Key Takeaways
- Financial freedom means having enough passive income from investments, savings, and other assets to support your dream lifestyle.
- It’s important to define what financial freedom means to you, figure out how much money you need to afford that lifestyle, and then try to live below your means and save the rest.
- One way to quantify financial freedom is to multiply your expected annual expenses by 25, through the multiply-by-25 rule.
Definition and Examples of Financial Freedom
Financial freedom happens when you have enough cash and investments on hand to pursue the things you’re passionate about—regardless of how much they cost. By having financial freedom, you can make decisions that align with your values and life goals instead of worrying about how you’ll make your next paycheck.
According to the Consumer Financial Protection Bureau, financial freedom and well-being can further be defined through these four elements:
- Having control over your day-to-day, and month-to-month finances
- Having the ability to absorb financial shock
- Being on track to meet your financial goals
- Making the choices that enable you to best enjoy life.
Note
Many people achieve financial freedom when they’re able to live off the passive income generated by their investments. This passive income could include interest gained from retirement and investment accounts, money received through rental and other real estate properties, or wages earned by owning a business.
Suppose you need to incur and save $72,000 a year to fund your dream lifestyle of living in a city and traveling around the world part-time. You currently have $1.8 million in investments and retirement savings.
Many financial advisors say it’s best not to exceed a 4% withdrawal rate of your retirement savings during the first year of retirement if you want your money to last a lifetime. Plus, it’s best to adjust the amount annually for inflation.
Using the 4% withdrawal rate rule, your portfolio is already generating the $72,000 you need to fund your lifestyle ($1.8 million x.04 = $72,000). Therefore, you’ve reached financial freedom.
Note
Remember that financial freedom will look different (and be defined differently) for every individual. A few of the many factors that impact financial freedom include your individual measurement of quality of life, income, and the area you live in. While one person’s version of financial freedom may include paying off their student loans, another’s may include becoming a high-net-worth individual.
How Does Financial Freedom Work?
The process of working toward financial freedom can be broken down into a few key steps.
- Define what financial freedom means to you: If you had all the money in the world, how would you spend your days? What would you want to accomplish in life?
- Figure out how much money you need to afford your version of financial freedom: Calculate how much money you need to save in order to fund the lifestyle outlined in the previous step. How much money you’ll need to have saved depends on your expected annual expenses.
- Save as much as you can: When you reach financial freedom, you are no longer living paycheck to paycheck, but instead have enough funds to last and protect you in the event of an emergency. By continuing to save as much as you can, you will be one step closer to your savings goals, no matter what those may be.
- Live below your means and save the rest: If you are able to, spending less than you earn is recommended for reaching financial freedom.
How Much Money Do I Need to Reach Financial Freedom?
As mentioned, there is no one amount of money that every person should reach for in order to achieve financial freedom. The amount will vary depending on the individual and their lifestyle goals.
Generally, though, the amount of money you need to reach financial freedom depends on your expected annual expenses, as well as your annual income. The multiply-by-25 rule is a helpful guide individuals use to calculate how much they should save for retirement, and it can be applied to financial freedom, as well:
- Financial freedom (quantity) = expected annual income x 25
Let’s say you need to have $50,000 a year to afford your dream lifestyle. In this case, your financial freedom amount would be $1.25 million ($50,000 x 25 = $1.25 million).
Ideally, though, in addition to saving regularly from your salary, you would increase the amount of money you save through things like 401(k) employer matches, compound interest on investments, and other sources of passive income.
