The exact threshold for financial freedom varies by definition, but in reality, you are not financially shackled to a life unshaped by your preferences one day and financially free to pursue any lifestyle the next day. By pursuing financial growth in five key areas, you can provide yourself the opportunity to experience a growing rate of financial freedom each day. While achieving these steps may not mean you will never have to work again or make a frugal choice, it does mean you will not have to work a job you hate or make a frugal choice that diminishes your happiness.
Assuming you do not have a nine-figure net worth, creating financial freedom involves making tradeoffs. Determine what makes you happy, and make sure you keep it. Determine what does not add significant joy to your life, and discard or downsize it. Keeping insignificant expenses in your life is the cost of financial freedom. Skimping on expenses that provide happiness is the cost of joy.
The financially free take five simple concepts and fine-tune them for their lifestyle. If you are financially free, then:
1. Your needs are comfortably covered.
While this may seem like an obvious step, it is also the most common stumbling block to achieving financial freedom. Analyzing needs is an uncomfortable part of the process because so many of us have grown comfortable with more than we need. In a recent conversation, the individual I was working with had difficulty understanding that having a three-bedroom, two-bathroom home was not a “need” for them, a mostly retired couple with no overlapping hours for their small part-time jobs. The individual’s protest statement was that there would be no place to put all the stuff that goes in their third bedroom, arranged as an office, if they had a smaller place.
Most of that stuff is also not a need.
Honestly assessing your needs cost is mentally tough, particularly if you have grown accustomed to a degree of lifestyle inflation. However, if it is holding you back from achieving financial freedom, it is worth figuring out where to reduce your needs costs.
If you need help analyzing your own “needs” cost, read Do You Really Need That? Analyzing Needs vs. Wants to help you understand the true cost of your needs. If you need creative solutions to tackle your biggest expenses, typically housing and transportation, also read Eliminate Stress: Decrease the Cost of Needs. Thinking creatively on these large costs is the quickest path to discovering the room in your budget to spend on happiness and enjoy the extra money that can buy you the freedom of choices.
Covering your needs costs with a comfortable amount of your budget remaining is a required prerequisite to achieving the other financial freedom steps. Getting out of that paycheck-to-paycheck lifestyle without wiggle room is the beginning of freedom.
2. You have an emergency fund and the willingness to use it.
After a functioning checking account, setting up a high-yield savings account to house your emergency fund is the second step for financial wellness. Your emergency fund is there to pay for the unpredictable: the layoffs, the hurricane damage, the emergency dental surgery that your insurance did not fully cover.
The larger emergency fund you choose to amass, the longer it could potentially cover your lifestyle. While you should initially just save an emergency fund to cover your risk and provide peace of mind before starting to invest for retirement, building a larger emergency fund once you have the means can offer additional opportunity.
Having an emergency fund that could fund your basic needs for three months is terrific. Having an emergency fund that could cover your whole lifestyle for a year is better. This huge safety net allows you to take risk-free risks.
Risk-free risks? In short, when your emergency fund is small, it should only cover the obvious emergency. If you build it, the threshold for an emergency can be lower. This does not mean it covers when you really want a Starbucks peppermint hot chocolate. (Although I understand this urge, it is not an emergency.) However, it can provide you the freedom to leave your job if it violates your values or happiness in any way. Unsatisfactory work conditions is exactly the type of emergency for which to use a robust emergency fund.
This can sometimes be called having “F/U money.” F/U money provides you the freedom to demand a certain level of respect and flexibility at your job. If you do not receive it–your boss tries to prevent you from taking a week off for your sister’s destination wedding–you put that F/U money to use. Patrick did this when his previous employer would not allow adequate telework flexibility. A robust emergency fund that lets you say no to unreasonable job demands: Your employer accepts your boundaries, or you leave.
3. You invest intentionally for your future.
Before you feel truly free, you need to know that your future self is financially stable. The easy threshold for an employed city or suburbs dweller to achieve this is maximizing contributions to a 401(k), IRA, and HSA, but if you enjoy a more frugal lifestyle, sufficient retirement contributions may be much less. If you know you want to retire early, you should probably invest 50% of your income. If you are fairly happy with your employment situation or have already invested heavily and experienced growth, investing much less may be sufficient.
Next week, I will get into the details of retirement math a bit further, but for now, if you are maximizing your accounts or contributing a significant percentage of your money to retirement, you are creating more financial freedom for yourself with every contribution. These contributions enjoy the wonder that is compound interest, which is practically compounding freedom.
4. You buy happiness.
Lean needs costs mean larger happiness budgets. In particular, you will feel free if you are funding two simultaneous purchases towards your happiness:
One recurring expense: This is the predictable expense that you get to enjoy throughout the year, or at least seasons of it. It may fund a hobby or a membership of some kind. This is your gym membership, spa membership, fees for your softball league, pub pass, weekly trivia, etc. (Example from my life: My recurring happiness expense is a rugby fund. It funds a monthly sports massage that is a regular expense and also has some extra money each month to spend on new equipment, gear, gas, or even my social bar tab.)
One unpredictable expense: This is where you save for the day when your team makes the big game or your best friend finally gets married in Aruba like they have always said they will. These are the big trips, concerts or shows, sporting events, cultural events, etc. (Example from my life: My baseball fund paid to attend the World Series in 2018. It also paid for the AL Wild Card game in 2021 after some replenishment. The biggest events do not usually happen every year, but make sure you can say yes when they happen.)
If you are being true to your values and what gives you joy, you are funding at least one recurring expense and one unpredictable expense in addition to the previous points that set up your financial stability. Once you have baseline financial stability, you can and should use your money to increase your happiness.
5. You have extra to buy the freedom of choice.
You streamlined your needs costs, built an emergency fund that covers 12 months of expenses at your current lifestyle, maximize your retirement contributions, and fund your happiness through at least one recurring expense and one unpredictable expense.
And you just got a raise and have money left over for the first time ever!
Welcome to financial freedom.
Once you hit step five, you have the freedom of choice. This is when finances start getting fun. You can add a little bit more to your emergency fund in preparation for leaving your job and building your dream business. You can choose to add a third happiness expense. Maybe even a fourth! You can hit the gas pedal on your retirement contributions and start investing more than 50% of your income towards investments. These can be used to retire early or on a fun investment goal like purchasing an investment property or small business. The opportunities for extra money are endless.
Perhaps most importantly, extra money buys the freedom of confidence. Patrick left his job in December because he did not want to begin going to the office two days a week for a job where he successfully teleworked full-time since March 2020. The confidence to say no to unjustified work demands stems from financial freedom. You know you have a backup plan, and your employer probably assumes you do not. Use that to create the flexibility you deserve.
But I’m not rich…
So what? It is not as difficult to achieve this level of freedom as you expect. It certainly does not require a six-figure salary or a $1 million net worth, even if you live in a high cost of living city or have kids. The most fun part of working with so many individuals at Phippen Tax & Financial Services is we get to see all the different paths that folks choose to get to this point of financial freedom. We work with financially free families with seven kids making $65k/year with frugal “needs” expenses that prioritize traveling as a family. We also work with folks in their 20s who house-hack or share housing expenses with roommates so they can spend money on concert tickets, sporting events, and/or travel while still maximizing 401(k) contributions. Whatever your situation, you can achieve financial freedom!
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