To become financially independent your savings need to generate enough money to pay for your monthly expenses. But what is "enough"? How can you tell how much money you need to save in order to become financially independent? How do you calculate something like that? This, of course, differs from person to person. What level of comfort do you need or want? How much money do you need on a yearly basis to sustain your preferred way of living? I can't really answer that, that's up to you! But to give you an idea, if you want to be on the absolute safe side think about the 4% rule*. The 4 % rule basically means that when you want to be careful and conservative you can expect at least a 4% return on your investments every year. In real life this doesn't look so pretty. You can have a 12% return one year and a -8% return in the next year. The year after that maybe 6%. The 4% rule basically means you can expect a 4% return on your investments averaged over 15 to 20 years.
If you want to know how much money you'll need every month you can do several things.
... You can guess how much you need/want. Maybe €3000 sounds like a great monthly passive income. Or maybe €2000 is already enough and could also potentially get you to your goal faster. It is never a great thing to guess, but it is a way to get started.
... Your goal can be to get the same amount you get now from employment. If your current monthly income from work making you feel comfortable, than maybe go for that. Keep in mind, though, that when you become financially independent your expenses will most likely drop significantly. Also, you might start some small businesses for fun and receive "extra" income. You will probably not need to this much, but then again, everybody is different and we are not all in the same situation.
... You can accurately calculate how much your average spending is and make that your target. This option takes a little more effort, but has some great side affects. If you keep track of all your monthly spending (to the cent) you will get a better insight in your money and where it is going. You may discover unnecessary payments for luxury goods you don't really need or insurance that makes no sense.
When you finally have a fairly accurate estimate of how much you will need or want each month you can easily calculate the amount of money you will need to save (and invest). The 4% of your total invested savings should be the conservative average that you can expect every year. To calculate the amount needed use the formula below.
((total invested savings) x (long term interest rate))/12 = monthly income
E.g.: If you want a monthly passive income of €2000 then this is how much momey you will need to save and invest:
((total invested savings) x 0,04)/12=2000 => (12x2000)/0,04= €600.000
So, you'll need a total of €600.000 to have a monthly income of €2000 without impacting your initial savings. No need to go to work any more. Mind you that the 4% rule is very conservative. If you know how to invest your money wisely you can probably get an average annual return of 11%. Also, keep in mind that when you stop working your expenses will almost always drop dramatically.
OK, so €600.000 sounds like an astronomically large amount. And perhaps you need more than €2000 a month. You might think that you will never be able to save this much money in your lifetime. But, when you don't have to work you can start a small business (or several) based on your hobbies and interests and generate some extra cash with that. Just for the fun of it! And although €600.000 may sound like a lot of money, it is quite possible to save this amount by living frugal and investing your money wisely. I've been saving and investing money for about 5 years now and I managed to save about €350.000 so far. And the more savings you have the faster it can grow. Or shrink when the economy turns bad again! I will talk about that later, but for now remember that the stock markets go up and down all the time. Just be sure NOT to chicken-out of your investments when the economy is not doing so well. Wait a while. The markets almost always go up again. Remember the crash of 2008? That was a really bad one, but halfway 2012 the markets were already back on the same level as just before the crash in 2008.
If you are afraid that the economy will collapse beyond repair and you will loose all your invested money, then don't be. If this happens money will have no value anyway.
* When I wrote this article 4% was the minimum expected return on any investment. Often in practise it was a lot more. However, currently there is a debate on the minimum expected return. Some people say it is closer to 3%.
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