Let’s start by going to our good friend Wikipedia, whoknows everything 🙂
Financial freedom is the status of having enough income to pay one’s living expenses for the rest of one’s life without having to be employed or dependent on others.
Basically, financial freedom means getting your assets to generate enough money to cover your expenses. At that point, you no longer need your daily job to make money.
You can do whatever you want with your life, since you’re not tied to a job, so you have all the time in the world!
You can spend your days diving in Madeira, volunteer for a good cause, travel around the world, or just spend more time with your family and hobbies.
The income generated by your assets is known as passive income. It is called passive because you don’t need to do any work to generate this income.
Meaning of financial freedom to me
If I were to achieve financial freedom, I would like to go and live by the sea in southern Spain, in Cadiz. Why would I do that, you wonder?
In Cadiz you have good weather, good food and the sea, what more can I ask?
To methe meaning of financial freedom is exactly that, to be free.
I want to share a video that sums up very well what financial freedom is.
It is a video edited by JLCollinsnh from the film The Gambler.
He explains the wonders of being in the F You position
I saw the movie some time ago, and I loved this scene. I recently found this edited video, and I liked it even more since it talks about investment and financial freedom.
Wouldn’t you love to be in the F You position?
Financial independence retire early
Financial freedom is also known as financial independence. In the last few years financial independence has become more and more popular.
The idea of not having to work to pay your bills gained traction, and a movement was born: FIRE.
FIRE stands for Financial Independence Retire Early. It’s followed by people who want to achieve financial independence by spending less, saving more money, investing wisely and retire in their 30s.
It’s based on the idea that you don’t need to be constantly spending money and buying compulsively to be happy. The fire community advocates for simplifying your lifestyle, reducing your living expenses in order to live frugally.
Reducing your cost of living will have a massive impact on your savings rate.
To achieve fire you need to set targets for your retirement annual income and your retirement age, which in turn will give your target retirement savings.
If you want to achieve financial freedom you need to invest and obtain good returns. As I have mentioned before, one of the best investments in the stock market is the etf index funds, since their fees are low. These low cost etf funds are also very popular on the fire community.
Strategies like the 4% withdrawal rate and the 25 times rule are the most accepted and followed among the fire people. In order not to drift away from the main topic, I will talk about them in another post.
The idea is to have enough passive income to quit your job, and have the financial security that all your needs will be covered. To be financially free 🙂
Wouldn’t that be great?
Financial independence retire early UK
There is also a fire UK community, where people give advice on best practices. UK is a great country to carry out your journey to financial independence.
The average salary in UK is high if you compare it with other European countries (much higher than in Spain, for example).
That allows you to have a high saving rate. As you should be thinking by now, a high savings rate allows you to save money and invest more, obtaining bigger returns on your investments.
Taxation in UK is very attractive, it can help you to build your wealth. On the tax year 2019-20 you have 20,000£s allowance to use on stocks and shares ISAs accounts.
This means that you can invest 20,000£s per year in stocks, and you will not have to pay any tax on all the profits you obtain.
All the profits on stocks and shares ISAs accounts are tax free.
On the other hand, the state pension in UK is low compared to other countries. The maximum you can get is 8750£ a year, which amounts to 730£ per month. Doesn’t sound enough, does it?
Now that we know what financial freedom and the fire movement are, let’s dive into how to achieve them.
How to achieve financial freedom?
Well, I hope by now the target is clear…
What?? Not yet?? Don’t worry, I’ll tell you again 🙂
Generate passive income that covers your expenses so you don’t have to work
Once you learn the meaning, the hard part is knowing how to achieve financial freedom.
The best way to generate passive income is through investments.
In order to start investing you need capital. And to get that capital you need to save. It is therefore very important to be able to save regularly if we want to build our path to financial freedom.
The steps to achieve financial freedom are as follows:
Become debt free
Increase your income
If you focus on those six ideas, I assure you that you will be closer to achieve financial freedom.
The most complicated in my opinion is to increase your income. In order to do that, you need to have different activities that create passive income for you.
In my case, I’m working on this blog, let’s see if I succeed on making money with it!
It’s also important to optimise the tax you pay. Getting to know the tax world can have a massive impact on your net worth over time. I recommend you to spend some time learning the tax guides of the country you live on, and how you can cut your income taxes.
This strategy is based on a very simple idea: to buy companies that pay dividends to their shareholders, in order to be able to live off these dividends.
For example, if a company pays dividends each year that account for 15% of its share price, if you invest 100,000 pounds in that company, you could get 15,000 pounds per year.
In many countries you can live with 15,000 pounds a year. So you already have it, that could be your strategy for achieving financial independence.
The strategy I have just described is a simplified example, so that the concept is understood. I don’t recommend following it since investing all your capital in just one company would be very risky. If the company has problems and enters in bankruptcy, you would lose all your money.
Instead, I would recommend you to invest in 10 companies that give you 15% in dividends. You have a diversified portfolio and you reduce your risks.
Financial freedom calculator
Well, by now we know what’s the meaning of financial freedom, and we have designed a plan to achieve it.
How can I calculate the time to reach financial freedom?
Now I’m going to show you how to calculate it. You have to take into account the following data:
Returns on your investments
Target annual income
Once you know the income you want to have per year to cover all your expenses, you can obtain your final targeted capital by dividing it by the expected annual return rate for your investments.
Financial freedom calculation example
Let’s say that you have current savings of 50,000 pounds, that you save 1,000 pounds per month and that you get a return of 10% on your investments. We assume that your goal is to earn 30,000 pounds a year. If we divide 30,000 by 10% annual return we get that your final targeted capital is 300,000 pounds.
If we use the calculator we see that in 9 years you would get to that amount.
It is important to note that stopping working in this situation would be very risky, since if there was a stock market crash your portfolio would reduce its value, and you would not earn the 30,000 pounds per year.
In that situation you would not have financial security, so you must have greater capital, in order to be able to deal with potential future crises.
That’s why it’s important to use a margin of safety. We are going to put that margin at 50%, which would lead to a final targeted capital of 450,000 pounds.
Let’s see how many years it would take to generate that amount through your passive income:
12 years! Just three more years, it’s not so much, is it?
At this point you’re in a much better situation, and you could face an eventual crash in the stock market
Please find below the Financial Freedom calculator.
Now that you know how the calculator works, you can use it to set your targets to achieve financial freedom.
Now I’m going to tell you my financial goals to achieve fire.
Financial freedom goals
How am I planning to reach financial freedom, you ask?
If I want to stop living paycheck to paycheck and be able to afford retiring, I need good retirement planning.
It’s not only about having money, it’s also about keeping it. In order to do so, you need a wealth management plan.
Reaching financial freedom will not happen overtime, it will take time. It’s a long term goal, and it should be understood as such.
It’s better to take baby steps, one step at a time. Things are always easier when you set yourself objectives that are achievable. That’s why I have defined the following three targets:
1st Stage – Survival
On this phase I am aiming to get to a point where my portfolio can produce enough income to cover my basic expenses.
As I have mentioned in several posts, my investment annual return target is 10%. That’s the return I am assuming I will get in the future (hopefully I will get a bit more!).
So the calculation is done as follows. If you can live frugally, having just just 1000 pounds of monthly expenses, you would need 12 000 pounds per year. In that case your portfolio must reach 120 000 pounds to achieve the 1st Stage of financial freedom.
At this point you should not stop working, since you don’t have any margin of safety. As a result, a recession could put you in serious problems. In the previous example, imagine that there is a big market crash and it sends your portfolio to 60 000 pounds. That means that the following year you will only get 6000 pounds (assuming you will get a 10% return), so you will not have enough to cover your basic expenses.
We need room for downturns in our investments. That’s when the 2nd stage comes in 🙂
2nd Stage – Financial freedom
At this stage I am in a comfortable position, and I can take a big hit in my investments without suffering. In order to reach here, my returns should cover three times my basic expenses.
At this point we can seriously consider stop working and move to a place like the one below
For consistency purposes, if we stick to the previous example where our basic annual expenses are covered by 12 000 pounds, we would need 360 000 pounds (12000 * 10 * 3) to reach here.
3rd Stage – Wealth
Now my target is that my portfolio generates enough passive income to cover 10 times my basic expenses.
I would be in a point where not only I would benefit from my wealth, but the people surrounding me as well. That’s something beautiful that I would like to achieve.
If you want to keep learning about financial freedom, I recommend you read the following posts: