Sunday, March 15, 2015

What is financial freedom?

This retired couple looks happy, but I don't want to wait this long before reaching financial freedom.  Picture taken from LearnVest
I often write about financial freedom.  It’s the goal we’ve been working so hard to reach.  But what is it?  For me, financial freedom is the point where one can generate enough passive income to cover all living expenses, with no obligation to work at a particular job to secure a specific paycheck. 

When you achieve financial freedom, you are now free to live a life on your terms.  You no longer need a steady paycheck to pay for your living expenses. You can now travel and live in far away places.    Traveling at old age is not going to be as fun as traveling now.  You can now explore other opportunities, try new hobbies, start new businesses, or work on side projects.  Financial freedom gives you a new world of options.   

In our quest for financial freedom, we have moved beyond a paycheck-to-paycheck existence and into a lifestyle of abundant saving and investing.  Mr. Money Mustache has taught us that being frugal is actually badass and that spending less money on consumer products can actually pay off with a more rewarding life. 

Having a high savings rate has made us feel rich, and has eliminated our financial stress.  But feeling rich is not just about the numbers in your bank account.  It’s about having a rich attitude towards life.  It’s about being healthy with minimal stress.  It’s about looking around at the gluttony of mass-produced consumer products and realizing that you already have everything you could want or need.  For me, feeling rich is about being happy, having enough, and being surrounded by loved ones.

How much money should you save?

I use the Mr. Money Mustache simple guide to early retirement as a reference.  As it turns out, saving more has multiple benefits: you save more money now, you save more on future expenses, and you live a more badass life.

When it comes down to it, your savings rate is an even more important predictor of the time it takes to reach financial freedom than your income.  I know plenty of people who are always in debt and always complaining that things would be better “if I only made a higher salary.”  How many people do you know who are making a good salary and yet always find a reason to complain about not having enough, getting taxed too much, or being crushed by too much debt?

If you spend 100% of your income (or more), then you will be working forever unless someone else is supporting you (inheritance, social security, etc).  Mr. Money Mustache suggests that if you save and invest 50% of your income, you can reach financial freedom in 17 years.  If you invest 75% of your income and only live off 25% of your pay, then you can retire in 7 years.  The more you save, the more options and flexibility that you have.  If you’re living paycheck to paycheck and barely making ends meet, one injury or job layoff and then you’ll be at risk for getting trapped in debt.    

I don’t think we are prepared to save 75% of our income yet - we’re currently saving around 50% of our take home pay.  Thankfully we both find our work enjoyable.  Because we have so few needs right now, it’s easy to save.  I would like us to continue saving 50% of our take home pay.  However, when the baby comes in June, everything could change. 

Optimizing our use of money has helped tremendously.  Spending money isn’t bad, but it’s much better to consciously spend money on things and experiences that bring value, while relentlessly cutting costs on everything else.  It’s easy to have a high savings rate if you look at spending money from an efficiency standpoint.

Is it efficient to pay $150 a month for electricity when you can pay less than $40?  Of course that depends where you live – we live in sunny Southern California.  Is it efficient to pay $8 a day (or more) to eat fattening unhealthy food for lunch and / or dinner?  Is it efficient to spend 2 hours of your day commuting to work in a gas-guzzling vehicle?  Is it efficient to keep buying crap while owing credit card debt with interest rates over 25%?  Is it efficient to pay for $80 a month towards your cable or satellite television bill when you can pay for all the shows you want to watch individually on Amazon or Netflix?  If you optimize the way you look at money, you will find a lot of ways to trim your expenses.

How much money do you need to reach financial freedom?
When the value of all of your investments equals 25 to 30 times your annual expenses, you’ve reached true financial freedom.  Income from work now becomes optional.  This doesn’t mean that you need to quit your job immediately; but you can now choose how much or how little you’d like to work. 

Since I love my career, I am in no hurry to abandon it.  However, working 3 days a week and teaching on the side sounds extremely appealing to me.  Working until the day I die does not sound pleasant at all, although this could be your reality if you spend 100% or more of the money you make.   
What is the source of your financial freedom passive income?
Income streams to cover your financial needs can come from your investments, savings, real estate, side hustles, or even a side business.  While you can’t expect social security to cover all of your retirement income needs, you can think of that income as the icing on your retirement cake.  If your company offers any sort of pension, that can add to your monthly income as well.  

Money from your investment accounts can be slowly withdrawn to fund your life expenses.  Suppose you have a side job that earns you $200 a month - can you turn that monthly income into $400, $800, $1,000 or more?  If you are a hands-on investor, maybe you can own several rental properties that provide steady income on a monthly basis.  If the property has appreciated value over time, selling it can provide a large chunk of money.

What’s holding you back from financial freedom?
People have been persuaded by the media and their peers to believe that buying material things makes us happy.  We’ve been told that we aren’t successful unless we own a luxury car, brand name clothing, and live in a rich neighborhood.  The irony of it all is that such material possessions are the exact things that that prevent us from truly reaching financial freedom.  When your wants no longer exceed your income, it is easy to dramatically increase your savings rate.
The late Thomas J. Stanley, co-author the classic finance book The Millionaire Next Door, taught me that “wealth is more often the result of a lifestyle of hard work, perseverance, planning, and most of all, self-discipline.”  Him and his co-author William D. Danko showed me how most people who live in very expensive neighborhoods actually had very little net worth.  This was because they spent most of their money paying for social status.  The authors also discovered that wealthy parents who gave their adult children more money ended up handicapping their children’s personal drive to succeed.  Ironically, the more money parents gave to support their adult children, the less wealth those children actually accumulated on their own.

Having fun along our journey
Unfortunately, life can sometimes be unexpectedly short.  It is important to make the most of our time on this Earth.  If you value your time, don’t spend all of it working away to chase the things that don’t provide real value.      

I’m thankful for credit card points and miles, since they have allowed us to travel to many places around the world for very little.  We feel very blessed to have satisfying careers.  While we don’t eat out very often, we do indulge in nice meals from time to time.  Since we both spend less than 15 minutes on our commute, we get to enjoy a lot more free time with each other. 

On your journey towards financial freedom, I hope you live for the day - just don’t forget to plan for tomorrow while you’re at it.  The average life expectancy of Americans is 78.7 years.  With improvements in technology and modern medicine, I expect that we will only be living longer.  For most people, life is long and we should plan accordingly.   

There are many paths to achieving financial freedom.  I’m not here to tell you how to live your life or how to save your money.  If you are only living for the moment and waiting for the future to start saving, you may one day find yourself broke and depending on the handouts of others.  Some in this world may have been born into financial freedom.  For the rest of us, we have to earn it.

No comments:

Post a Comment

Comments? Questions?

Related Posts Plugin for WordPress, Blogger...