The tagline to My Money Design has always been designing financial freedom. For as long as I’ve been into reading financial books and blogs about money, I’ve seen a lot of them try to answer the question of what is financial freedom. However, I feel as though the weight of this term often gets lost or trivialized.
In this post, we’re going to layout a definition for financial freedom and explain where we need to focus in order to achieve it.
The Basic Principle of Financial Success:
The fundamental principle of financial success is that you can never spend more than you take in. Look at any budget in the world. No business or individual can break this rule for very long without heading for failure. We can express this as:
Therefore, in its simplest form, there are two elements to balancing this equation: Income and Expenses
Minimalism Can Only Take You So Far:
There are a lot of people out there who use frugality and minimalism to help balance the Expenses side of achieving financial freedom. The belief is that fewer expenses will result to a need for less income. Mathematically, this is correct. Consider if you were able to live off of $1,000 per month. You’d only need some sustainable income above $1,000 to be set:
While there is nothing wrong with living modest or reducing your expenses, the problem with this approach is that reducing your expenses is limited. As the saying goes, “you can only squeeze a lemon so hard until it runs out of juice”.
For example, say you have $5,000 in monthly expenses. You may be able to cut corners to shave a few hundred or even a thousand dollars off your expenses. But what about your mortgage? Rent? Car payments? Food? Utilities? Taxes? Medical expenses? Eventually you’ll hit a wall of things you CAN’T eliminate without a very extreme lifestyle change.
Despite the few examples of people of people who have reduced their expenses down to around $1,000 per month, it is my opinion that the grand majority of us (and our families) aren’t ready or willing to live like this. Myself included.
This leaves us to focus on the income side of the equation.
The Difference between a Laborer and Capitalist:
When I think of the Income side of financial freedom, one of the best quotes I ever read came from the book Your Money Ratios by Charles Farrell. In the Introduction, he gives us a great mantra to live by:
“All decisions you make should help move you from being a laborer to being a capitalist (p. 11)”
He then goes on to define how being a “laborer” means being paid a wage for your services. This we could think of as our “job” or anything else that requires us to work for our money.
Meanwhile being a “capitalist” means being paid for you the use of your money. This would be money you make from your investments, retirement accounts, passive income streams, and any of your other assets.
If we insert these terms into our equation, we then have the following:
The reason I tend to favor this side of the equation is because unlike your expenses, your income has unlimited potential. You’ll find a lot more success stories about regular people who were innovative enough to make thousands or millions of dollars as opposed to people who try to live off of $1,000 per month.
Defining What is Financial Freedom:
This brings us to the meaning of what is financial freedom. Going back to Farrell’s statement, achieving financial freedom is when you no longer NEED to be a laborer to generate enough sustainable income to cover your expenses.
Basically, if you were to stop working:
Then our equation would look like this:
Therefore, once your assets can reliably take care of you for any length of time, you have achieved financial freedom.
Most people associate achieving financial freedom with being retired. This is usually because at the age 59-1/2 we are allowed access to our tax-advantaged retirement accounts like our 401k, IRA’s, etc.
But what if you want to achieve this sooner? The goal is to figure out how you can generate enough after-tax cash flow to support you and your family OUTSIDE of your classic retirement accounts. If you’d like to see how I plan to do this, read the latest update to my money design. Or if you want to investigate some good passive income ideas, check out my page devoted to this topic.
Readers – If someone asks you what is financial freedom, how do you respond?
Image courtesy of Sira Anamwong / FreeDigitalPhotos.net