The Crossover Point: Key to Financial Independence Explained
Financial Independence Journey - Photo by Eneko Uruñuela on Unsplash.
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Introduction
Discover How to Achieve Financial Independence by Understanding the Crossover Point
This personal finance blog aims to increase your financial literacy and guide you on the path to achieving financial independence. Achieving financial independence involves saving diligently and investing wisely so you can eventually live off your investments and eliminate the need for paid employment. For many, financial independence happens at traditional retirement age, allowing them to live off pensions, savings, and investments. However, with strategic planning, financial independence can be achieved much earlier.
To be clear, in this blog we don’t advocate for early retirement as escapism. Instead, we focus on meaningful societal contributions. When we stop working for money, we may be out of a job, but we will never be out of work. There are countless ways to meaningfully contribute to society outside the structures of paid employment. Similarly, as advocated by the ancient Greeks, enjoying a healthy amount of leisure is essential for a well-rounded life, allowing for intellectual and cultural pursuits integral to personal and societal development.
In today’s post, we explore the key concept of the crossover point in achieving financial independence. What is the crossover point, and how can you determine if you have reached it?
What is the Financial Independence Crossover Point?
The financial independence crossover point occurs when your investment income exceeds your living expenses, indicating that you no longer need to rely on a traditional job to cover your costs. This point signifies financial independence, where your passive income from investments is sufficient to sustain your lifestyle indefinitely.
The concept of the crossover point is widely attributed to Joe Dominguez and Vicki Robin, who popularized it in their influential book, "Your Money or Your Life" (affiliate link). The book outlines strategies for achieving financial independence and emphasizes the importance of tracking expenses, increasing your savings rate, and investing wisely to reach the crossover point as quickly as possible.
How to Track Your Progress Towards Financial Independence
Use a wall chart to track your progress towards financial independence. As part of her 9-step program to achieving financial independence, Vicky Robin advocates that you create your own “wall chart” to motivate you on your path to achieving financial freedom. In a nutshell, and as depicted in Figure 1 below, the wall chart is a graph that tracks in one place the evolution over time (x axis) of your income (blue), your expenses (green), and your (potential) passive income (purple). This wall chart is a one stop representation of your financial journey over time, from full financial dependence (no income-generating assets) to full financial independence (income-generating assets cover your monthly expenses). Further below we explain how to track each of these lines.
Figure 1. Financial independence journey wall chart. Evolution of monthly income (blue), monthly expenses (green), and “potential” investment income based on assets.
Track and optimize your monthly expenses.
You can’t manage what you can’t measure. It is not much of an understatement to say that it will be nearly impossible for you to reach financial independence if you don’t have a good understanding of what you are spending your money on. A lot of high earners are terrible at tracking their expenses and have only a vague idea of what their savings rate is or where their money is going.
It is really important to build the habit of tracking your expenses. Building this new muscle is the small price to pay for unlocking a lot more freedom in your life. In principle, you can choose any medium you’d like to record your expenses on. For most, a simple excel sheet is probably the best approach, since you will be able to store the information and compare the data easily across months. The way I do it is as follows: at the end of each month, I spend 30 minutes recording every single expense that has left my different accounts over the past month. I am particularly careful about recording cash payments separately; otherwise, it is easy to forget them several weeks later.
Understanding your average monthly expenses. You can start to have a solid understanding of your average monthly expense once you have recorded several months’ worth of data (see Figure 1, above). Of course, a real world example may look more messy than the wall chart provided: you may have some months with unusually high expenses (for example, vacations or Christmas). It doesn’t matter—over time a pattern will emerge.
Cutting and optimizing expenses is crucial for financial independence. Once you have a clear picture of your spending habits, it's important to question your expenses and find areas where you can cut costs or make adjustments. Ideally, if we want to speed our way to financial independence, we want to the green line to go downwards. This doesn’t mean depriving yourself but rather making mindful choices. Are there subscriptions you don't use? Can you find cheaper alternatives for certain products or services? By bringing your expenses down or at least keeping them constant, you increase your savings rate and move closer to your crossover point.
Monitor and record all sources of income for better financial planning.
It is equally important to track every dollar that enters your accounts. Make it a habit to record all your sources of income, whether it’s your salary, bonuses, side hustles, gifts, tax returns, or any other source. This detailed monthly tracking will allow you to see the full picture of your financial health and identify opportunities to increase your income.
Invest the difference to grow your net worth faster.
The larger the difference between your income and expenses, the more you can save and invest, and the faster your net worth will grow. In this blog we advocate for simple, long-term investing in low-cost index funds or ETFs that track them.
Regularly track your net worth and potential passive income streams.
Tracking your net worth is a crucial step in understanding your progress toward financial independence. Your net worth is the total value of all your assets minus your liabilities. By regularly calculating and updating your net worth, you can get a clear snapshot of where you stand financially and how close you are to reaching your crossover point.
To track your net worth, list all your assets, including cash, investments, real estate, and other valuable possessions. Then, subtract any debts, such as mortgages, loans, and credit card balances. This calculation will give you your current net worth. Monitoring this number over time will help you see the impact of your saving and investing efforts. It can also highlight areas where you might need to reduce debt or increase assets.
The purple line in Figure 1 represents 4% of your income-generating assets. The 4% rule is a spending rule that is used widely within the personal finance space to determine how much you can spend sustainably from your portfolio in retirement to avoid running out of money in your older years. As the name implies, it suggests that you can safely withdraw 4% of your savings portfolio in the first year upon retirement. To illustrate, consider the last data point in June 2024 of the wall chart in Figure 1. It represents a portfolio of $350,000, made up of stocks and bonds. 4% of this is amount could provide a monthly income of $1,167 ($350,000 * 0.04 / 12 months). This is the amount you could potentially withdraw in the long term from your portfolio without fear of running out of money.
The 4% rule (of thumb) and safe withdrawal rates are critically important concepts you need to familiarize yourself with. For now, we should consider this 4% figure as a ballpark number we are using to explain the crossover point.
Reaching the crossover point
The crossover point is reached the moment your passive income from your investments exceeds your monthly living expenses, as depicted in Figure 2 below (red box). This signifies that you no longer need to rely on traditional employment, as your investments generate sufficient income to cover your needs indefinitely. Start your journey towards financial independence today by subscribing to our blog and YouTube channel for more tips and strategies.
Figure 2. Financial independence crossover point (red square). You reach this point when 4% of your income generating assets—normally, a portfolio of stocks and bonds—is sufficient to cover your monthly expenses (green). From this point on you no longer need to rely on paid employment.
Enjoyed this post? Don’t miss our insights on reaching your first $100K investment milestone and our post on flexible spending rules for early retirement.
