Wednesday, November 3, 2010

Financial Freedom « Scott H Young

Financial Freedom « Scott H Young
Financial Freedom


Financial freedom isn’t the same as being rich. Although people often confuse the two, they are completely separate goals. One person could be completely financially free earning $15,000 per year. Another person could be trapped, even with millions of dollars.

Last week, I touched on the topic of financial freedom. I wrote about my goal to build an emergency fund with a year’s worth of living expenses in savings. This would give me the freedom to make drastic career or business moves without feeling the effect on my bank account for an entire year. But this is just a first step towards financial freedom.

What is Financial Freedom?

I define financial freedom as not needing to worry about money. Money shouldn’t be a dominating force in making decisions in your personal or professional life.

A good way to view financial freedom is another type of freedom most people in the Western world enjoy: freedom from hunger. As a human being, I need to eat to survive. But the relative abundance of food in my life has meant hunger is never a driving force in my decisions. If food were scarce, getting enough to eat would probably occupy all of my thoughts.

Being financially free, is the same as being free from hunger. Money will always play a role in your life. But you are free when it no longer becomes the dominating influence on your goals.

Financial Freedom is More Important than Wealth

With food, there is an upper limit to the amount you can consume. Once you reach a minimum threshold, freedom from hunger is basically guaranteed. But there is no upper
limit for spending money. That’s probably why there are far more people free from hunger, than those free from money.

Wealth is only part of the picture. If your spending outpaces your income, it doesn’t matter whether you are rich or poor: you aren’t financially free. Pursuing wealth is a noble goal, providing you do it by contributing value. But it doesn’t guarantee the peace of mind and satisfaction associated with financial freedom.

Originally all of the financial goals I set were strictly income or savings goals. Have $__ by a certain date. Now I realize that this isn’t enough. Earning more money won’t bring me closer to financial freedom unless I also make progress in the other elements of financial freedom.

There are three main elements to financial freedom:

1.Automatic income to sustain yourself without needing to work
2.Higher income than spending
3.A low poverty threshold
1) Automatic Income: Not Needing to Work

Complete financial freedom would mean your income is automatic: either through interest on savings, passive income or a business. If you stopped working for an extended period of time, your life wwouldn’t make a noticeable turn for the worse.

Of course, this is an extremely difficult goal to achieve. However, you don’t need to achieve 100% financial freedom to enjoy the benefits. Making progress towards any of the three elements will improve your life.

Building an emergency fund with one year of income is a large positive step towards this first element. If I’m living paycheck to paycheck, I’m forced to work to survive. With a large enough emergency threshold, I have at least a one year buffer before being forced to work.

In a perfect world, material wealth would vastly outstrip needs so that people pursued work entirely for the joy of creating and a professional mission. That’s not reality, but you can be another step closer by having enough automatic income or savings to create a buffer between you and the need to work.

2) Greater Income Than Spending

It’s amazing that in one of the wealthiest countries in the world, we have so much consumer debt. Some debt is an investment. Student loans or borrowing money to launch a business are often necessary to reach more

But much of today’s debt has nothing to do with investing in the future. It’s excess spending on credit cards. Buying bigger cars and bigger homes in excess of our means. Consuming for today at the price of tomorrow.

In this point, the difference between wealth and financial freedom is most noticeable. Persons earning six-figure salaries are often burdened by consumer debt. If your expenses outpace your income, you can’t be financially free. You are always sitting on the knife’s edge of your ability to spend, so money must be a constant factor in your life.

The goal, of course, isn’t just to eliminate debt, but to be actively saving. When you have the ability to put away 10%, 30% or 50% of your income into savings, you have increased freedom. Now, there is another level separating you from the chains of money. Instead of wondering whether you’ll have enough food to eat, you always have an excess in your cupboard.

3) A Low Poverty Threshold

The poverty threshold is a term I use to describe the minimum amount of money you need to enjoy a comfortable life. Some people require $70,000 per year for comfort. Other people need less than $10,000.

A low poverty threshold means you could be perfectly content with a bare minimum of material conveniences. If all your savings were stripped from you, and your income was reduced by 80%, could you still enjoy yourself? Or would you be miserable having to adjust to a lower level of income.

Your poverty threshold is psychological. It’s not about actually having to survive poverty. Having a low threshold simply means you’d be willing to sacrifice

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