What is Financial Independence? Simply put it’s having the means to support yourself without having to work. For some it’s having a stock portfolio for others it’s rental properties. However, in essence, it’s having enough passive income to cover your expenditure in a sustainable way. Many use the concepts embedded within financial independence to retire early, whilst others use it to help them pursue their passions and interests without being financially tied to an employer.
The truth of the matter is that, if you choose not to research financial independence, then there is a real risk that you will never be able to stop working. The fact of the matter is that you cannot rely on the state pension to fund your retirement and final salary pensions are a thing of the past. There are some very fundamental concepts tied to financial independence that you need to know, to achieve financial success.
What Is Financial Independence Philosophy?
Many people, including myself, are brought up with the mindset that you save money to spend it. At an unsustainable rate. For example, if I save £2,000 this should be spent on something tangible like a car. This is usually something that depreciates in value over time and although you might consider it an asset, it’s more of financial liability. Our society and culture are built around a culture of accruing debt, to buy things that we don’t probably even need.
By contrast, the Financial Independence mindset is to save, invest, accrue money so that it can be withdrawn at a sustainable rate thus never being depleted. If you can buy an apple watch, you might look rich and maybe you are rich, but if you own Apple Shares you are truly rich. If you invest in companies or index funds then as the profits or economy grows, so does your wealth.
What Is Financial Independence Important For?
Financial Independence is also connected to the idea that you can retire at any age, even say 31 as Pete (Mr Money Moustache) has done due to discovering the shockingly simple maths behind retirement. This is because financial independence is a sustainable method of deriving passive income indefinitely.
The Longevity Risk
Life expectancy is increasing and people are living longer than ever before. This concept of unsustainable wealth and an unsustainable retirement is dangerous due to this fact. The traditional approach to retirement is potentially becoming outdated.
Many people may plan retirement with the view that they retire at 65 and live for 20 years. So what happens when someone retires at 55 or 65 and lives until 110? What if they can’t retire at all and have to work until 75-80 if this is possible. It’s absolutely essential to understand the underlying factors of successfully managing an investment portfolio.
This highlights the fact that if financial independence is not the end goal there is a risk you will always be trading time for money. By contrast, once you realise that this is the equation behind working, your whole appreciation of money changes! You can retire early for example.
Check out this short clip about the Financial Independence Retire Early movement.
Retirement As A Financial Figure Not An Age
Having the goal of early retirement pushes people to consider how much money they need and the lifestyle they want. Moreover, there is a shift away from passively waiting to retire at a given age, regardless of the savings pot. Instead, people are driven to save more to bring forward the date of their financial freedom.
By the time many people begin to plan for retirement, it’s too little too late. Moreover, in the UK you can’t access your workplace pension until at least the age of 55. This age has increased in recent times and is expected to further increase.
One of the key things of financial independence is about having control of your money for when the situation arises. For example, you never know if you might be made redundant so even waiting for the traditional minimum retirement age is a risk.
Key concepts to a successful retirement:
The 4% Rule
Returning to the concept of sustainable wealth, a pretty valid question is how can the money be withdrawn and spent without never running out? This is essentially all due to the average growth of the stock market resulting in a safe withdrawal rate, known as the 4% rule. Although people have argued that this is potentially higher. On the other hand, there are limitations and things to take into consideration, like the market performance and inflation.
The other valid question people may ask is how can I get to a net worth where withdrawing 4% would cover my annual expenditure? This is where putting your hard earned money in the right place is critical. According to most sources, the average return from an index such as the S&P 500 is around 7% after accounting for inflation. Therefore the stock market is essential in growing investments.
Investing For The Long-Term
There are some key behaviours to also be aware of such as; investing for the long-term, investing as early or regularly as possible. By contrast not trying to time the market or panicking and selling out if the market falls. If you tie this up with the power of compound interest the math dictates that the investment will grow exponentially.
Just look at the below example of a £5,000 investment, after 15 years the balance is +£13,795 with the total interest in year 10 nearly equalling the initial investment. This underpins the key aspects of financial independence – getting your money to work for you!
The earlier you invest and the longer money is invested, the more it compounds and the greater the returns are, to me this is a life-changing mentality! Why spend your whole pay-check and have to earn even more money when your money can be working harder than you.
Compound Interest Calculation:
Base amount: £5,000
Interest Rate: 7%
Effective Annual Rate: 7%
Calculation period: 15 years
So What Is Financial Independence Really About?
Whilst I agree that you should have fun while you’re young, the other side of the coin is that if you show some restraint and invest, just think how easier things will be in the future! Even if you can’t retire early, consider the impact of an early investment, imagine the above balance after, 20, 30 or 40 years. After 40 years that £5000 would potentially be worth +£75,000!
Financial Independence is all about taking control of your finances. It’s working towards having passive income, so that you are not reliant on a pay-check. It’s the opportunity to break the correlation between trading time and money. This can give you the time-freedom and options to make choices that facilitate your enjoyment of life.
You could simply choose to spend your days relaxing, reading books and sipping cocktails. By contrast, you work for a charity, or accept a lower paying job that you enjoy more because you don’t need the money.
The point is, the choice is yours. Don’t take the risk of simply saving your cash and defer your retirement like the majority of the population. Take action and start your journey to financial independence today.
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