Financial Security, Financial Independence and Financial Freedom. What is your goal?
Goal setting is an essential part of any plan. That’s also the case if you plan to improve your money management and finances. While some people’s mantra is to “fight poverty” and “escape poverty“, for others is to “grow and protect their wealth“. Such statements risk being linked to different socio-economic groups, “the poor” and “the rich”. The same statement may risk suggesting strikingly different needs and strategies to be applied.
I beg to differ.
While the starting point, the expectation and the level of effort will differ, I believe the mindset, the methodology (CFQ; the Wealth Triangle), and the mechanisms required to achieve the expected outcomes realistically will be similar:
1) Acknowledge the situation. Take responsibility. Be accountable. Make an actionable plan
On an individual level (without considering social welfare or government policies), you don’t escape poverty by being less poor or not poor. You escape poverty by creating some levels of wealth. Wealth creation is the only direction.
While the definition of wealth includes financial factors (making money, growing assets, protecting assets), it should also include non-financial factors (health, security, happiness). Indeed, I believe true wealth is invisible to the eye.
Once the direction is clear and wide factors are considered, I find it helpful to rely on a set of technical milestones (stages) along my financial journey. Although some of these definitions are not formally recognised or even used interchangeably, such stages will let you know where you are going and where you are along your financial journey.
I have identified two major stages. You can only be in one stage at a time. Such stages can be grouped under your Financial Health, Financial well-being scores.
1) Financial Security/Financial Stability is the first milestone.
- It already requires “getting your house in order” by:
- Getting a decent income
- Controlling your debt
- Balancing your income and expenditures by living under your means
- Saving and investing regularly to be able to retire in due time plausibly
Unless you already have a good job, wise financial habits, and a great pension scheme, this goal implies mastering and successfully managing all the big financial decisions right (income streams, saving, investing, debt control). While Financial Security should be achievable for all of us, it is still a dream for most individuals worldwide, including individuals in developed countries. To a certain extent, developed countries saw a decrease in financial security due to several factors (global competition, less stable job markets, lower welfare policies, and increased living expenditures).
2) Financial Independence/Financial Freedom is the second milestone
You achieve financial independence when your current savings and investment returns are expected to cover all your upcoming annual costs (fixed and variable). Technically, you no longer need to work for a living. You have achieved early retirement. You now work or dedicate your time to activities you feel highly motivated to do. You don’t do it out of need.
Practically, Financial independence is not achieved only if you become wealthy. It is a mathematical projection based on your expected passive income and annual expenditures. You can fast-track your financial independence if you reduce your needs and wants (simple living, minimalism, etc.). It is still up to know to decide your annual budget: it can be 30,000 USD, 300,000 USD or 3 Million USD, etc. You got the point.
Unless you rely on a bullet-proof fixed annuity, It is important to re-state that Financial Independence is calculated as a forecast of future earnings from investments (real estate, capital markets, etc.). By definition, future earnings have a certain degree of uncertainty due to macroeconomics (inflation, wars, pandemics), and micro-economic factors (quality and type of investments). As I like to quote, all models are wrong, but some are useful. A popular model to calculate the size of your investment portfolio (your freedom number), and your expected annual earnings is the 4% Rule (the Trinity Study).
You can either have a modest defensive goal (escape poverty), or a bold and aggressive goal (become wealthy). In both cases, if you want to take the matter into your own hands, I believe you will use the same mindset, financial knowledge, and models tweaked to your ultimate goals. Become Financially Secure or Financially Independent does not imply being rich or having a lavish lifestyle. To a certain degree, a lavish lifestyle delays and put at risk the overall financial well-being of an individual that relies on a balanced control and management of current and future earnings and expenditures.
Keep It real. Sweat Your Assets.
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