick calculation of budget and savings.

The first step to calculating your "true" financial independence number is to look at your monthly budget. Because we want to calculate your financial independence at your current standard of living, don't take anything out of your budget. Next, calculate your annual expenses by multiplying your monthly budget by twelve. Just like that, you're halfway there!

Now, let's look at your investments. Calculate the current value of your investments. Remember to count only investments you can liquidate today, as you will need to pull funds annually to support your lifestyle. Divide your annual expenses by your liquid investments and there you have it: the rate of return you will need to earn annually to meet Graham's definition of financial freedom. Remember, you will need to earn at least this percentage on your investments every single year in order to cover your day-to-day expenses with your investment returns.

Now with real numbers

Let's do an example to bring "true" financial independence to life. Assume that you spend $5,000 per month on your lifestyle and have $750,000 in a brokerage account.

First, let's calculate annual lifestyle spending. We will include the full $5,000 per month because that is the lifestyle we would like to lead. Multiplied by 12, your annual spending is $60,000. Now we'll bring in the investments. The $750,000 represents liquid assets that we can tap to fund this lifestyle. Dividing $60,000 by $750,000 gives us 8%, the rate we need to earn annually to cover our living expenses.

Remember that risk tolerances vary by individual, and no return is guaranteed in the financial markets. However, as a rule of thumb, Graham's "true" financial independence number might be a strong place to start when thinking about financial freedom.