Financial freedom and financial independence

When we talk about financial freedom and financial independence, people often think that the two are similar.

As a result, they often use the following phrases:

“I finished my emergency fund, now I have financial freedom” and “I have financial independence because I moved out of my parents’ house and paid my bills”.

But are they really right?

Today we’re here to show you that financial freedom and financial independence are different concepts.

In general, financial freedom is a stepping stone that you climb in order to achieve independence:

What is financial freedom? 

We consider a person to have financial freedom if they are able to support themselves.

In addition, they must invest at least 10% of their income.

Therefore, a person who has achieved financial freedom has the freedom to make decisions according to their goals and values, without worrying about money.

When we talk about financial freedom and financial independence, it’s also worth pointing out that a financially free individual has a robust emergency fund, which represents 12 times their cost of living.

That’s why they can quit their job and start a new business.

This is because the person is not so dependent on work, since they have the resources to support themselves for a while.

From another point of view, if you become financially free, you don’t have to worry about what you put in the supermarket trolley.

At the same time, you don’t think about whether a product you’ve bought will affect your budget for the month.

But note that this doesn’t mean that you are negligent.

In order to have financial freedom, it is essential to have a high level of control over income and expenditure.

The point is this: if you have financial freedom and financial independence, you know your cost of living.

In the case of financial freedom, you know how far you can go with your own spending.

So, when a person says:

“I’ve finished my emergency fund, now I have financial freedom”. This is not correct.

Although having money to deal with unforeseen circumstances is an important step, it alone does not guarantee you freedom.

Finally, with financial freedom, you guarantee a better quality of life and mental health.

This is because in times of economic crisis, illness, accident or unemployment, you are protected for a certain period.

Financial freedom and financial independence – what is independence?

Some experts say that a person achieves financial independence when their earnings are greater than their monthly expenses.

On the other hand, some think that it means having a balanced budget and sufficient reserves to live on, without depending on work.

This second explanation is the most correct because we said that a person is financially independent when:

Achieve a good reserve which, applied to the right investments, will give you the returns you need to maintain the lifestyle you would like.

Again, the phrase “I’m financially independent because I moved out of my parents’ house and pay my own bills” is not correct.

Talking about financial freedom and financial independence, know that independence goes far beyond paying your bills.

You are not protected for a certain period, but for your entire life.

As such, there are different types:

For example, if you have bill independence, you are 100% debt-free.

And by that we mean all types of debt, whether it’s a credit card, a loan or even a mortgage.

There is also job-related financial independence.

In this case, if you lose your job, you’ll have another source of income to live on.

In total independence, you literally live off a passive income.

There are no debts and you don’t need your job because you live off the income that comes from your investments and the assets you’ve built up.

In other words, your standard of living can be easily sustained by receiving dividends or renting out property.

To clarify the difference between financial freedom and financial independence, check out the information below:

Financial freedom: having enough income to cover your expenses and the freedom to choose your job or even change careers.

But manage your investments and income actively to ensure peace of mind and comfort in the future.

Financial independence: accumulate enough wealth to sustain your lifestyle indefinitely.

Don’t work for money, and have the freedom to choose how you spend your time.

How much do I need?

If you’re wondering how much you need to define that you’ve achieved financial freedom and financial independence, let’s clarify that below:

Grant Sabatier, author of the book Financial Freedom – a proven path to all the money you will ever need, points out that the value of achieving financial freedom is subjective.

This means that values change from person to person, because everyone has different goals.

According to him, “only when you know your destination can you discover the best route to get there”.

That’s why you need to figure out your number.

There are calculations that help you estimate how much wealth you need to accumulate in order to be financially independent.

But in the case of freedom, the calculation is more difficult.

Although it’s complicated to know how much you need to have financial freedom and financial independence, let’s consider the following:

To be financially free is to be able to support yourself for 3 years completely without income and to be financially independent is to be able to support yourself for 30 years with your income.

In the case of financial freedom, the first step is to define how much you would spend during the period.

For example, if you need US$1,500 to live comfortably for a month, to have financial freedom you would need US$54,000.

Still, on the subject of financial freedom and financial independence, let’s now think only about independence.

Here, we can use the 4% rule that was developed by financial advisor William Bengen in the 1990s.

Bearing in mind that financial independence is related to retirement because you don’t necessarily need your job when you reach that level, let’s consider the 4% rule that is normally used for retirement.

Financial freedom and financial independence – Applying the 4% rule to understand how much I need

By analyzing historical returns, Bengen concluded that for a diversified portfolio of 50% stocks and 50% bonds, retirees could withdraw 4% of their portfolio balance each year.

As a result, their savings would last 30 years.

For simplicity’s sake, let’s say you’ve managed to save $1,000,000 for your retirement. 

According to the 4% rule, you can withdraw US$40,000 (US$1,000,000 x 4%) in the first year of retirement.

This means that initially, you would have more than US$3,000 as income per month.

This way, over the next few years, you only need to adjust the amount withdrawn to inflation in order to maintain a stable lifestyle without depleting your savings.

So you see, although the rule is used for retirement, it applies to a savings target before that period.

As such, it can be a great ally in understanding the amount you need to have financial freedom and financial independence, especially independence.

Daniel 2 de April de 2024