Financial Freedom, or Financial Independence?

Michael QuanEducation, FI / FIRE, Misc6 Comments

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financial freedom vs financial independence

So what do you want? Is it financial freedom! Or, perhaps financial independence? Or, maybe F.I.R.E?

The acronyms on the Internet can be a bit maddening, no? So, what is it??

Well, it’s time to set things straight once and for all.

You see, I’ve been researching this question for the better part of 6 years now and I’ve come to some important conclusions so that you don’t have to wonder anymore yourself!

Financial Freedom vs. Financial Independence

I used to think there was a clearly defined definition of financial freedom. There is NOT, and here’s why.

Isn’t it true that you have felt freedom during different parts of your life? How about when you first got your driver’s license or moved out of your parent’s home? Surely you felt “freedom” then.

Isn’t it also true that feelings of freedom can shift over time?

Financial Freedom

Therefore, Financial Freedom is not a finite number. It is a mindset.

So, although everyone’s definition of financial freedom could be different, I’m going to highlight the most recognized levels and the definition that I like to use. It’s also the definition you’ll see in mainstream media (ex. Dave Ramsey, or Investopedia)

Financial Freedom:

  • free from financial constraints
  • free to work (or pursue work) based on passion vs. economic need
  • enough money in the bank to whether economic downturns
  • enough money to provide food, shelter, and clothing
  • automatic savings/investing are in place
  • paying off credit cards in full

I believe if you have these fundamentals in place, you are free to “self actualize” and become the most that you can be.

This is where I direct a lot of my coaching clients on their personal journeys initially. And when they reach this point, many choose to move onto Financial Independence or FI.

Financial Independence

Financial Independence is much easier to quantify and more widely accepted in its definition.

It’s when your passive income is high enough to fully cover your current lifestyle expenses.

Passive Income = Current Lifestyle Expenses

Let’s use a couple of examples to illustrate this.

  1. Example A) John and Maria are married with 2 kids and a dog. They make a combined $10,000 per month income and also own some rental properties bringing in $4000 a month. Their monthly expenses including rent, food, bills, etc. are $6000 a month. Are they financially independent?
    • They are well on their way to financial independence, but they haven’t reached it yet. Even though they bring in $14,000 per month of income, only $4000 of that is passive. They need to create an additional $2000 of passive income per month in order to meet the definition fully.
  2. Example B) Faith and David are married with 1 kid. They make a combined income of $8,000 per month and have $5000 in passive income ($3000 from dividends & $2000 from rental properties). Their monthly expenses are $4500 per month. Are they financially independent?
    • Yup, they sure are! Even though they make less money than our first example, their passive income exceeds their monthly expenses. They live in a lower cost of living area so their rent is cheaper lowering their monthly expenses. With $5000 in passive income per month, they even have an excess of $500 per month.

There you have it. It’s much easier to quantify financial independence.

As such, you can also see that it’s all relative to your passive income and your expenses.

This direct relationship tells us that in order to reach financial independence you can make changes in either:

  1. Passive income – increase this number to exceed monthly expenses, or…
  2. Monthly expenses – decrease this number to reduce monthly expenses

I prefer a balance of the two, but I do favor accelerating passive income over reducing expenses.

As such, I guide my coaching clients towards pursuing a F.I. Accelerator which is typically one of these:

  1. Saving/Investing 50%+ of your household income
  2. Investing in real estate for cash flow
  3. Entrepreneurship

There is no limit to how much passive income you can create, yet there is a limited number of reductions you can make with your expenses.

Financial Independence Formula

Using passive income from real estate investments is easy to calculate. But what if you want to focus on stocks and bonds primarily?

The good news is that it’s pretty much figured out for you already. Now bear in mind, this is a rule of thumb, but it’s a great way to see how close you are to financial independence using your stock portfolios as a gauge.

Ever heard of the 4% rule? It’s based on a study that says you should be able to pull 4% of your retirement from your portfolios until you die with a reasonable degree of certainty… aka safe withdrawal rate.

What to know more? Check out my post I wrote – FIRE Equation: The 4% Rule and Beyond

We also learn that we can reverse this formula to determine the ideal portfolio size we’ll need in order to reach F.I. (financial independence). This called the rule of 25.

You simply take 25x your monthly expenses to come up with this number. Let’s say you need to have $60,000 in retirement every year. You can calculate:

$60,000 x 15 = $1,500,000

Now you know that you want at least $1,500,000 in your equities portfolio to reach FI.

F.I.R.E. – Financial Independence, Retire Early

Alright, F.I.R.E. has become a very popular topic in the past few years. And we already covered F.I. above, so what about the R.E. (retire early)?

Well, if you reach financial independence, then you’ve got some options in life, right!?

For some, this could be their “financial freedom” which is why you’ll hear it interchangeably sometimes.

I digress though. When you reach FI, it can be tempting to walk completely away from work you don’t enjoy anymore. And, it’s something I’ve done myself.

After selling my IT business, I worked for the acquiring company for a while. However, there was a disconnect of values, so I decided I wanted to move on.

Thankfully, I had reached my FI number already so I took my retirement early.

I binge-watched a bunch of movies & tv, went fishing a LOT, took a special effects course, etc. It was awesome!

Yet, this effect wore off after a few months.

So, I decided to reduce some of our expenses. Since I was home now, we didn’t necessarily need a nanny anymore. And that became the start of my new identity for a while… stay at home dad!

Of course, once you’re an entrepreneur, you’re always an entrepreneur and I tried a half dozen side hustles at the same time.

The beauty of early retirement is that you have the freedom to do what you want without fear.

I say all of this simply to say that retirement early looks different for everyone.

However, you will need to find something that fulfills you otherwise you will go mad.

We are either growing, or we are dying. So, make sure to choose activities that are providing value.

Financial Freedom 2.0

I mentioned earlier my definition of financial freedom and how the mainstream media covers it.

But it’s also interesting to note that the second most popular definition of financial freedom is when you are beyond financial independence.

I like to call this Financial Freedom 2.0.

This is where you have:

  • financial independence
  • 35x your monthly expenses
  • able to support your older parents
  • able to support your children and their children
  • can leave generational wealth
  • can buy whatever you please without regard for cost

So again, financial freedom is different for everyone. And many times it’s relative to your friends and family around you.

If you’re interested in this upgraded definition of financial freedom for yourself, check out bloggers like Financial Samurai, Physician on FIRE, Tony Robbins,etc.

Final Thoughts

I hope this post finally cleared up some confusion between Financial Freedom vs. Financial Independence.

It can be a little confusing in the beginning, but once you know the distinctions, you can adopt the one that feels right to you.

Once you decide, it’s best to stay consistent.

And remember, “freedom” is only an idea in your head.

You’d be surprised to find out just how wealthy you already are when you focus on gratitude.

Readers, what is your definition of financial freedom? Where are you in your journey?

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6 Comments on “Financial Freedom, or Financial Independence?”

  1. The problem with all of this (no matter your definition) is that it is simply hard to do, takes a lot of time and definitely requires restraint. So our take is a little different – https://costaricafire.com/fire/aiming-for-fire-is-a-useful-career-planning-tool.

    In terms of where we are: we like to say that we are FIRE in the sense that we are no longer working for others, and we could move to Costa Rica, downsize our expenses, and be fine. However, we do still need a certain level of income to live the life we really want, where we: (a) support our adult but not quite on their own kids – which includes 3 more years of private college, (b) maintain our apartment in NYC and (c) fund the travelling we love to do. So we continue to work on consulting and building other streams of income, and don’t care whether it is called FIRE, financial freedom, financial independence, or whatever else 😉

    1. Yes, the semantics are just a framework from which to work from. So good for you and your wife for pushing the FI envelope.

      I believe true FREEDOM is not a destination, but a journey of constantly growing into our full potential.

      1. Thanks for clearing up the differences! I think in my mind, I’d just always thought of them as synonymous terms.

        I personally really enjoy my current job and would probably stay even if I was financially secure, but even for folks like me, there’s still a huge psychological benefit to achieving FF, FI, F.I.R.E., or FF 2.0

        I’ve found that people tend to act more confidently and less risk averse when they are constantly worried about the personal financial consequences of their actions.

        1. Yes, I think you nailed it on the head… the psychology makes all the difference. I tell my coaching clients that if they love the work they’re doing the “RE” is optional! If the don’t love it, pull the plug and create fulfillment elsewhere. 🙂

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