Just so that we’re all on the same page I’ll write a small introduction to Financial Independence for those that didn’t encounter the term before.
Financial independence: When you live in a way so that you don’t have to go to work to support your lifestyle.
This can be done in a few ways in Denmark:
- Bonderøvsstyle: Buy and pay off a small property then live off the land. Trade certain commodities for what you need.
- Traditional retirement: Work for 40-50 years and then live on a combination of folkepension (public pension) and your savings.
- Investor: Save a large portion of your income. Invest it and live off the interest.
I didn’t list kontanthjælp (unemployment benefit) even though that is a way to live without a job – but you’re not independent while on kontanthjælp. You must attend meetings, write job applications and generally jump through hoops all the while living on a small amount of money. While there absolutely nothing wrong with 1. or 2. neither are for me. I still think there are a ton to learn from both.
Regarding 1.: I don’t aim to be independent of the labor market only to then rely on getting a good harvest. I think that direction is noble (reduce consumption, reduce environmental impact etc.) but I don’t think it is very freeing. Instead of working hard and relying on paychecks from the corporate world you now work hard and rely on nature to play its part and not throw any wildcards your way. And while it is freeing to be your own boss I think it’d be far more work than I do now. What we can learn from people pursuing this lifestyle is that most modern amenities are just luxury. If push came to shove do we really need cell phones, fancy cars, imported Italian wines etc. to survive. Although we may want all those things it illustrates that most of our work could be eliminated right away if we didn’t feel the need for all those luxuries.
Regarding 2.: I actually might end up working till I’m 70. Given that I keep working jobs I like and with the flexibility I crave then I don’t see anything inherently bad with work. What is inherently bad though is the NEED to work to sustain your lifestyle. So instead of working for 40-50 years all the while being on the edge of the seat every time there is a recession, losing sleep speculating if I can afford house payments if I’m laid off I plan to get ahead of that. Not only do I not want to be tied to the job by my bills, but I also want to make sure that I do have enough funds socked away to last through retirement no matter if it ends up being 5 years or 40 years.
So, 3. it is. “Is it even possible?” you may ask and yes, it is. “Do I need to earn millions of crowns a year?“, “Will I have to live in my parents’ basement and eat only potatoes and cabbage?” and “Why doesn’t everyone do it?” you may follow up. No, no and because you must make some sacrifices along the way. The key insight is that neither your actual earnings nor your actual spending has any influence on how long it will take to invest your way to financial independence. What matters is rate at which you save. Yes, that’s it. If you are a waitress and earn 15,000 post tax and you invest 6,000 of that (saving 40%) then it will take you roughly the same amount of time to become financially independent as it will for a CEO earning 50,000 a month post tax and investing 20,000. The difference is that the CEO can afford a lot more luxury on the 30,000 she spends than you can on your 9,000. So, while it’s definitely easier to save more on a CEO’s salary than a waitress’ what you need to focus on is your savings rate.
Savings rate and its profound effect
The reason savings rate is the important metric is that not only does it reflect that you save and invest a big portion of your assets it also reflects that you can live on a lower amount of expenses. To illustrate this point rather simplistically the time until you are financially independent as a function of your savings rate (in Denmark):
- 10% 55 years
- 20% 42 years
- 30% 33 years
- 40% 27 years
- 50% 22 years
- 60% 17 years
- 70% 13 years
- 80% 9 years
- 90% 5 years
As I said this is oversimplified with a set of basic assumptions, but let’s look as an example of how this works for a 50% savings rate. Let’s say you make 240,000 post tax each year and spend 120,000 (or 10,000 kr a month). You invest the other 120,000 in stocks. After 1 year you have 120,000 invested. After 1 more year (2 years total) your initial 120,000 of stock has gained value and is now worth 120,000*1.06=127,200 kr and then you invest this year’s savings of 120,000 and you have a total of 247,200 kr invested. After 1 more year (3 years total) your 247,200 has again gained 6% in value and is not worth 262,032 kr and then you again add another 120,000 to your investments for a total of 382,032 kr. Let’s quickly do this for another 19 years and then you might have around 5,200,000 kr. Now you are finally financially independent. According to a study called the trinity study you can now proceed to pull out 4% (5,200,000*0.04=208,000 kr) a year with less than 5% chance of ever going broke. So, if you want you can then stop working and just each year pull 208,000 kr out of your investments which is about 128,000 after taxes – just a tad more than your expenses.
You can see that to actually become financially independent before traditional retirement age you must invest a significant portion of your take home income and that is why it is not for everyone. It is obviously easier to just work until retirement; spend everything you earn along the way and then try to make do with your arbejdsmarkedspension and your folkepension. But it is still quite possible to attain financial independence in Denmark and while those savings rates might seem absurd to you now most people could get there rather easily if they avoided lifestyle inflation. While we can all agree that it isn’t exactly fun to live on kontanthjælp we also know that it can be done – and if some people can live on say 8,500 a month what is your excuse for spending double that. It may be that you just need that new iPhone and that is fine if you want to live on the terms of the labor market for the rest of your working years. I am not here to condemn your way of life but I just want to inform you that there is another way.
Traditionally in our society people work for many years and save some money in their house, in retirement accounts and in their bank accounts and then retire and gradually spend those funds along their folkepension so that when they die they either own nothing or a little bit. You could say that those people are financially independent at their time of retirement – they no longer have to hold down a job just to continue supporting their lifestyle.
It is hard, but not that hard to FIRE
Although the time lines outlined above might be discouraging there are a few factors that help us. I’ll try to list some of them but I invite you to contribute even more:
- First of all, you don’t have to achieve financial independence as such to succeed. Even if you just manage to save half of what is needed that might allow you to only work part time for the rest of your working life or allow you to take 3 years off to start a business – you will almost never regret money saved.
- Secondly we do have folkepension in Denmark which will provide a nice boost to your income after age 69 or so and significantly reduce the size of the nest egg you will need to call it quits.
- Thirdly you can try to minimize taxes in a multitude of ways. The above example assumes taxes for life of about 40% on all your investment withdrawals. This can be mitigated a lot by spending less since the first 80.000 of expenses each year is only effectively taxed at about 14%. This means if you’re a couple and you can live on 13,500 a month combined then taxes will have a relatively small impact on you. At the same time, you can also mitigate taxes a lot using retirement accounts – specifically Alderspension. I will do a post on this in the future but it can have quite a big effect on your overall taxation through life.
- A lot of people already contribute a lot to retirement through work. Where I work, I contribute 6% of my pretax pay to retirement and my employer matches that with 12% of my pretax pay. So, I already effortlessly save 10% or more (depending on tax efficiency) without even noticing.
- Although your savings rate is not that high right now it might not be impossible to grow it over the years. Generally, people’s income grow through their working life while at the same time their fixed expenses lower. Childcare expenses are temporary, so is a mortgage if you stay in the same house for many years.
- Your expenses might be lower when you don’t have a job. I know I spend a lot on transportation to and from my job which is only partially reimbursed through kørselsfradrag (mileage tax deduction). My lunch is also more expensive while at work even though I try to pack a lunch for most days. My holidays sure are more expensive when I have to travel at peak season mid-July or other school holidays because that is when my girlfriend can take time off.
I hope at least some of you are with me so far. I know it was a long read – certainly a lot longer than what I set out to write even though I feel like I breezed past so much important information. Rome wasn’t built in one day I guess. Before I leave you, I feel like I owe an explanation for the blog name: firedk
FIRE: Financial Independence, Retire Early
While I’m not sure if I want to retire early, FIRE makes for a great acronym and is used widely in the community. The dk part is meant to signify the Danish angle. A lot of stuff is similar when trying to attain fire in Denmark and the US but there are also a lot of differences regarding taxes, retirement accounts, stock market, brokerage fees, social security etc.
Well I know I skipped quite quickly past a lot of things that I will want to expand on in the future. Like how valid is the trinity study?, can we assume 6% growth in investments?, what are more realistic timelines for financial independence?, how do I start? and so on. But for now, do you have any questions?
By the way. Here is a link to the calculations for saving rate and years to financial independence. You can inspect it and see where I go wrong or you can make a copy and play around with your own asumptions. I will post more advanced spreadsheets in later posts.