What is Financial Freedom ?

First of all, the terms Financial Freedom (FF) and Financial Independence (FI) are both commonly used. As far as I’m concerned these are interchangeable, but I will mostly stick with FF as it’s easiest to type!

I guess most people will have some pre-formed thoughts and opinions of FF. What it is, how do you know if you are or not, whether FF is a good thing, something to be despised, neither good nor bad, etc.

Here is my take on it :

I’m a Scott Pape (Barefoot) fan and he is always talking about buckets, so let me use the same approach here. To start off with let’s assume we have an Earning bucket and a Spending bucket. Hopefully if your basic finance and budgeting is in order, the former will be larger than the latter one. Therefore each month as you pour Earnings into the Spending bucket, there will be an overflow of water that needs to go somewhere else. Let’s call it Savings. This bucket is your bank account deposit, online saving account, term deposit etc. It’s a rainy day fund to provide for emergencies and other known expenditures that you’re saving up for in advance. So far we have three buckets – Earning, Spending and Saving. For many people this might be the end of it. But for those on a path towards FF, there should still be some additional water overflowing from the Savings bucket and looking for somewhere else to collect, which would be Investing. It looks something like this :

For those accountants out there, you would recognize this as a monthly Profit and Loss statement. This gives us a basic framework to start, but we need to add a further piece which is to split our Earnings bucket into two compartments – Active and Passive. Active earnings come directly from our own sweat, toil and keyboard tapping. Passive earnings flow in as returns from our investments (e.g. dividends on shares, interest on deposits, rent on investment property, etc). A further piece to add for the accountants is the Balance Sheet. This is a summary of all our Assets and Liabilities. Once again, hopefully if you basic financial skills are in place, Assets will exceed Liabilities and the difference between the two, your Net Worth, is a key measure that you will be looking to grow each year by year. Here is an updated picture with these new aspects included :

 

Thanks for your patience, finally we are getting to the point which is FF. In the above picture it’s clear this person is reliant on Active earnings in order to make this waterfall flow. But if you can imagine after some years the Investments will accumulate and start to generate more Passive earnings in their own right. Furthermore, hopefully with career progression, Active earnings will also increase, creating even more Investment growth. Eventually, a point might be reached where passive earnings become big enough to feed the entire waterfall, allowing our friend to finally put his feet up, sit back and admire this ongoing monthly process from the sideline. It is now driving itself and no longer depends on personal time, labour and effort. Equally our FF hero is no longer dependent on money, and has a free rein over his time to do what he pleases. The waterfall might be so abundant that it starts to spill over into a fifth bucket which we will call Giving.  This is how the picture might look now :

 

This is how I think about FF. And I intend to use these buckets as a structure for the various posts to come in the weeks ahead :

0.       Financial Freedom

1.       Earning

2.       Spending

3.       Saving

4.       Investing

5.       Giving

Please feel free to comment and share your views on FF. What does it mean to you, what would you do next, does it even matter really…..