The Term Financial Independence
Financial independence usually refers to a situation when you can cover your daily expenses without working. Instead, you have what is known as a passive income.
It can also be defined as having enough wealth to live on without being dependent on income from some form of labour or employment.
There is, however, no single accepted definition or set of criteria for calculating or estimating whether a person is financially independent or not. As such, the definition is highly individual.
Assets and Expenses
How do you know if you have reached financial independence or not?
Your assets and expenses are key factors. If you can generate enough income from your assets to meet your needs, you have achieved financial independence.
Estimate Your Needs
The first question you must ask yourself is: What are my needs?
Creating a budget and tracking living expenses are important for anyone who wants to become financially independent. We call this conscious spending.
You must also have clear vision of where you will be later in life. Will you consume more (or less) when you get older? Will you travel more once you are financially independent? Will you live in the same place?
Estimate Your Future Income
Being financially independent doesn’t mean you must stop working. It only gives you the opportunity to do so – if you want to.
People who are financially independent often continue working but change their career path. They may stop working for others and create their own business based on hobbies or interests.
If you stop working completely and lose contact with colleagues and friends, you will probably not be happier than you were before.
Again, try to picture yourself later in life. A passive income should cover all your needs for you to be truly independent, but more likely there will be other sources of income too. Also, will you withdraw money from your assets as well as interests or yields? If you do, your passive income will become less further down the line.
You must also calculate with inflation and taxes. It’s easy to lose financial independence because of costs that rise more than expected and new taxation rules.
What is FIRE?
FIRE (Financial Independence, Retire Early) is a movement with members that try to cut expenses through simple living and increase their savings to gain financial independence and retire early in life. They often save 50 percent or more of their income and invest in passive high-yielding streams of income.
Instead of treating savings as whatever is left over after a month’s usual expenses, members of FIRE have the reverse mindset. They put savings first. They shop just for necessities and do it smartly.
Most of us are used to a consumption that does not really make us happier.