November 19, 2022
Explore the 3 Hidden Destinations to Financial Freedom

People will often mention financial security and financial independence during everyday conversation. Practically everyone in my social and professional circles desires financial freedom or independence. But, financial freedom and independence are still far from reach due to the fuzzy concepts and the ambiguities people hold about these terms. To clear up any misunderstandings and to reveal the true meaning behind financial independence and financial freedom, I am the first person I will be speaking.

Financial freedom can be understood by understanding that, no matter how much you make, you will only achieve financial independence if you generate passive income (non-earned). A return on capital invested. Oder, to put it another manner, money should work for us rather than us working hard for it!

What I wanted to do now was find out “what’s the number?” What amount capital is required to attain financial independence, financial security and financial protection? Over the weekend, I tried to calculate the cost of each level of financial well-being. Let’s get started!

#1. Financial Protection

This is your minimum level of financial security and the first step on the path to financial freedom. It ensures that you and your family are financially protected, no matter how difficult or long-term the economic situation may be. This is how you can know if you and your family have financial protection.

  1. Your liquid capital is sufficient to cover your basic living expenses for at least 3 months, and possibly up to 2 years. If your monthly basic living expenses were $3,000 per month, you would need at least $9,000 in liquid capital and ideally $72,000 in liquid capital.
  2. A life insurance policy is in place to provide income to your dependents and family members to help them maintain their lifestyle in the event you are unable to work.
  3. To protect yourself and your family in the event that you are disabled and are unable to work or earn income, you have insurance protection.

Your savings will directly impact the amount of disability insurance that you need. You should consider getting disability coverage if you have 3 months of liquid capital. This will cover 21 months of your living expenses. You should insure for 60% of your income. The monthly cost of disability insurance is typically $30 if you are 30 years old, and $100 if you are 50 years old. Each $1,000 coverage can cost you about $100.

#2. Financial Security

Financial security is achieved when you have accumulated enough capital through your investments to be able to cover the following living expenses without having to work again. We’ll assume some numbers for the purposes of this illustration.

  1. Your private home mortgage payments until it’s sold, e.g. $1,500/month
  2. Families have different food requirements, e.g. $500/month
  3. Utilities, electricity and gas, e.g. $250/month
  4. Transportation needs e.g. $250/month
  5. Insurance – Health, Disability, House e.g. $300/month
  6. Taxes, such as property taxes, e.g. $200/month

Your monthly living expenses would rise to $3,000 per month or $36,000 annually. To achieve financial security, you will need to have a critical mass capital of $450,000. This would be based on an investment @ 8% return per year which would generate $36,000.

This calculation removes the fuzzy, subjective meanings that financial security has. It distills financial security into a finite number. I find this extremely helpful for anyone trying to attain it.

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#3. Financial Independence

Financial independence is achieved when you have accumulated enough capital through your investments to be able to invest in a safe environment with an 8% return and still have enough cash to fulfill the six financial goals previously discussed.

  1. Your private home mortgage payments until it’s sold, e.g. $1,500/month
  2. Families have different food requirements, e.g. $500/month
  3. Utilities, electricity and gas, e.g. $250/month
  4. Transportation needs e.g. $250/month
  5. Insurance – Health, Disability, House e.g. $300/month
  6. Taxes, such as property taxes, e.g. $200/month

AND The following 3 financial goals are also possible:

  1. Provision for your children ‘s education (substantially and completely), e.g. From $100,000 to their 18th birthday, you can say PS50,000 for 3-4 years at college/university. This is $150,000. That’s an average of $7,000 per year over 21 years.
  2. Provision for basic entertainment – dinner out, concerts, etc. (at least 50%) $300/month, $3, 600/annum
  3. Provision for purchase of new clothing or 1 or 2 “luxury” items like a plasma TV, car, etc. e.g. $5,000/annum

These 3 provisions add up to $15,600/annum. Add $36,000 annually to this cost and the cost for financial vitality would be $51,600/annum. To achieve financial independence, you would need to have a critical mass capital of $645,000 to get an annual 8% return.

Financial independence simply means that you can live comfortably without the help of any income or work. In one sense, you are trying to have enough capital to replace your current salary.

If you want to know the true cost of financial independence each year, you can adjust upwards at an inflation rate of 3.5% per year.

If you are saving or investing a significant amount of your income, the amount you will need to live a similar lifestyle is decreased. If you save 20% of your salary ($10,000), the amount you need to become financially free is $51,600-$10,000 = $41,600.

There you have it. This is how we define Financial Protection, Financial Security, and Financial Independence. It’s a sum of capital that is required to generate sufficient non-earned income. To determine the exact amount of money you need to meet your living expenses/lifestyle needs, add your numbers to the above equation. If someone says they want to be financially independent or secure, you can now say, “Really? Cool, I can show how much capital it will take to do that!”

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