The Concept of Financial Freedom

Every activity done by human beings is generally linked to a larger goal, a pursuit to achieve something important in life. Financial planning is also not very different in this regard. The month to month activity of financial planning is tied with a larger goal. For most people, financial freedom is an important milestone in this process, if not the desired end outcome. Hence, in order to understand any philosophy related to personal finance, we need to understand the concept of financial freedom and how it can be achieved.

What is Financial Freedom?

Most people around the world have to live their life bounded by financial constraints. This often means that they have to stick around in jobs that do not appeal to them or save money by foregoing activities that are important to them. Many people view this as a life that is bounded by financial constraints.

Financial independence is a financial condition in which a person is free to make his/her decisions without being excessively influenced by financial constraints. This is because the expenses that they need to live their day to day life are covered by the income that they earn passively from their investments. Hence, they can continue to live off the investments in perpetuity.

How Much Money Is Required For Financial Freedom?

The average person needs to save a substantial corpus in order to achieve financial freedom. Financial planners have worked out the detail and provided the formula in order to calculate how much money is required.

The rule of thumb is that 25x of the expenses that a person will incur before they retire need to be saved up in various income-generating investments so that they generate enough passive income to cover all the expenses.

Hence, if the expenditure of a person is expected to be $100000 before they retire, then they need to save 25x that amount which means around $2.5 million needs to be saved.

What is the 4% Rule?

The 4% rule assumes that the investor will withdraw only 4% of their corpus every year. If they do this, then their corpus will sustain them till infinity. This is because based on historical returns financial planners have calculated that the portfolio will grow by an average of about 7% each year.

On any given year, the fluctuation can be much higher. It could be as high as plus or minus 25%. However, over the long run, the portfolio grows by an average of 7% per annum. This means that if a person is only withdrawing 4% per annum, they are actually adding an average of 3% to the corpus. This 3% per annum gets compounded over many years and helps take care of the inflation which tends to increase their costs.

The 4% rule means that if a person only withdraws 4% of their corpus amount each year, then the corpus can fund their day to day life till infinity.

Why is Financial Freedom Important?

Financial freedom has become increasingly important because of certain factors. It is no longer optional but almost necessary for every middle-class person to consider this concept. The reasons have been stated below:

  • Robotic process automation is on the rise. This means that companies are finding ways to automate a lot of the tasks which are being done manually by people.

    It is believed that over the next decade, most of the jobs that we know today will become obsolete. This means that over the course of the next few years, companies may require a smaller workforce.

    It is therefore important for people to have a nest egg ready so that even if they are laid off, they do not have to worry about where their next meal will come from. Instead, they have enough money so that their families can sustain this temporary shock.

  • Most people working today are working in high-stress jobs. Seventy and eighty-hour workweeks have become the norm. This also means that the career of the person will also end up being shorter. It is quite likely that health conditions or other circumstances may force people to take early retirement. Hence, they need to have savings in hand in order to better mitigate the uncertainty.

  • There are many people who want to make a difference in society. This would mean working in a meaningful job even if it pays less. There are people who want to support charities or work for NGOs. They are unlikely to be able to do so unless they have enough money in their corpus to meet the household expenses every month.

  • The nature of pension plans in the world has changed. Earlier, it was the responsibility of a company to pay their employee a fixed benefit every month for the rest of their lives. However, that has changed now. Companies are not required to pay anything apart from what they have invested in the retirement accounts of their employees. The value of these retirement accounts is linked to the markets and hence is unstable. As a result, people need to have a separate investment portfolio if they want to have enough money for them to self-sufficient when they retire.

  • The advances in medical science have increased the life expectancy of people. Hence, if people will live longer, they will need more money for their medical as well as day to day expenses. It is important for retirees to have the ability to pay these increased costs over the long run. This is another reason why financial freedom is important to the present generation.

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