I’m interested in financial independence, as I think it is very responsible thing to do, as well as the most sustainable way to live life.  I remember first learning this from Rich Dad, Poor Dad.  A lot of people do not like that book.  I think the major reason is that the thought of passively making income is so overwhelming that one’s “fight” reaction takes over.  It’s just my guess, though.

Essentially, passive income is earnings where your efforts are not actively needed.  It is much easier to define active income: a job (where time and skill and traded for $bling).  In financial terms, passive income is generally investment capital traded for $bling.  Examples of passive income are dividends, apartment rent (if you own an apartment complex), and the part of the pyramid scheme where you profit from others’ efforts.

Passive income can also be viewed as potential.  As ERE’s post describes, the 25 and 33 scalars, applied to one’s annual budget, are commonly used for estimating this potential.

If you need your money to last 30 years and you invest it 100% in index funds and you withdraw your annual expenses every year, you need 25 times as much money in index funds as your annual expenses (including taxes).

If you need your money to last 60 years instead and follow the same procedure, you need 33 times as much money.

(If I remember correctly) this concept of potential is defined in Work Less, Live More.  The book, as well as firecalc, describe how those numbers take into account risk, so that one will be financially independent.

The time to generate these amounts are below,

in general terms, and

in a more applied form.

Applying the equation above in terms of the percentage of your pay that you save, you’ll come up with a pretty graph.  I have two versions, out of respect for the scale.  The first is in a scale for Joe American.  The second is for the whacky nut job ladies that plan to leave millions of dollars to their cats.

It’s interesting to see that saving extremely, in terms of one’s earnings, provides a nearly inversely proportional relationship in time for retirement.  These are not revolutionary ideas.  I just like visualizing numbers.

It’s interesting to note that spending less, as opposed to making more, has a greater impact to achieving financial independence, faster.  This is logical, if you look back to the equation.  The accumulation denominator is a function of earning and spending, yet the state of the system in the numerator is a function of spending scaled by a factor of 25.