So we’ve talked a lot about financial independence as a side-note and we’ve talked a lot about the book Your Money or Your Life (and some about Mr. Money Moustache and Early Retirement Extreme), but mainly in the context of other things like what to do if you’re not enjoying your career, or why are hardcore bloggers so popular.
I was looking for a link to define financial independence when replying to a comment the other day, and it turns out we don’t have one.
What is financial independence?
Well, my dad says that success is when the money you make from investments is greater than your salary income. That’s one version of financial independence– being able to replace your earned income with passive income.
Your Money or Your Life defines it as when your income from passive investing covers your living expenses.
A somewhat simple definition is: You have enough money from other sources that you don’t have to work for pay. You only work if/because you want to, not because you have to.
There’s some disagreement with the nitty-gritty details. Do rental properties count if you’re the one doing the property management? Does drawing down stocks at 4% count or do you have to live off the dividends alone? (Note: draw-down vs. dividends is kind of a red herring–depending on the tax structure you may prefer a company that reinvests profits to one that spits out dividends.) Does having a working spouse paying some of the bills mean you’re not financially independent? It can be hard to say. And in the end, it probably doesn’t matter except for getting into silly arguments on the blogosphere with all your new-found free-time.
How do you get to financial independence? Well, you get rid of your debt. You get your living expenses as low as you can/want. You save a lot of money. You put that money in places that are going to make money for you in a relatively low-risk setting. (Note: the stock market is low risk over the long term but high risk over the short-term… diversification is *very* important to manage risk.) You keep saving and investing until you hit a magic “crossover” point, in which the money you make from your investments is “enough” to cover your “enough”. Then you’re financially independent.
At that point you have the freedom to walk away from your job. To take a risk on your current job or on a new job. You can stop working, keep working with the freedom that you could lose the job and still be ok, or change work entirely.
Financial independence is freedom.
Now, you may not want to achieve full financial independence, or may not be able to achieve it any time soon (because your “enough” is too large compared to your income), but you can still achieve partial financial independence.
Partial financial independence is when you have a very large emergency fund and you’re on track or ahead of the game with your other saving. Partial financial independence means you’ll eventually have to find another job, but you can still leave employment or take risks with your employment and you’ll be ok for a while. (In the academic context, it’s a nice thing to have when you want to take a sabbatical and aren’t sure on funding sources.) Many people call this type of financial independence having an “FU fund.”
In the US, of course, there are sticking points for those under the age of 65. Health insurance is the big one. Hopefully it will become easier to get affordable health insurance not tied to your job as the Affordable Care Act continues to be rolled out, but health costs will still be increasing over time.
Have you thought about what it would take to be fully or partially financially independent? Is this something that, absent of getting a large inheritance or other windfall, would be of interest to you?