There are three stages of achieving financial freedom:
- Financial security
- Financial independence
- Financial freedom
Let's talk in more detail what these stages are and how much money is needed for each of them.
FINANCIAL SECURITY
First, you need to create a financial cushion - a supply of money for a rainy day. The pillow will provide you with financial security for at least 3-6 months.
Start saving money today if you don't already do this and save enough money to cover your necessary monthly expenses for 3-6 months.
Real financial security will be achieved when you accumulate enough capital, to cover your minimum living expenses, through passive income.
How much is needed for this? First, estimate the size of your minimum expenses. Let's say this is $2500 per month (you can substitute another amount).
Bodo Schaefer in his book "The Way to Financial Freedom" advises to multiply this amount by 150. In our case, we get $2500 * 150 = $375,000
Why multiply by 150? (if not interested in details, skip the next two paragraphs)
Bodo Schaefer assumes a return on investment of 8% per annum. This means that 8% of our capital must cover our minimum annual expenses ($2500 per month = $30,000 per year).
Proportion:
- 8% is $30,000
- 100% is 30,000 * 100/8 = 375,000.
But there is one problem. If you want to live on these funds for a long time, you must know: your standard of living will fall due to inflation.
Over the past 30 years, the dollar has depreciated in half:
This means that now you can buy half as much for $1000 as in 1990.
This also shows that average inflation during the last 30 years was 2.32%.
FINANCIAL SECURITY FOR THE REST OF YOUR LIFE
Lifetime financial security is achievable if you do not spend all the investment income, but only the part that is higher than inflation.
Then your capital will not “lose weight” in purchasing power (ie, in the ability to buy the same amount of goods and services), which means that real incomes and living standards will not fall.
The maximum passive income “above inflation”, which is reasonable to count on, is 4-5% per annum (4% is a moderate estimate, and 5% is an optimistic one). Let's calculate the required capital for 4%.
You need to multiply the amount of annual expenses by 25 (or the amount of monthly expenses by 300): $30,000 * 25 = $750,000. This is the minimum capital that you need when spending $2,500 a month to stay financially secure for the rest of your life.
You can accumulate twice as much ($1,500,000) with the expectation of withdrawing 2% of capital per year instead of 4%. This will be completely reliable, although 4% is also a working figure.
Achieving financial security is the minimum program for every person.
Once you've achieved financial security, it's time to move on to financial independence.
FINANCIAL INDEPENDENCE
Financial independence is when you have capital, from which passive income covers your usual expenses.
You can quit your job and not lose your standard of living. To calculate the required capital based on 4% per annum, you need to multiply the average annual expenses by 25 (or monthly by 300).
If your average expenses are $4000 per month, then you need capital of $4000 * 300 = $1,200,000.
If you have a coveted million dollars, then it can bring you about $3500-4000 per month or $40,000- $50,000 per year until the end of life (based on 4-5% per annum) - without loss of purchasing power (covering inflation).
In numbers, your million and monthly $3500-4000 will grow every year along with inflation. But in purchasing power, it will be the same million and the same $ 3500-4000 as the day you started receiving this passive income.
When you are financially independent and passive income covers your expenses, you can aim for more.
FINANCIAL FREEDOM
Financial freedom is when you have capital that covers your expenses and you can not limit yourself to them.
It is clear that you can always want more and there is no universal amount here.
I think that the basic figure of financial freedom is still not $ 1 million, but from $ 2-3 million. They give $80-150 thousand a year, which imposes minimal restrictions on the standard of living.
$ 1 million is closer to financial independence, although everything is individual. I am also writing this in 2021, and every 20 years, about $ 1 million will have to be added to the announced amount of $ 2-3 million (depending on inflation).
HOW TO ACHIEVE FINANCIAL FREEDOM?
The only way is to set aside a percentage of your income in investments. And do it for decades if you don't have windfall profits. The sooner you start, the better because of the magic of compound interest .
If your wife or husband also works and does not invest, then help to start investing too, or in your calculations, proceed from the general family expenses. This is necessary so that there will be enough for everyone in retirement.
I wish you to gradually achieve at least financial security, and preferably financial independence or freedom. This is rarely done quickly, but it is achievable if you save more and invest wisely.