Financial Freedom Definition | Financial Independence
What is Financial Freedom?
Financial freedom is a term used to define an economic position reached by an individual (or a household), where said individual does not depend on income from an employer and/or traditional employment. This can happen when the individual has enough cash flow from investments to cover all living expenses. And/or the individual has enough funds saved to cover all future living expenses.
KEY TAKEAWAYS
- In the most ideal scenario financial freedom requires having enough cash flow from passive income investments to cover all living expenses.
- Cash flow investments can be in the form of dividends, real estate, online businesses, etc. The more passive the income the better.
- A less preferred financial freedom strategy requires accumulating wealth to cover all future living expenses. This strategy requires an aggressive saving plan and a frugal lifestyle. An example of this strategy is the popular FIRE (Financial Independence Retire Early) movement.
- Financial freedom and financial independence are interchangeable.
Understanding Financial Freedom
The term financial freedom is synonymous with financial independence. Financial freedom refers to the economic position reached when an individual no longer depends on income from an employer and/or a traditional employment. This independence results in freedom from financial concerns and worries.
People often talk about financial freedom or financial independence as a goal. An individual is said to have reached financial freedom when he has enough cash flow from investments to cover all living expenses. Alternatively, the individual may have enough money saved up to cover all future expenses.
Financial Freedom Through Cash Flow
A preferred strategy is to attain financial freedom from an ongoing and sustainable form of passive income. However, there is an inverse relationship between the passivity of an investment and the return on investment.
A common example of acceptable cash flow is real estate income. Some may argue this form of cash flow isn’t necessarily passive. But most will agree real estate provides the right balance between return on investment and passiveness.
A person is said to have reach financial freedom through cash flow when the amount of monthly cash flow is equal to or it exceeds the individual’s monthly expenses.
A benefit to this strategy is that the cash flow source is never depleted. In fact, the opposite can be true. In the example of real estate, the underlying asset is likely to appreciate. And as such, it is also likely that rents will continue to increase proportionally to the value of the asset.
Often cash flowing assets are held under a business entity. This can often provide for certain tax advantages.
Financial Freedom Through Wealth Accumulation
Another strategy involves aggressively saving money and investing it money in paper assets such as stocks and mutual funds. The intent is to accumulate a large amount of money to be able to withdraw money to cover all future expenses.
This strategy is often combined with a goal of achieving early retirement. The popular Financial Independence Retire Early (FIRE) strategy is essentially an accumulation strategy combined with the goal of achieving early retirement.
In most cases the FIRE strategy demands a frugalist lifestyle to avoid early depletion of the accumulated wealth.
Proponents of the FIRE strategy suggest accumulating wealth of approximately 25x the amount needed during retirement. The amount needed during retirement (say 20 years from now) should account for future inflation.
Another thing to consider is the tax related implications of withdrawing money from an investment account.
Wealthy Individuals
Regardless of how wealth is obtained (through cash flow, through accumulation, or a combination of both), it is evident a wealthy individual is also financially free. Interestingly, most wealthy individuals don’t talk about financial freedom or early retirement. Most often wealthy individuals have multiple sources of income. And although wealthy, many of these individuals remain occupied with managing their assets and businesses.
It is particularly interesting that real estate investors appear to have figured out the financial freedom formula. These investors are often concerned with acquire more cash flowing assets, rather than the definition of financial freedom.
Recommended Reading
Financial Freedom is About Cash Flow
Related Terms to Financial Freedom
Financial independence and financial freedom share the same definition.
FIRE – Financial Independence Retire Early
This refers to a strategy to pursue financial independence based on accumulating a large sum of money to withdraw from for future living expenses.
For investment purposes, cash flow is an ongoing stream of income received from an investment.
For investment purposes, passive income is income derived from investments that demand little to no active participation from an investor (i.e. dividend income).