What is financial independence?

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?

51 Responses to “What is financial independence?”

  1. Liquid Says:

    I’m definitely striving for full on financial independence. Right now I would consider myself in a partial financial independent state where if I were unemployed tomorrow I could sell all my investments and live on the savings for five to ten years without going into debt. It’s hard to fight the temptation of living beyond my means sometimes. I actually plan to buy an ostentatious gift for myself tomorrow worth about $2000. My bank account wont like that much lol.

  2. plantingourpennies Says:

    We’ve still running some models, but it looks like we have a good chance at being mostly financially independent in about 5 years given current saving/spending rates. But you’re right – a lot of that depends how the ACA shakes out and how health insurance prices play a role since we pay for very little of our health insurance at the moment. We hope that we’ll have some information to make some decent projections as everything gets implemented over the next few years.

  3. NoTrustFund Says:

    My first job out of college had a lot of upside potential and we all used to talk about FI (not using that term). Back then when you could get close to to 5% for little risk, and we were in out early 20s, a cool million seemed like plenty.

    When I do back of the envelope calcs now I use a 4% withdrawal rate or 25x our annual spending.

    I spend a lot of time thinking about our enough. Not in terms of FI as neither of us wants to be permanently taken out of the work force at this point, but a level where one or both of us could take some career risks. We are fairly close to that point, but a little hard to know exactly when we’ll get there. The current stock market is helping but obviously things can change!

  4. Jacq Says:

    And a kid is called financially independent when they can pay their own bills.
    Even at partial independence of a 5-10 year stash, you’re still way ahead of most people’s game.

    • Debbie M Says:

      Not relying on my parents or student grants and loans was definitely my first definition of financial independence!

  5. Michelle Says:

    I want to be financial independent. I’m working on multiple streams of income and starting a new business soon to help me with this!

  6. bogart Says:

    FI is never needing to touch the principal, period, end of discussion (unless as per @Jacq we are talking about the kids, in that case I can indeed colloquially describe them as FI when they no longer phone home asking for money :)!).

    If you are 102 (or 44 with a serious illness and a poor prognosis) then you may touch the principal without having your FI status revoked.

    If rental property provides income that makes you FI that is OK and you may even manage the rental(s) yourself provided that you don’t need to do so, that paying a property manager wouldn’t make you not FI. Similarly, you may work for pay, but if quitting would make it necessary to touch the principal, then you are not FI.

    It’s entirely possible that we need a richer vocabulary to describe various conditions (another pet peeve: AARP talking about “working during retirement” when they are describing working to make ends meet. If you need to be paid for work to make ends meet, you are not retired…).

    In fairness, life is uncertain, and I’m not sure how much unpredictable weirdness it is fair to expect people to anticipate in describing themselves as FI (say, should I reasonably incorporate into my financial scenario a tax of 10% on my bank deposits, just to pull an example out of thin air?). But looking at the Internets, I worry about those who are young and healthy and consider themselves FI, or envision themselves becoming FI, without IMHO making reasonable predictions about their future needs (or wants).

    Also, someone relying on assistance or charity is not FI. Not that relying on assistance or charity is bad, just that doing so eliminates the I from FI. Of course this then opens the can of worms of whether my mortgage interest deduction, e.g., is assistance (in this context I’d first say no, and yet in a larger fiscal policy sense I’d quickly and emphatically say absolutely!).

    Someone taking absurd risks (e.g. foregoing health insurance) is not FI.

    Based on the above, we are a good distance from FI, although I am not claiming that one must achieve FI nor that the trek to FI must be an uninterrupted never-wavering one.

    • nicoleandmaggie Says:

      Wow! Those are all really good points on what is or is not FI.

      We disagree with you on the retirement definition– we have a post on that in the future. We had to post this one first though! (Bottom line: Retirement is self-defined and has no standard definition, even in labor economics, therefore working in retirement is a perfectly good thing to say.)

      • bogart Says:

        Just to be clear, I have no problem with working in retirement as a practice. I’d just like clarity in word meaning, and to me (the ultimate authority, natch), retirement means: exiting the workforce with the sense that one has achieved at least lifelong FI (i.e. drawing down principal is OK, if based on a reasonable rate). Obviously there remain plenty of hairs to be split, e.g., if I can afford canned tuna but want fresh salmon and to travel to see the grandkids … . But I personally would prefer to limit retirement to the above definition and have some other word for the other situation. However, it is quite clear I am outnumbered!

      • nicoleandmaggie Says:

        Save those arguments for a few weeks from now!

      • nicoleandmaggie Says:

        Maybe we’ll have to turn it “deliberately controversial”…

      • Debbie M Says:

        Oh, I like all of these points. I haven’t really thought about most of them because I’ve only thought of FI as it relates to me. And for me, FI means pension. I’ve paid off my house, I’ve maxed out my Roth IRA since it was invented, but that’s all still nothing without my pension. With my pension, my house being paid off means I can easily live on my pension alone. And my IRA means I have an extra cushion against inflation and increased health care costs. And SS means I have an additional cushion later on.

        Because I can only stop working now forever if I cash out principal, I’m not FI by your definition. Only I’m not cashing out my pension, so I’m still FI by my definition.

        I have an extra point/pet peeve to add, though. If you say you’re FI because you can afford your monthly expenses, but your monthly expense calculation doesn’t include anything ever breaking or wearing out and it requires that everything go according to plan, then you’re not FI. For example, if your lifestyle includes car ownership, the fact that your car is paid off doesn’t mean you’ll never pay for any car expenses but gas and oil for the rest of your life.

      • nicoleandmaggie Says:

        You’re supposed to prorate those expected maintenance and replacement expenses in!

        Or, just ride your bike everywhere. ;) (Depending on which blogger you listen to…)

    • Linda Says:

      Why do you say this? “If you are 102 (or 44 with a serious illness and a poor prognosis) then you may touch the principal without having your FI status revoked.” If you have $1 million in assets, then I think that means you have $1 million in principal, right? So, I have to leave that principal untouched until I’m 102? What if I die at 102 1/2? I’m not trying to leave a legacy for anyone, so what’s the point of not using some of that money when I’m 88 or 93 or 100? (Assuming I live that long, even.) Or maybe this was all tongue-in-cheek and I didn’t get it.

      • bogart Says:

        It was a little tongue-in-cheek. It’s OK to start spending down principal at 96, though we should bear in mind that $1 million won’t buy then what it does now ;) .

        No, seriously, my big concern with drawdowns is the risk of outliving your money. I’ll admit I am something of a fan of intergenerational transfers or other legacies, though obviously the former requires a next generation, and the whole idea is based on a particular set of values and expectations that comes with good and bad points.

        And that’s in a context where I don’t think that FI should be everyone’s goal, or that it’s necessarily worth foregoing other priorities to achieve FI. Certainly I have not put FI at the top of my list of priorities. And I suppose those who die before the principal runs out (even if it’s dwindling), or, heck, before the bank forecloses, did with the benefit of hindsight achieve FI. But it was a less certain FI in the experience of it, because it depended on kicking the bucket before a certain date.

  7. EMH Says:

    If I lost my job today, then we would be fine so I guess I consider that financial independence. If my husband and I both lost our jobs today, we would be okay for 10 years without jobs. Not awful but not great since we are 37. Sometimes I think we should reevaluate our spending and learn to live off less but I like travelling, I like eating out, and I love my fancy cheeses, too. I read Mr. Money Mustache for motivation but I don’t follow all his advice. I do bike a lot more! The hardest thing for me is to figure out what I would do if I wasn’t working at my current job. I don’t have a passion that makes me want to quit and take advantage of the FU money we have saved.

  8. Leigh Says:

    It’s hard to think about whether or not I would actually quit my job if I reached full FI. I could live off of my cash savings and stock index funds for about 14 months at their current valuation and my expenses and I only live off of about half of my monthly base pay before I stop paying Social Security tax, so I think I have pretty good financial freedom right now…just not enough to live off of forever. At my current expenses, that will take a little while yet (up to 10-12 years), but that number could change if I get married, have kids, and/or sell my condo and buy a house. So in the meantime, I’m just building options for myself, which is pretty awesome to see how those play out as well!

    I have a feeling that I would actually quit my job sometime after reaching FI. My personality is such that maintaining a job is really hard and tolling on me, so I’m not sure how long I can realistically do this for.

  9. First Gen American Says:

    The idea of drawing down principal really doesn’t sit well with me but I realize that is the conservative side of me talking. I can understand it for doing periodic big purchases like cars, etc, but its so hard to calculate a reasonable draw down rate when you don’t know how long you”ll live and how healthy you will be during that time.

    My definition is more like…being able to live off the passive income and only drawing the principal as a form of emergency fund for big ticket unforseen expenses.

  10. Linda Says:

    Yes, sort of. Because of where/how I started from, the set-backs I’ve had, and that fact that I am completely self-supporting (no spouse to provide health insurance or additional income), I just don’t see myself able to become FI or retire early. I am doing very well, but unless I do receive some sort of windfall I will be paying on my mortgage until I reach 61, and I just couldn’t consider myself FI while I have a mortgage. Healthcare is the big issue, as you note. Until I’m 65 and am eligible for Medicare I will very likely need to keep working for someone else to be able to afford the level of healthcare I have now, even if ACA doesn’t get challenged or effectively overturned.

    Really, this idea of FI sort of started in the 20th century, didn’t it? It used to be that people who had their own farms or land on which they could subsist were considered FI. If you could grow or barter everything your family needed, then you were very well, right? I guess I look at that lifestyle and feel more comfortable with it. So, even if my home is mortgaged, I’m doing so much better than many by having this asset/resource available to me. I can rent out rooms to make extra income, I can grow a portion of my own food, and I can build a community with my neighbors that will make it much easier for me to get through the ups and downs of the financial markets. Isn’t that as much a viable strategy as “not spending down principle?”

    • Debbie M Says:

      Probably more viable. Your eggs are in more baskets!

      Most of my money is tied to financial markets, one way or another–scary! I’m not good at growing my own food or bartering, but I am good at doing some things for myself so I don’t have to rely on money quite as much as some people do.

  11. chacha1 Says:

    I would love to get a giant windfall, but since I don’t play the lottery and the only inheritance I’m in line for is (I predict) going to be consumed in the late-life care of my parents … eh.

    “Financial independence” is a lovely concept that I think principally sees debate only because financial services professionals use it to sell financial products, and financial writers use it to sell daydreams.

    I don’t consider I will ever truly be financially independent, because I expect to receive some lifetime payments from Social Security – as most other Americans alive today will – and have no intention of waiving those payments. I’ll take whatever they’ll give me.

    The best I can do seems to be to secure a paid-off retirement property with the capacity for producing some of my own food, power, and water, with carrying costs less than what I can expect to receive from Uncle Sam. My retirement savings, meanwhile, will be earmarked for quality of life (i.e. not living entirely on homegrown zucchini).

    This particular scenario will require at least another fifteen years of full-time work from me and my spouse. Because of the desirability of maximizing our cash accumulation during these highest-earning years of our lives, neither of us has any real intention of stopping work “early,” i.e. before age 65. I am hopeful that my husband, who currently works six days a week, will feel comfortable enough to scale back to five after he’s 60, which is a little less than seven years from now.

    We both like what we do for a living, and we like *where* we’re living. Stopping work early just for the sake of stopping work early would seriously compromise our quality of later life.

    • nicoleandmaggie Says:

      Hm, I do think of Social Security as an annuity. It should count even if TANF doesn’t.

      • bogart Says:

        I concur, Social Security is an insurance program, albeit one structured by the US government and that we cannot choose to buy into (or not) in any meaningful sense of “choice.” As such (insurance), I’d list it among the tools available to receiving FI, not something distinct from FI.

      • chacha1 Says:

        I’m down with that. :-) I should add that we have to plan for me to live to age 95 based on my family history & current state of health. So stopping work full-time almost certainly does NOT mean stopping work entirely, because 30 years of doing nothing but housekeeping would bore the snot out of me.

  12. hush Says:

    “Financial independence” is not something I perseverate on, though by a couple of these definitions I suppose I already sort of have a version of it, by other definitions, not at all. Also, I plan to work until I die: I actually love my work. I own my own businesses, and I have loads of fun with them. I also don’t have a problem with the idea of debt – I like taking on some strategic business debt here and there for leverage. Anyway, “early retirement” and even “on-time retirement” would be utter hell for me. I’ve already traveled everywhere I want to go. I already make plenty of time to see my family, so I guess it just does not have the same allure for me as it perhaps does for others. To each their own.

  13. undinenotofgeneralinterest Says:

    It’s never been a possibility with the salary of a humanities professor, so I haven’t thought much about it.

  14. Rumpus Says:

    I like to think of it as financial freedom.
    Independence makes me think of dependent and independent terms in an equation.

  15. oilandgarlic Says:

    Financial independence hasn’t been a goal of mine as I like my job enough not to wish for early retirement. I would just like more flexibility and job security. We have a big enough emergency fund that if either of our jobs/careers became unbearable, we can try something else or look for options. I hate the feeling of being tied to a job due to debt or lack of savings. I also think that striving for early retirement means too much deprivation (for me). We make just enough to live frugally, indulge on occasion and save. I also dream more of flexibility and longer vacations than a permanent early retirement.

  16. frugalscholar Says:

    When some tenured professors were let go a few years ago, I upped my savings rate. It would be nice to say that I work because I WANT to, rather than HAVE to. definite reduction in the fear factor.

  17. Jacq Says:

    Forgot to say that my FI spreadsheet file name is actually “Financial Independence.xlsx” – not “Retirement.xlsx” (not even kidding about that.)
    And the results are backed up by about half a dozen internet calculators (some with Monte Carlo scenarios but not all) with no principal draw, in fact accumulation – because I’m weird that way.
    For more on the “Die Broke” philosophy, I recommend the book by the same name by Stephen Pollan (Michael and Tracy’s dad.)

  18. Mados Says:

    This is so much above my financial situation, however I would like to comment about one point – That in the US, health insurance is tied to employment (~ one’s job).

    I had a subject named ‘American Studies’ in uni, and the teacher mentioned a real life example where a man was made redundant from a big firm because they had to cut staff (salaries), but then offered (and was accepted to) continue to work without pay, just so he could keep the health insurance cover. His wife had cancer and there was no way they could afford her expensive treatments without the health cover or get a new health cover through another employer’s health insurance (if he could get another job, that is) since she was already ill.

    It sounds like a system that puts people deep into their employers’ pockets and keep them there. – almost like slavery if they and their families for whatever reason depend on health insurance.

  19. Debbie M Says:

    I’m in a grey area. I could quit and have enough money to cover me until my pension kicks in by cashing out my Roth IRA contributions. However, that would mean not making charitable contributions, not making IRA contributions (obviously) and not saving for renovations. So I’m going to keep working, not exactly because I have to, but not because I want to keep working, either.

    Currently my work involves a mission: a new bureaucratic system is in development, and I’m advocating for the users of this system to make it as accurate and user friendly as possible. It’s like banging my head against a wall, though. I’d really much rather audit some classes, do some tutoring, try writing a book, learn some Spanish, throw some parties, write a song, make a game–basically I’m pretty sure I can think of way more fun things to do with myself all day than explaining, “no, actually, that really is a bug,” and “no, as I explained already, that is not a solution because although it works for this one student, it would not work for students with situations b, c, or d.” That’s in addition to doing the actual work I’m being paid to do (mostly boring but sometimes fun in a puzzle-solving sort of way).

  20. Virginia Says:

    I’ve gotten tired of my career and I used to daydream about being rich enough to quit and never work again. it takes a lot of money to get there (in my opinion, MMM would disagree) so I’ve decided to focus on finding work that I enjoy instead. I tend to stay home a lot. If I didn’t have to work, I might turn into a hermit.

    • nicoleandmaggie Says:

      It is true. And I would need more money if I didn’t work, I think. Money to live someplace I’d want to go out and do things. Money for charitable causes I’d take up. Money to keep me out of trouble. I don’t think I’d be happy puttering around, as much as I sometimes daydream I would. (#2 probably would though)

  21. Rosa Says:

    We were on track for financial independence at about retirement age (it’s slightly up for dispute because my partner is a worst-case scenario person and I’m not) but I put us totally off track by not working, first when our son was an infant and then again this last year because he was having some issues that took up a lot of time to get stabilized/addressed.

    I don’t really care; though; emotionally, financial independence is the ability to tell a bad job where to shove it, and I’ve always had that. When I was younger because I kept my fixed expenses low and my hustle sharp (and the better economy didn’t hurt); now because we have a lot of rainy-day savings.

    A few years ago we did the math on how much lottery winnings it would take for us to actually quit our jobs and just live on investments; at that point it was about $8 million (assuming you net about half that after taxes). But that was with a pretty large allowance for lifetime medical expenses, since that’s such a wildcard. And, actually, if we *had* won $8 million back then and I’d quit my job, we’d have shelled out close to half a million having our son – the cost to the insurance company was about $200k, and uninsured people get billed higher.

    So I guess I feel like, for Americans, between the uncertainties of the stock market and the health insurance market, there’s no such thing as FI without some sort of pension or annuity income. My folks are financially independent and will remain so, because they have pensions. I don’t know if I ever will be unless they don’t spend down their principal before they die (which I hope they do, spend it down – just not so fast they outlive it.)

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