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:
Written alternatively:
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?
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Image courtesy of Sira Anamwong / FreeDigitalPhotos.net
To me, financial freedom is when we are comfortably able to quit our 9-5 jobs. I think we will always work in some way or another….but we want to choose when and where. It will get here eventually!
Agreed! If you can quit your job without sweating your finances, then you’ve reached the point of financial freedom.
I like your explanation, when people ask me I simply say that it is when your assets are working for you so you don’t have to work for someone.
That is also a great way to put it. People always think that “more stuff” makes them rich. But they forget that assets which can generate money on their own are the real way to get rich and hit financial freedom.
For me financial freedom is having enough money to get by day to day without needing to work.
I think it’s having the freedom to do what you want to do, including working at a job you want. Living frugally is great, but additional income combined with that will generally help you get to that point quicker.
Financial freedom means making a lot more than my expenses, having plenty of money for retirement and things like a good emergency fund cushion, no debt (unless it’s a mortgage some day), and being able to enjoy my leisurely activities like movies, music, trips, etc.
Those are all great things to include in your definition. Believe it or not, the being able to afford “leisurely activities” part will be a very important part of when I feel I have achieved financial freedom. After all what’s the point of not having to work if you aren’t able to do anything you want to.
I would basically say the same thing but I wouldn’t go in as much detail. I would just say being able to cover my expenses with income from investments or over passive sources.
You’re not going to use 10 equations to explain it like I did? 🙂 You’re right – it would have been easier to just say it like that. But that would have been a pretty short post.
Very great and intriguing breakdown of how to explain it. Financial freedom (to me) involves having enough passive income coming in so that our bills/expenses are covered without having to work.
I have always used the “to be able to do what I want, when I want” sort of definition. Always knowing that to me, that meant that if I CHOSE not to work(be a laborer), then I would not have to. But if I wanted to work, that it was by my choice and not out of necessity to cover my expenses.
I like how it is defined above much better: financial freedom is when you no longer NEED to be a laborer to generate enough sustainable income to cover your expenses.
The key point is NEED. You don’t NEED to work at a job anymore. You may choose to because you truly enjoy what you do, but you are no longer doing it because you have to.
Thanks RJ, and welcome to the site! The “to be able to do what I want, when I want” definition still pretty much sums it up. I can’t wait until I reach this tipping point.
I agree with your assessment. In my mind, you reach financial freedom when your nest egg makes more for you in a year than you make working in a year. Doesn’t necessarily mean you can quit working at that point, but that’s a pretty nice place to be.
Thanks Brian! As long as we keep on saving and pick some modest investments, our nest eggs will be there in no time.
Very nice post. When I think about financial freedom, I think there are different levels. The first is just to get your head above water: income > expenses! That gives you the freedom to stop worrying about getting by each day and accumulating debt. When you get income substantially above expenses, it gives you freedom to save and invest and plan. After you accumulate money to certain levels, it gives you the freedom to buy a lot of stuff, even if like me you usually choose not to (excepting vacations!), you still have that freedom. Eventually the last rung is to have enough money that you can choose not to do things you don’t want to do – whether that’s not working your corporate job or not fixing your car yourself or whatever. Then you have the opportunity to do other things in life that you really want to do.
I’m shooting for that last rung. That one sounds like the best deal!
Financial freedom for me, right now is to be debt free. Once our debt is paid off we will have substantially more money…so my answer will change in a few years I imagine.
Being debt free is always a good and admirable first step. But I agree that eventually you’ll have a different definition – you’ll want something more. You won’t just want to cover your own expenses, but those you care about and causes you want to fund as well.
I am certainly in the camp that could not live on $1000 a month. I do sort of admire those who can, but there’s no way. That means I have to find ways to replace my income so that I don’t have to work. Working because I want not because I have to is financial freedom to me.
Me too. I want to keep my lifestyle AND make enough cash flow each month to replace my employer income. Only then will I feel like I’ve achieved it. Can I do that?