What is Financial Independence?

Victoria Sisters' Musings Leave a Comment

The word "retirement" is not sexy and doesn't necessarily motivate younger people to invest into their future. This is really a shame because the younger you are, the more difference you can make to your retirement, because you have so many years for your money pot to grow and for compound interest to take effect. 

Financial Independence seems a better name, but again, this term can be confusing. So let's shed some light on some of these terms and what we think they mean, as they can also mean different things to different people. 

To recap the main points:

  • Financial Security means being able to cover your costs for a year
  • Financial Independence means that you receive passive income to cover all your costs from non-work sources
  • Modern Retirement means that you can pursue your passions, which might include work as well.
  • The best time to start is now!

Actions for you to consider next:

  • Understand what your current pension plans look like ->are you maximising the benefits you get from your companies and tax free pension schemes? 
  • Set realistic goals to set you on a path towards financial independence

Starting off with Financial Security

We like Tony Robbins' definition of Financial Security, which he believes that you have achieved when you have "accumulated a critical mass of capital that is enough cash to meet your basic needs for a year". 

Note that this is different from your Emergency Fund, which most people agree should cover your basic costs for at least 3 months, ideally 6 months, or more if you have the money! Basic costs include rent/mortgage, food, household, utilities, transportation and health insurance. Also the Emergency Fund should be easily accessible, so most often it is held in cash in a separate savings account. 

By capital, we think this means someone's Net Worth, although this can be up for debate as your pension fund is generally not accessible until later in life so cannot provide financial security in the short term. It is up to each individual to adjust these guidelines for their own situation as well. 

Financial Independence

We talk of Financial Independence when you have accumulated enough assets that provide you with passive income that meets your annual expenses, forever! If you are reading this blog then you are most likely quite far away from achieving this goal, but don't let that put you off! The best time to start on your journey towards Financial Independence is today. 

So let's dive into this concept a bit more to see what you need to know now: 

1. Financial Independence means that you have your expenses covered by non-work income. 

Also called "passive income", this includes dividends from your investments in the stock market, rental income from investment properties, income from businesses that are up and running for which you do not have to do any work. The important part here is that you do not need to have a job to receive this income. You might also sell some of these assets to generate cash for your living expenses, more on that in the next point. 

2. Financial Independence means that your expenses are covered for ever

The theory behind this part is that because your assets continue to grow, they will give you income forever. This can refer to owning shares in the stock market - even if you need to sell some shares to cover your living expenses, the pot will continue to grow to give you this passive income forever. However, this could also be payouts from dividends or securities like bonds or credit notes where regular repayment of the amount being owed or interest will generate a stream of income coming your way.

Note: This is a simplistic view of your financial independence life, but we are focusing on covering the main points now. More clarity will come in the Fine Tuning part of the 5 Sister Steps. 

3. Financial Independence and Modern Retirement

Once your expenses are covered by non-work income, you can focus on designing the life that you truly want. You are free to do whatever you want, and this could (and does) often include working, but on a very different level. Once you are not obliged to work anymore, you can pursue work purely because it interests you and it is something that you are passionate about. This is what some people call Modern Retirement

Another idea linked with Modern Retirement is that you do it earlier in life than traditional retirement. For more information on this we recommend reading up on the Financial Independence, Retire Early movement.  

What about traditional retirement?

Many people get a bit overwhelmed when they fist read what it takes to become truly financially independent, your dear Finance Sisters included. The important point is to use this information to guide your own decisions and to make a start towards investing in your financial future. As we always say this is a journey, and the earlier you start taking a proactive role in managing your finances, the better. At the very least, be aware of what "doing nothing" will bring you in terms of retirement income when you reach the traditional retirement age, from about 60 years of age.

Financial terms alert.... we use some terms here that you may not be familiar with. Please look them up on places like Investopedia if you don't understand them. As we are just starting out with the blog we cannot cover them here now but we will strive to do so in the future. 

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