In here we share with you what is financial freedom and the path to getting there
Attaining financial freedom is an objective for most individuals. Financial freedom usually means having enough savings, financial investments, and cash on hand to afford the kind of life we desire for ourselves and our families.
It means growing savings that enable us to retire or pursue the career we want without being driven by earning a set salary each year. Financial freedom means our money is working for us rather than the other way around.
How do you become financially free?
To become financially free, you must pay off your consumer debts, build a safety net of savings funds, and create enough passive income through investing or business ownership to pay for your current and expected future living expenses.
We are burdened with increasing debt, monetary emergencies, excessive consumer spending, and other problems that keep us from reaching our most meaningful financial objectives.
Table of Contents
- Examples of Financial Freedom
- How Much Money Do You Need to Be Financially Secure?
- Seven steps to financial freedom
Examples of Financial Freedom
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.2
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.
How Much Money Do You Need to Be Financially Secure?
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.
Seven steps to financial freedom
If you are aspiring to become financially independent or at least become financially sound, you need to have certain essential things in place. Without having a plan in place, accumulating and investing on an ad hoc basis will not be fruitful over the long term.
Step 1: Organize finances
First, organize all your finances. Consolidating all your savings, investments, insurance, debt (personal and business), and non financial assets in one place can be a long-drawn process. Unless you know where you stand at present as far as your finances are concerned, the blueprint of your future financial life will not emerge with clarity.
Step 2: Cash-flow & debt management
Next, you need to jot down all the different sources of inflow and outflow. Inflow sources may include salary or business income, interest or dividend income, rental income, bonuses, amongst others. Take into account the spouse’s inflow also.
Segregate the inflow based on their frequency. This will provide you a better picture of cash inflows to take informed decisions.
Similarly, prepare an outflow statement which includes household expenses, business and professional expenses, loan repayment and any other outflows. Some of the expenses could be discretionary expenses while others could be non-discretionary in nature.
Segregating outflow over monthly, quarterly, half-yearly or annual basis will help make informed decisions while managing money.
Also find out how much debt you are carrying. The only constructive debt is a home loan as the value of a home is expected to go up over time. Make a plan to get rid of all unconstructive debt as early as possible in life. One must target to get positive cash flow year on year.
Step 3: Emergency cash & risk management
Now, plan for the worst times—job loss, medical emergency, economy and geopolitical uncertainty, etc. Such events may require you to arrange money to tide over the situation.
Therefore, have an emergency fund in place. Buy adequate professional indemnity, property insurance, life insurance and health insurance for a comprehensive protection.
Step 4: Managing financial goals
For achieving your financial goals, you need to have a proper plan in place detailing each goal. Start with identifying the financial goals and then estimate its cost and the time duration after which you need to achieve it.
The goal at current cost needs to be inflated to arrive at the actual cost for which you will have to save on a regular basis. This is the basic and first exercise for each financial goal.
Step 5: Wealth creation and second income
Building wealth over the long term is a slow process and requires patience. One of the most important factors in wealth creation is the right asset allocation.
Based on your risk profile and the goals, you need to devise an asset allocation plan and update periodically based on time horizon, risk capacity and market condition till the goals are realised. Choice of equities, debt, and alternative investment and the allocation towards them will go a long way in the creation of wealth over the long term.
While creating wealth consider income generating assets. It will give you the liberty to work on your own terms as the income generating asset will provide you a second income to maintain your lifestyle if required.
Step 6: Wealth management
As your wealth grows, you need to take all the precautionary measures to ensure the wealth grows and not depletes during the accumulation phase. How you manage risks, goals, savings and investments will determine how well you are able to manage wealth over the long term.
Step 7: Estate planning
Transfer of your assets or the wealth created is the last step. To ensure smooth transition of wealth to your legal heirs, you need to have a proper succession plan. Make a Will that will take care of the financial needs and goals of all the family members without any legal discourse in future.
Ask yourself if you are doing everything on the list now. Then ask if you have the ability to do every item on this list. Chances are your answers will be “no” then “yes.”
Your likelihood of achieving financial freedom increase dramatically if you can save money, control your credit and minimize your debt. You will be better able to provide for your family and yourself, not to mention the awesome feeling of being debt-free.
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