Financial Freedom vs. Financial Independence: What's Yours?

15-minute read.

Financial freedom and financial independence are two words that are used interchangeably in the personal finance world. But, does that mean they are the same?

Well, you can say yes, but not totally. You can be financially ''free'' before reaching financial independence. How?

Financial freedom boils down to mindset and personal desires; while financial independence is all about having enough income to afford your living expenses. Let's deep dive into both concepts and find out how they apply to your financial goals.

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What is financial independence?

Financial independence means being able to live off of your passive income. When you obtain financial independence, you don't have to depend on a day job or financial assistance to pay your own bills and fund your lifestyle.

You become financially secure with enough cash flow to cover basic living expenses and all other financial obligations.

Some people considered financially independent may keep a part-time job; out of passion, to maintain employee benefits, or to boost their spending money and protect their emergency fund.

Achieving financial independence is a standard of living many young adults are aspiring for, and it can be reached with a strict financial plan and discipline with your money habits. You'll also need to have robust investment strategies and retirement savings options.

For example, investing early in the stock market helps you prepare your financial future whilst generating enough passive income, thanks to compound interest.

Steps to become financially independent

Poor financial health has lots of negative consequences, with the first one being unable to cover basic living expenses.

But the path to financial independence isn't out of reach if you spend wisely and are in control of your household income. Here are the steps you can take for financial security:

1.    Make a plan

You can't be financially independent if you don't plan for it. You need to define your financial goals, know how much you want to earn, and set a reasonable timeline for yourself. Note that reaching financial independence is a long-term objective that may take decades. But if this leads to early retirement, is it not worth it?

To avoid overwhelm, you need to divide your long-term goals into short-term, achievable targets. Afterward, you devise a means to achieve them.

For example, if you desire to achieve a $1 million net worth in the next ten years, you would still need to break it down, depending on your current financial capacity. If you start from $0, your short-term goal could just be to get a job and save up to learn a high-income skill, whilst starting to save money in regular savings accounts or mutual funds.

But if you already have a high-income skill, your plan could be to open multiple streams of revenue or to start investing in various assets.

2.    Track your living expenses

There's a high chance that you won't know where your money is going if you don't track your current expenses. Many people are living from paycheck to paycheck today and they still can't tell where their cash is going.

As someone who's planning for financial independence, you must track your spending carefully - the Hiatus App is a great choice. This will differentiate essential expenses from unnecessary purchases - more for your nest egg!

Tracking active income and living expenses is a basic personal finance concept, but it can do wonders to free money.

3.    Build a savings culture

Saving is an uncomfortable topic in some households, but it's an essential step toward financial independence. Having a high-paying job is nothing without good saving habits. How much you can save is almost more important than how much you earn; financial security doesn't automatically come with higher-paid employment.

Also, savings provide you with the money for investing - and ultimately growing your net worth. Some brokerage accounts offer fractional shares, meaning you can invest in the stock market for as little as $1.

You can also use automation to set aside a specific amount of money in your regular savings accounts. Our top choice to invest easily in index funds for adult & children is Acorns - a micro-investing app. To find out how Acorns can help you save & invest, go to their website or check our detailed Acorns Review.

With consistency, you'll be able to save up a large amount of money that in turn, you can use to open another stream of income and increase your wealth. If you and your partner save just 2 dollars each a day, that's almost $1,500 in a year!

4.    Save for emergencies

Setting up a savings account is different from saving for emergencies. Building an emergency fund is all about preparing yourself for the unexpected. This is important, regardless of your age, and should provide most of the financial support you'd need in hard times.

About 60% of Americans cannot afford a $1,000 emergency when it arises, according to a study by Bankrate. This means that most people are one unexpected bill away from financial disaster.

When starting, experts advise that you have 3 to 6 months' worth of expenses available.

5.    Start investing

Whereas saving helps you keep your money, investing is one of the most popular ways to grow your wealth. Most millionaires and billionaires invest in assets. For someone looking for independence finance, investing is one of the financial vehicles that will help you immensely.

In investing, you buy an asset that has the potential to increase in value over time. When you sell the asset above the purchase price, you make a capital gain. There are many asset classes that you can invest in such as stocks, real estate, corporate bonds, and commodities.

However, investing comes with its share of risks, so you should know the basics. The Control All Finances Blog has you covered! Also, you need to be aware of your risk tolerance as this will help you pick the right investment strategy and determine the amount of capital you're putting in.

6.    Control your debts

Controlling your debts is part of your journey to financial independence. It's easy to swipe your credit card, forgetting that you're accumulating debts for yourself. Additionally, other arrears like student loans and mortgages could pressure you out of your goal to be financially independent. It's tough, but tackle these first.

The average student loan debt in 2022 stands at $28,950 owed per borrower on average. More than half of students leave school with debt to pay.

Before your current expenses get out of hand, have a quick read at 10 Easy Ways to Pay Off Debt and seek professional help when needed.

FIRE: What are the different types?

F.I.R.E., which stands for Financial Independence, Retire Early, is a movement that aims to achieve financial independence far earlier than the conventional age of retirement. There is more than one fire strategy, but all aim to retire earlier whilst being financially secure - at different levels.

Many young adults have adopted the FIRE philosophy and they are working tirelessly, saving and investing their money aggressively to reach financial independence as early as possible. In case you missed it, we wrote Is it Really Possible to Retire at 30?

Lean FIRE

In this type of FIRE, the individual adopts a pure minimalist type of living, so he can spend less and save aggressively.

Adopting this type of FIRE shortens the path to financial independence: live frugally now and save aggressively for the future.

Upon retiring though, one must continue to follow strict budgeting and lives off an income of $25,000 or less annually.

However, most people aspire to go beyond Lean F.I.R.E. Spending years penny-pinching to only live very frugally in retirement is not something most people want to do. For those wanting a family, for instance, this strategy can be limiting.

The below illustration from Financial Samurai shows the after-tax investment amounts by age to allow you to live the Lean FIRE lifestyle:

Fat FIRE

Fat FIRE is the exact opposite of lean FIRE. Individuals in Fat F.I.R.E. have enough income, savings, and investments that generate enough returns to fund their lifestyle, without compromise.

People who aim for Fat FIRE take time to achieve financial independence, especially when compared to the Lean FIRE timeline.

Indeed, a much larger nest egg is needed to be financially independent with this strategy. Somebody aged 40 would need to have saved twice as much when compared to the Lean FIRE concept.

Barista FIRE

In Barista FIRE, you've saved enough to retire early but you still choose to work part-time to complement your monthly income. Here you combine your savings and earnings from work to live on a decent income. One advantage of Barista F.I.R.E. is that you could continue to get employee benefits such as health insurance.

Barista FIRE proponents work not because they have to, but because they love to. Most of them quit their 9-5 job and pursue a career they're passionate about, or engage in the freelance economy.

Coast FIRE

Coast FIRE is similar to Barista FIRE. Coast F.I.R.E. represents a person who is on the slow path to financial independence and still needs a job to eventually live the true FIRE lifestyle. A Coast FIRE individual can ''coast'' through his or her job by working at a low-stress position that pays enough to cover basic living expenses.

You could say that, with Barista, having a part-time job is optional but working is a necessity with Coast.

Build a passive income with real estate

Real estate is one of the asset classes that can produce a substantial amount of passive income for investors. Because of the risk factor and the capital required to start, many people shy away from real estate investments.

Securing various income streams is key to retirement planning; rental properties can certainly boost your cash flow, for now, and for when you retire early.

In real estate, the investor can participate actively or purely passively, depending on the type of property investment he chooses. Below are ways through which you can earn passive income with real estate:

Single-family house

A single-family house is a free-standing residential property that's designed to serve only one family as the primary resident. An investor can purchase this type of property and then rent it out to a couple, an individual, or a small family.

Investing in a single-family home is one of the best passive income generators in the real estate sector, as you're sure of monthly income - as long as the tenant keeps occupying the property. And this leads us to the downside: when there's a vacancy, you won't be making any money.

You can manage the day-to-day running of your rental yourself, or hire an agency that will take care of all aspects for you, against a fee.

Look further afield and think of Real Estate Investing in the Philippines

Multiple-family home

A multi-family house is a single building that’s divided into separate units to accommodate more than one family living independently. This includes duplexes, triplexes, or any apartment buildings divided into up to four individual units.

Having more than one unit in a single property means you generate more money.

Also, there's a comparatively lower probability of vacancy as the risk spreads across multiple units. However, managing more than one tenant and multiple leases can be cumbersome.

Apartment building

Apartment buildings can have more than five units, generating more passive income for the investor. Apartment building demands intensive property management which can be costly.

You may need to hire a management professional to help you find tenants, collect rent and maintain your property. Of course, this will add extra cost to your expenditure.

Lands

Empty land is also a profitable asset in the real estate sector. An investor can buy land and lease it out to a tenant such as a farmer for short-term use. Also, you can lease the land for the long term such as letting it out to an individual who wants to build a structure on top of it.

Again, land tends to appreciate over time, so investors find a territory that has potential for development and buy land there. Heavy profits can be made when selling desirable land, with fairly low running costs. Unless you plan to develop it, mortgages can be more difficult to obtain for empty land, with a higher down payment required.

Commercial buildings

Owning and leasing commercial buildings is one of the ways to generate huge cash flow in real estate. Investing in commercial buildings requires heavy capital and you might need partners to bring funds.

Commercial property is usually more long-term leasing as the tenants use the property for business purposes such as shops or offices. Also, tenants tend to remodel the property to suit their business needs which might add to your costs when they depart.

As we've seen during the pandemic, many commercial properties, particularly retail units, became vacant, so this is a risk to consider.

Vacation properties

Owning a holiday home, especially near a tourist center, historical city, or developed area can be a lucrative means of generating passive income.

You can be charging the individuals on a per-night or weekly basis which could make more money than long-term leasing. However, investing in vacation homes comes with its share of downsides. It's usually affected by seasons, and maintenance cost tends to be high.

Also, you must be prepared for constant scheduling calls from clients, cancellations of bookings, refunds, and housekeeping services - although rental agencies can take care of these for you. Airbnb is the most popular platform for short-term rentals. Become a host on Airbnb and be on your way to financial independence.

Publicly traded REITs

REIT stands for Real Estate Investment Trust. Publicly traded REITs are listed on a stock exchange. This is one of the most passive investments in real estate. Also, it doesn't require huge capital as you can buy a REIT of your choice for less than $100.

When you invest in REITs,  you may earn dividends as the company is required by law to share 90% of its profit among shareholders. Again, when the REIT appreciates, you can sell it off and make capital gains - much like a regular stock.

To invest in a publicly traded REIT, the individual will need to carry out intensive research to know the one with a decent return potential. There are many public REITs, most focusing on specific real estate sub-niches like the commercial, healthcare, or residential market.

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What is considered financial freedom?

Financial freedom can be interpreted differently based on your circumstances. The financial standard you're aiming to reach to enjoy financial freedom might differ from the goal your friend aims for. At the end of the day, it's more of a mindset.

However, financial freedom generally means having enough savings, investments, and income to afford the lifestyle you desire. To become financially free, you must pay off your debts and mortgages, and have enough emergency funds and savings that can cover your expenses even if you lose your job.

Whilst it's not easy to achieve financial independence, financial freedom can also prove beneficial for your mental health. Indeed, feeling financially secure, without money-related pressure, is a great achievement on its own, even if you may not retire early.

Take control of your finances and future. We have found the top companies in the personal finance space and the most helpful tools that offer you practical strategies on budgeting, savings, investing, and more.

What are the 7 levels of financial freedom?

1.    Dependence

At this level, you're still dependent on your family or guardian for survival. Children and elderly relatives are usually the ones found at this level. No young adult stays at this level of financial dependence for long.

2.    Survival

At the survival level, you're earning just enough money to cover your primary needs, with little or nothing left to save. Sometimes, you might even need to borrow money from friends or family to afford some bills. 

It's at this level that most people learn how hard life can be and this could give them the motivation to create a better life. The desire for financial independence or learning about financial freedom is motivating.

3.    Stability

At the level of financial stability, you have started earning enough money for your survival and have saved up the amount of money that can take care of your expenses, whilst building your emergency fund.

Also, at this stage, you have the opportunity to properly manage your debts and pay off your loans and mortgages. If financial freedom is what you want, be careful not to settle at this level as this is where your financial stress starts to come down.

4.    Security

This is the level where you have a consistent flow of income and enough savings in your emergency and retirement accounts. At a level of financial security, your savings can sustain your current lifestyle for a while even if you lose your primary job.

Financial security comes with lots of benefits such as a drastic reduction in stress levels. Also at this level, you begin to learn about investments like stocks and real estate and start building your brokerage account. For true beginners, the Acorns micro-investing app offers an approachable investing platform. Sign-up and get a $10 bonus investment!

5.    Independence

At the stage of financial independence, you've built a substantial portfolio owing to long years of savings and investments. Now you can live off of your investment gains and dividends, which means your daily expenses can be covered by your passive earnings.

Financial independence means you can quit your job if you wish to, or be working part-time out of passion or pleasure.

Financial independence is the dream of many but few people make it to this stage. This is because it requires lots of discipline, hard work, savings, and investment knowledge. This Blog is here to help! Check out our Investing Articles.

6.    Freedom

This level is slightly different from financial independence. Here you have enough investments and savings to live the lifestyle you chose without having to worry about anything. You've gone beyond the fire movement at that stage.

You simply have enough! You have enough money to make your dreams come true.

7.    Abundance

At the ultimate level, you've built more than enough wealth to sustain your dream lifestyle. This is the financial zenith where most billionaires and multi-millionaires are found.

People at this stage usually engage in philanthropic work and help better the community. You can take any financial risk as you have no loss to fear.

As mentioned earlier, financial freedom doesn't mean being a millionaire thought, you can live a frugal, happy life.

How much money to achieve financial independence?

There isn't a magic number, unfortunately! This depends on so many aspects of your life such as your level of savings and passive income, the area where you live, the number of people you'll provide for, and more generally the lifestyle you aspire to.

To someone, having $1 million is enough to make him financially independent while to others, $10 million is still not enough.

But to answer this question objectively, you have to consider these two things, namely: your annual expenses and the number of years you have to spend on them.

A rule of thumb is to have 25 years of expenses set aside. So if your annual expenses are $100,000, you'll need $100,000 × 25 which is $2.5 million to be financially independent. How about if your annual expenses are $40,000? All you need is $1 million to attain a level of financial independence.

Is it good to be financially independent?

Financial independence is a dream for many people. You have enough funds and investments to cover your living expenses. It gives you control over your time and makes possible the opportunity to do what you're passionate about.

Having enough time for yourself and loved ones, coupled with the opportunity to do what you love, can greatly reduce stress levels, increasing your life expectancy.

What is the 4% rule?

The 4% rule is a financial guideline used to determine how much an individual should withdraw from their retirement savings and investments annually.

It indicates that the retiree should be able to withdraw and live off of 4% of the money in their investment portfolio in the first year of retirement, then slightly adjust the withdrawal amount to make up for inflation in the subsequent years.

The 4% rule is common although many financial experts highlight its caveats. However, it can be used as a starting point - and a basic guideline to help you save for retirement.

Before you get there, follow this proven budgeting rule we wrote about: The 50/30/20 Rule.

Is financial freedom just a dream?

If you're seeking to reach financial independence, you'll need to build up an adequate income-generating asset base. Financial independence means safeguarding yourself against life's potential curveballs and the uncertainties that come with them.

It doesn't mean earning a six-figure salary or having enough money to do whatever you want without thinking about the cost - you'll need discipline to succeed.

And if you're stuck in a job you hate, it's important to remember that financial freedom means embracing flexible work opportunities that can be accomplished with little hassle and time commitment, like freelancing or starting side hustles. We're on this journey with you!

Contributor: Vick Sani

No Financial Advice. This article does not provide financial advice and has been prepared without taking into account any person’s investment objectives, financial situation, risk tolerance, or particular needs. 

 

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