Everybody, no matter what their current financial circumstances, can achieve the rarefied reality of financial freedom. This article details what it takes to reach the first 3 destinations on the road to financial freedom. So, listen up, as what you are about to read would probably cost you a few hundred dollars if you went to a financial advisor to help work this out. Hopefully, this article will have saved you a trip and a few hundred dollars!You’ll often hear people mention terms like financial security or financial independence in the course of everyday conversation. Within my own social and business circles, practically everyone I know desires some level of financial independence or freedom. However, I’ve found that financial well-being remains hidden and out of reach as a result of fuzzy concepts and even sketchier numbers people have in their head about what these terms mean. Therefore, the first thing I want to do here is dispel any myths or misunderstandings and reveal the true meaning of financial independence and financial freedom.
The key thing to understand about financial freedom is this - no matter how much money you earn, it’s vital to understand that you can only ever achieve financial independence through the generation of non-earned (passive) income i.e. a return on a capital sum invested. Or to put it another way, making money work for us, rather than us working for money!
Now, what I wanted to do was figure out ‘what’s the number’? In other words, how much capital do you need to achieve: 1. financial protection; 2. financial security, and 3. financial independence? So, over the course of a weekend I decided to have a go at describing and calculating the hypothetical cost of each of these 3 levels of financial well-being. Here goes!
1. Financial Protection
This is the minimum level of financial wellbeing and first destination on the road to financial freedom – making sure you and your family are protected no matter what short or long-term financial challenge may befall you or the economy. Here’s how you know you and your family have achieved financial protection:
1. You have enough liquid capital to cover your basic living expenses for a minimum of 3 months and ideally up to 2 years. So, if your basic living expenses came to $3,000/month, you’d need a minimum of $9,000 and ideally $72,000 in liquid capital.
2. You have a life insurance policy in place that provides income to your family/dependants to maintain their lifestyle if you were to pass away.
3. You have disability income protection insurance to protect you and your family should you become disabled in any way and prevented from working and earning income.
The amount of disability insurance you should have is directly related to the amount of money you’ve saved. If you have say 3 months liquid capital saved, then you should really consider having disability protection to cover the outstanding 21 months so that ideally you have a combination of savings and/or disability income in place to cover 24 months basic living expenses. As a rule of thumb, insure yourself for 60% of what your income is. Typically the monthly cost of disability insurance can be about $30(if you’re 30yrs old) and up to $100 (if you’re 50yrs old) per $1,000 protection
2. Financial Security
You will have achieved financial security when through your various investments you’ve accumulated a critical mass of capital, that, invested in a secure environment at an 8% rate of return, provides you with enough cash to meet the following living expenses forever without you having to work again should you chose. For the purpose of this illustration we’re gonna assume some numbers.
1. Mortgage repayments on your private home until it’s paid off e.g. $1,500/month
2. Family food needs e.g. $500/month
3. Utilities, gas and electricity e.g. $250/month
4. Transportation needs e.g. $250/month
5. Insurance - health, disability, house e.g. $300/month
6. Taxes - such as property taxes e.g. $200/month
This would bring your total monthly living expenses to $3,000/month or $36,000/annum. Therefore, you would need a critical mass of capital amounting to $450,000 (which invested @ 8% return per annum would generate $36,000) to achieve financial security.
What I like about this calculation is that it removes fuzzy, subjective meanings of financial security; it distils financial security into a finite number…something which I think is enormously helpful for anyone looking to achieve it!
3. Financial Independence
You will have achieved financial independence when, through your various investments, you’ve accumulated a critical mass of capital that when invested in a secure environment at a 8% rate of return, provides you with enough cash to meet each of the 6 goals of financial security previously mentioned i.e.
1. Mortgage repayments on your private home until it’s paid off e.g. $1,500/month
2. Family food needs e.g. $500/month
3. Utilities, gas and electricity e.g. $250/month
4. Transportation needs e.g. $250/month
5. Insurance - health, disability, house e.g. $300/month
6. Taxes - such as property taxes e.g. $200/month
PLUS the following 3 additional financial goals:
1. Provision for your children’s education (substantially or completely) e.g. $100,000 until their 18 and then say £50,000 for 3 or 4 years in college/university = $150,000 or an average of c. $7,000/annum over 21 years.
2. Provision for basic entertainment needs – concerts, dinner out etc (at least 50% of what you enjoy now e.g. $300/month, $3, 600/annum
3. Provision for the purchase of new clothing, or 1 or 2 reasonable “luxury” items such as plasma screen TV, car etc. e.g. $5,000/annum
When you sum up these 3 provisions it comes to $15,600/annum. Adding the cost of $36,000 per annum then the cost of financial vitality would come to $51,600/annum. Again, using an annual 8% return on investment would mean you’d need a critical mass of capital amounting to $645,000 in order to secure financial independence.
Financial independence is simply what it costs for you to live reasonably comfortably assuming complete autonomy from work/earned income. In one sense, all you’re trying to do is have enough of a capital sum invested to replace your current salary.
Now, if you will want to really nail the annual cost of financial independence, adjust upwards at an average inflation rate of say 3.5% each year and you’ll know exactly what true financial independence will cost you each year into the future.
Finally, if you’re saving or investing a substantial amount of your current income, then the amount of money you need to duplicate your actual current lifestyle is reduced by the same amount. So, if you’re saving 20% of your salary (say $10,000) than the new number you would need to be financially free would be $51,600-$10,000 = $41, 600
So, there you have it. We’ve defined exactly what Financial Protection, Financial Security and Financial Independence is in terms of a sum of capital required to generate adequate non-earned income. Put your own numbers into the above process to arrive at the exact dollar amount you require to satisfy your own living expenses/lifestyle requirements. Next time someone tells you they want to be financially secure or financially free, now you can say: “Really, cool, I can show you how much capital you’ll need to achieve that!

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