“It’s the ability to live and maintain the lifestyle which you desire without having to work or rely on anyone for money.” T Harv Eker
Financial Peace guru Dave Ramsey proclaims that “Financial freedom means that you get to make life decisions without being overly stressed about the financial impact because you are prepared. You control your finances instead of being controlled by them.”
It’s about having complete control over your finances which is the fruit of hard work, sacrifice and time. And, as a result, all of that effort and planning was well worth it!
Nevertheless, reaching financial freedom may be challenging but not impossible. It also may seem complicated, but in just a straightforward calculation, you can easily estimate of how much money you’ll need to be financially free.
What is financial freedom? Financial freedom is the ability to live the remainder of your life without outside help, working if you choose, but doing so only if you desire. It’s the ability to have the things you want and need, despite any occurrence other than the most catastrophic of outside circumstance.
To calculate your Financial Freedom Number, the total amount of money required to give you a sufficient income to cover your living expenses for the rest of your life
Step 1: Calculate Your Spending
Know how much you are spending each year. If you’ve done a financial analysis (net worth and cash flow), created a budget, and monitored your cash flow, then you’re ahead.
Take your monthly budget and multiply that amount by 12. Make sure you include periodic expenses such as annual premiums and dues or quarterly bills. Also include continued monthly contributions into accounts like your emergency fund, vacation clubs, car maintenance, etc.
Add all these together to get your Yearly Spending Total.
Keep in mind the lower the spending total, the lower the amount of money you’ll need to become financially independent. Learn how to lower your monthly household expenses and determine the difference between needs and wants.
Step 2: Choose Your Safe Withdrawal Rate
The safe withdrawal rate (also referred to as SWR) is a conservative method that retirees use to determine how much money can be withdrawn from accounts each year without running out of money for the rest of their lives.
The safe withdrawal rate method instructs financially independent people to take out a small percentage between 3-4% of their investment portfolios to mitigate worst-case scenarios. This withdrawal percentage is from the Trinity Study.
The Trinity Study found the 4% rule applies through all market ups and downs. By making sure you do not withdraw more than 4% of your initial investments each year, your assets should last for the rest of your life.
Step 3: Calculate Your Financial Independence (FI) Number
Your FI number is your Yearly Spending Total divided by your Safe Withdrawal Rate.
To find the amount of money you’ll need to be financially independent, take your Yearly Spending Total and divide it by your SWR.
For example:
- Yearly Spending: $40,000
- Safe Withdrawal Rate: 4%
Financial Independence Number = Yearly Spending / SWR
- $40,000 / 0.04 = $1,000,000
Who becomes financially free? According to most financial advisors, compulsive savers and discipline investors tend to become financially free since:
- They live on and spend less they earn.
- They organize their time, energy and money efficiently in ways conducive to building wealth.
- They have a strong belief that gaining financial freedom and independence is far more important than displaying high social status and financial symbols.
- Their parents did not keep on helping them financially.
- They have a keen insight to recognize financial and wealth building opportunities.
Net worth is the most important number in personal finance and represents your financial scorecard. Your net worth includes your investments, but it also includes other assets that might not generate income for you. Net Worth can be defined to mean:
- Income (earned or passive)
- Savings
- Investing to grow and to put your money to work for you)
- Simple and more frugal lifestyle
Financial freedom means different things to different people, and different people need vastly different amounts of wealth to feel financially free.
Maybe financial freedom means being debt-free, or having more time to spend with your family, or being able to quit corporate America, or having $5,000 a month in passive income, or making enough money to work from your laptop anywhere in the world, or having enough money so you never have to work another day in your life.
Ultimately, the amount you need comes down to the life you want to live, where you want to live it, what you value, and what brings you joy. Joy is defined as a feeling of great pleasure and happiness caused by something exceptionally good, satisfying, or delightful—aka “The Good Life.”
It is worth clearly articulating what the different levels of financial freedom mean. Grant Sabatier’s book, Financial Freedom: A Proven Path to All the Money You’ll Ever Need, the levels of financial freedom are:
Seven Levels of Financial Freedom
- Clarity, when you figure out where you are financially (net worth and cash flow) and where you want to go
- Self-sufficiency, when you earn enough money to cover your expenses
- Breathing room, when you escape living paycheck to paycheck
- Stability, when you have six months of living expenses saved and bad debt, like credit card debt, repaid
- Flexibility, when you have at least two years of living expenses invested
- Financial independence, when you can live off the income generated by your investments and work becomes optional
- Abundant wealth, when you have more money than you’ll ever need
The difference between income and wealth: Wealth is accumulated assets, cash, stocks, bonds, real estate investments, and they have passive income. Simply, they don’t have to work if they don’t want to.
Accumulating wealth and becoming wealthy requires knowing what you want, discipline, taking responsibility and have a plan.
Hundreds of thousands of Americans have great incomes, but you wouldn’t call them wealthy because of debt and lack of accumulated assets, instead:
- They owe for their homes
- They owe for their cars and boats.
- They have little savings and investments
- They have few “paid for” assets
- They have negative net worth
Essentially, if you make a great income and spend it all, you will not become wealthy. Often, high income earners’ true net worth is far less than they think it is.
Here are several factors and steps to improve your financial life:
- Establishing financial goals
- Paying yourself first and automate the process
- Creating and sticking to a budget. Know where you money goes.
- Paying down and/or eliminating credit card and other bad debt. Debt which is taking from your future to pay for your past.
- Saving for the future and investing for the long term consistently
- Investing the maximum in your employer’s 401(k)
- Living on and spending less than you earn
- Simplify – separating your needs from your wants. You don’t need to keep buying stuff.
Financial freedom can look something like this:
- Freedom to choose a career you love without worrying about money
- Freedom to take a luxury vacation every year without it straining your budget
- Freedom to pay cash for a new boat
- Freedom to respond to the needs of others with outrageous generosity
- Freedom to retire a whole decade early
When you have financial freedom, you have options.
“Your worth consists in what you are and not in what you have. What you are will show in what you do.” Thomas Edison
References:
- https://www.phroogal.com/calculate-financial-independence-number/
- https://www.ramseysolutions.com/retirement/what-is-financial-freedom
- https://thefinanciallyindependentmillennial.com/steps-to-financial-freedom/