Financial freedom is a state of being where you have the power to make your own choices with your money. It’s a feeling of liberation and empowerment that allows you to live your life on your own terms. Imagine the feeling of no longer having unwanted debt, owning investments that provide you sustainable income, and having enough money to do whatever your heart desires. That’s what financial freedom means. For me, financial freedom meant being able to do the job that I love, allowing me to work from anywhere in the world and have the flexibility to travel and spend time with my loved family. It’s a journey that requires discipline and determination, but the rewards are satiable and truly worth it.
Table of Contents
Financial freedom is an end goal that all of us hold – for others it may just be a dream, but regardless most people have pondered this idea.
In order to clearly define financial freedom, you need to answer two important questions:
- At what point would you consider yourself financially free? In dollar terms.
- How much time would it take for you to achieve financial freedom?
My Definition of Financial Freedom
I have amassed sufficient wealth through saving and investing to not only support my standard of living, but also indulge in what I feel necessary.
Say your goal is to become financially independent within the next 10 years. How much cash must you have accumulated by then?
Let’s say your family’s annual costs are currently at $160,000.
So, if inflation is around 2% per year, 10 years later your annual costs would be $195,000.
You goal is to have expenses that represent less than 3% of your portfolio at that time.
The 3% Rule
We call this the 3% Rule. Using the 3% Rule – we know that our portfolio today should be about ~$6.5M (3% of $195,000 = $6.5M). I have an entire article on the 3% Rule here.
So, building up a $6.5M portfolio over the course of the next 10 years is the goal. Of course, this target is completely different for everyone as everyone has different goals. For instance, you might feel more at ease using a more conservative inflation assumption, such as 4% (rather than 2%) annually, or maybe your target is to retire in 25 years.
The Planning Session
This is the time for you to look at your financial situation and understand where you’d like to be. The primary goal is to understand what your expenses would be. Second, set the withdrawal rate (3% in this case), and then adjust for inflation. You now have a target to aim for. There are countless variables in every person’s life that will provide completely different outcomes. Expenses for one person might include vacations and shopping, whereas another person may want to cover only what is necessary. It’s important for you to put pen to paper (or Excel) and draft your thoughts on your wants, needs and dreams, jot down everything you spend today, what areas you can cut, and all that you want to spend.
- Step 1 | Defining your end dollar amount and determining the time to get there. For this example, we’ll continue to use our 10-year target of $6.5M.
- Step 2 | Finding out where you stand right now is all that’s required. How close are you to achieving financial freedom? For example, if you’ve already managed to save $1.5M, then you’re already over 20% of the way there.
- Step 3 | Planning and executing the paths necessary to reach your goal. This is obviously widely different and unique for everyone, but there is one certain thing. Your planning will require Saving and Investing.
Savings & Investing
When it comes to saving and investing there are many different combinations that can get you to your desired goal. Let’s look at this in terms of Savings, and Investment.
Let’s say that your current portfolio is $1.5M, and you need to add another $5M over the next 10 years to get you there.
Key concept: Keep in mind that there are many combinations of Savings and Investment that will get you there.
If you’re able to save $500K per year, that would provide $5M over 10 years. This $5M in addition to the $1.5M, you already have saved would get you to your goal. Savings: $500K and Investment: 0%
Now, trying to reach your goal while earning 0% along the way will make it much more challenging, but not impossible. Trust the process. But if this is the path that you choose, and want to be conservative, then you will simply need to save, and you won’t have to invest.
Starting with No Savings
Another example with no savings. If you can take your current savings of $1.5M and manage to earn %Investment of 17.5% per year for the next 10 years, this will take you $7.5M without having to save any more money. Savings: $0 and Investment: 17.5%
Just like the first example, neither of these are the typical path to financial freedom, but I wanted to illustrate the point, that there are many ways to work toward your desired goal. Most likely, you’ll fall somewhere in the middle of both, and be relying on a combination of both Savings and Investing.
The more you can save, the less you will need to earn from investing. And vice versa.
Here is a picture showing various combinations of Savings:
X Axis (bottom) = Savings | Y Axis (left) = Investing
The green area is where our goal is to be, on a yearly basis, in order to achieve Financial Freedom.
As you can see, the return required from Investing decreases as your Savings increases.
This chart showing red/green can be a very helpful tool to understand where to begin. These numbers will be different for everyone, but this will help you understand the correlation between saving and investing.
Conclusion
Here are the key concepts to remember:
- Set your goal as to what represents financial freedom for yourself. An example may be, “to build a portfolio of $5M over the next 15 years.” You should think about the broad assumptions, such as living expenses and how they may change inflation, withdrawal rates, and taxes. The clearer your picture is, the better you can plan, so try to get down to the detail. But it’s important to at least draw out a broad-based plan.
- Determine your expectations for Savings and Investing. These two numbers are extremely important to get you to your goal. I aim to be more conservative on the investing side and lean heavier in increasing the savings, but some people have higher expectations for %Investments.
- Periodically review, assess, and modify your goals. Your lifestyle and earnings may change over the course of time, so it’s very important to review and make changes to your plan. The important thing is to be aware of your goals, and the path to achieving them.
Modifying the goal from time to time is completely normal and will happen with most people. After all, determining goals is not a precise science. Your tastes, earnings, lifestyle, and family will most likely change along the years. The important thing is to review the goal and change it accordingly if it no longer fits. You might find yourself much further ahead in your goals and modify your investment approach to be more conservative. This is not a race, but rather a slow and steady growth mechanism that will allow you to reach your definition of Financial Freedom.
Remember, slow and nimble, and do not take huge risks.
Frequently Asked Questions – FAQ
What is Financial Freedom?
Financial freedom is a state where you have sufficient personal wealth to live without having to actively work for basic necessities. Your assets generate income that is greater than your expenses. It means you have the power to make your own choices with your money, allowing you to live your life on your own terms.
How do I achieve Financial Freedom?
To achieve financial freedom, you need to set a goal in dollar terms that will cover your expenses and allow for your desired lifestyle. Then, you create a plan that involves saving and investing to reach that goal within a set timeframe.
What is the 3% Rule?
The 3% Rule is a guide that suggests your annual expenses should represent less than 3% of your portfolio. This helps to ensure that your wealth lasts longer and can continue to generate income.
How much money do I need to accumulate to be considered financially free?
The amount of money required to be considered financially free depends on your personal lifestyle, expenses, and financial goals. It’s calculated based on your estimated annual costs and adjusted for inflation, considering the 3% rule.
How important are Savings and Investing in achieving Financial Freedom?
Both savings and investing are crucial in achieving financial freedom. Savings form the base of your wealth, and investing helps grow it to reach your financial goal. The balance between savings and investments varies depending on personal circumstances and risk tolerance.
Can I achieve financial freedom if I start with no savings?
Yes, starting with no savings does not preclude you from achieving financial freedom. It requires a strong commitment to saving and smart investment decisions to grow your wealth over time.
How often should I review and modify my financial freedom goals?
It’s important to periodically review and modify your goals as your lifestyle, earnings, and circumstances change. It’s not unusual to change your goals over time to reflect changes in your personal life.
Is it important to consider inflation while planning for Financial Freedom?
Yes, considering inflation is crucial while planning for financial freedom. Inflation impacts the future value of money, so it’s important to factor it into your calculations when deciding on your financial freedom goal.
What risks are associated with trying to achieve Financial Freedom?
Like any financial endeavor, achieving financial freedom involves risks such as market volatility, inflation, and changes in your personal circumstances. However, with careful planning, disciplined saving and investing, and regular reviews of your goals, these risks can be managed effectively.
Can achieving financial freedom allow me to retire early?
Yes, if your financial freedom goal covers your lifestyle and expenses without the need for active work, you can potentially retire early. However, early retirement requires careful planning to ensure that your wealth can sustain you for a longer retirement period.