How much money do you need to have financial freedom?
Your answer to that question will spell out the route markers on your financial journey. But so few people actually take the time to think about how much they need.
Is it a million dollars? What about 10 million dollars? Or a hundred million?
Depending on the lifestyle you hope to achieve, the person you hope to become, your answer might vary wildly as compared to your friends and peers. You also need to consider what financial freedom really means to you.
Is it the freedom to quit your job? The freedom to take a well-deserved vacation? The freedom to retire?
Freedom means different things to different people. And even throughout your life’s journey, that meaning will change drastically.
Fortunately, financial freedom is often achieved long before financial independence. Unfortunately, for millions of people out there, financial freedom is just as much a pipe dream as financial independence.
What is Financial Freedom?
Financial freedom can broadly be considered; the ability to make choices in spite of the economic impacts, rather than because of the economic impacts. This means you are free to choose. To take time off. To work somewhere else. To live out of the shadows of looming financial catastrophes.
Financial freedom is being able to take command of your own life choices, and not fear the next mail delivery.
James Clear describes this “wealth” as:
“Real wealth is not about money. Real wealth is: not having to go to meetings, not having to spend time with jerks, not being locked into status games, not feeling like you have to say ‘yes,’ not worrying about others claiming your time and energy. Real wealth is about freedom.” - James Clear
Financial freedom is therefore achieved when you have a financial safety net. Enough resources stockpiled that you can look out for yourself. This might be a 6-month emergency fund. Or enough to go backpacking in South America for a month. Whatever the amount is to set you free.
Financial Independence: What is it? And Why?
If financial freedom is the ability to make a choice over your life in spite of the economics, financial independence takes that idea further.
Financial independence can be considered the ability to live, and continue living on the income from your investments for the rest of your life. To find out what this number is for you, you first need to understand what your annual expenses are.
Map out your expenses. How much do you need each year to live? Consider the lifestyle you want to live. Don’t skimp out here. Understanding the life you want to be living is essential. An underestimation might just leave you eating boiled potatoes and cat food.
Once you know what your lifestyle costs, you’re up to the Financial Independence calculation. Unfortunately, there isn’t one clear formula for this calculation. Factors such as inflation, deflation, investment returns, etc. all play a crucial role. There are two such calculations that are usually used; the 4% rule, and 30 times.
The 4% Rule and FIRE
The 4% rule essentially says you can withdraw 4% of your investments each year, and that fund will continue to exist for the rest of your life. A common calculation used for establishing an effective withdrawal rate for your retirement savings, this calculation also serves well for determining the size of the pot you need to achieve financial independence.
An increasingly popular movement, the Financial Independence, Retire Early (FIRE) tells us that to safely live off the earnings from your investments, you need 30 times your annual expenses.
The difference is essentially 3.33%, compared to 4%.
Depending on the measuring period, either of these values work. 90% of the time a 4% withdrawal rate has proven to be effective. But, you certainly don’t want to be in that 10% group! That’s why FIRE is slightly more conservative, to further reduce the risk of running out of funds.
When deciding which multiplier to use, it’s important to think about the lifestyle flexibility you’ve built in. Can you cut back a bit during economic downturns? Living on less than the 4% you planned? Or is that annual expenses number a must have? If so, airing on the side of caution is a better idea for you.
Take a few moments and jot down what your annual expenses number is. Now set up your range. Divide that annual number by 4%, and multiply the annual number by 30. That should set your aim on a more tangible goal.
That is what it will take for you to reach financial independence. Now all that’s left is to keep laying the bricks of your financial fortress. One brick at a time.
How much do you need to be free? To make the choices you want to make? To break the shackles of “can’t wait until payday”, and start living life on your terms?
And how much do you need to enjoy that level of financial independence for the rest of your life?