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What is financial independence?

What is ‘financial independence’?

Financial independence is a term which is used subjectively. It could mean being able to move out of your parents house.  It could mean paying your own way. For most (myself included), financial independence means owning assets generating more income than your expenses. If your expenses are $30,000/y , your assets need to make at least $30,000/y. This eliminates the need to work for your basic needs.

Why would I want to be financially independent?

The number one reason to strive for financial independence is freedom. If you didn’t need to worry about money, what would you do? Travel the world? Volunteer at your favourite charity? Spend more time with family?  All of these things become possible through financial independence.  If your living costs are covered without you lifting a finger, you can focus on what truly is important to you.

Money is only one of the reasons we go to work. You might enjoy chatting around the water cooler, or the satisfaction of nailing a big presentation.  If you take joy in what you are doing then there is no reason to stop.  Nothing says you have to give up your job just because you can afford to. Picture everything you love about your career, but without the stress that money brings into the equation. Considering that new role that looks interesting but would mean a pay cut? No worries – the income isn’t important if you are financially secure.

So how do I become financially independent?

The journey to financial independence involves two major stages.

Step 1: Reduce your expenses, increase your savings

Reducing your expenses has a significant impact on the amount of time and assets it takes to be financially independent.  The effect of reducing expenses is two-fold, not only are fewer investments required to be sustainable, but also more funds are available to dedicate towards wealth creation. The below table outlines the effect of increasing your savings rate on the time it takes to become self sufficient:

Savings Rate
Years until
financial independence
Less than 3

Eliminating debt is a key component to reducing expenses. Every dollar of interest paid on debt is another dollar that needs to be earned. Repaying debt is a simple way to reduce your expenses without effecting your standard of living. This strategy is most suitable for high interest debt such as credit cards or personal loans. Some may choose to borrow tax-effective money in order to invest, this is a personal preference and depends on risk tolerance.

Step 2: Build your wealth

In order to generate the income required to cover the cost of living, building wealth through investment is required. As with all investment, it is important to consider risk and return. Low risk (defensive) investments such as cash and bank fixed deposits provide a stable income, however often the rate of return is quite low. Riskier (growth) investments such as shares to investment property provide a more attractive return at a higher risk. You should consider holding a combination of both defensive and growth assets in order to diversify your portfolio.

Income generated through royalties, patents or business distributions can also contribute towards generating the required income. Upon reaching financial independence, many choose to spend a portion of their time developing these sources of passive income through blogging, publishing or other creative works.

So how do I get started?

Financial independence doesn’t just happen overnight. As with any journey, the best way to reach your goal is to take it one step at a time. There are countless resources online to help you along the way.   Set yourself a goal – it doesn’t need to be a deadline for reaching self sufficiency. Here are some ideas to get you started:

    • Write a budget to determine where your money is going.
    • Make reducing debt a priority.  consider using unexpected windfalls to repay debt.
    • Research the basics of investment.
    • Consider meeting with a financial planner.

Becoming financially independent doesn’t take a genius – just patience and common sense. Good luck!

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  1. August 26, 2013

    Those calculations are always impressive. While living on 20% of your income is a bit extreme, living on one income when two are working and saving 50% is generally feasible, and 17 years to FI is nothing when most people work over 40 years.

  2. August 26, 2013

    I agree, financial independence doesn’t just happen, you have to work at it and you MUST have a plan of action.

  3. August 26, 2013

    No enough people actually have a plan. I think even less think it is even possible and fewer even know what or have a meaning for financial independence. The wifey and I dont want to live off just 20% of our income. We are right now living off of one to help us achieve our goals sooner. It takes planning and sacrifice.

  4. Evan
    August 26, 2013

    Pauline and Thomas – I agree that it is a bit extreme to live on just 20% of your income. I currently live on approximately 45% of my income quite comfortably but I’d need to cut back my habits or standard of living quite substantially to get above this rate. There are definitely people who live on a smaller percentage, but it’s a fine balance between saving for the future and living comfortably now. As my income goes up I aim to keep my expenditure relatively constant so over time my savings percentage should still increase.

    It’s a game of diminishing returns. Going from a 10% savings rate to a 20% rate will knock 14 whole years off of your time until independence, wheres going from an 80% rate to 90% doesn’t even reduce it by 3 years. Additionally, it’s a lot easier to go from saving 10% to 20% as you still have quite a lot of fat left in your budget to trim on this end of the scale.

  5. August 26, 2013

    It definitely takes action and time to become financially independent. You can’t just decide one day to become financially independent and expect things to change overnight.

  6. August 26, 2013

    Growing up, I always thought that financial independance meant getting a good job. Although, that’s not the case these days is it? I save at a rate of 30%, I couldn’t imagine being able to live on less than 50% of my income but, who knows, maybe it is doable. Anyway, thanks for the great morning read!

  7. August 26, 2013

    Oh, that chart really opens the eyes to the work that is involved with reaching financial independence. Nice work putting this together.

  8. August 29, 2013

    Saving 90% of income would be incredible! Actually, if people got a decent job right out of college, they could save something like 50% to 70% of income if they did things like this:

    Move back in with parents
    Drive an old beater car
    Don’t spend excessively on guys/girls weekends
    Don’t have student loans to pay off

    Saving as much as possible as early as possible in life can make things much easier when older. I know a few people that did something similar to this, and I’m certain it helped them immensely.


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