There is a lot written about obtaining financial freedom (often included in the pitches of various business opportunities), and it generally is thought of as the end goal of most of our human endeavours related to business and investing. What exactly is financial freedom? I define it basically as the point in life where money no longer becomes an issue in deciding how, where, and with whom you choose to spend your time. Notice that the important part in my definition is that earning money becomes completely removed from the equation.
The thing about financial freedom is that it’s essentially a function of income and expenses. It is very dependent on the standard of living you desire. If you “need” to fly around the world, spending winters in Switzerland on the slopes punctuated by shopping sprees in Paris, the level of income needed to become free financially is going to be a lot higher. Looking only from the expenses side of things and at the extreme end, the easiest way to achieve financial freedom is to move to a remote mountain top and live out your days as an aesthetic hermit.
I don’t think that’s what most of us have in mind when we envision financial freedom, however most of us have very little control over our own expenditures and often let them be dictated by society. Avoiding simple, needless, societally reinforced wastes such as trading in your depreciating vehicle every few years to keep up with the Jones family is a good start. Buying a new car and driving it for 15 years makes economic sense, yet how many people do you know that do that?
For most of us, it is pretty easy to find areas in our lives where needless expenses can be removed. However some things, such as international education for your children, may not be an area you are comfortable being cheap. Thus we can only do some much on the expense side of the equation by living frugally. Since financial freedom means having the ability to do what you want, where you want, and with whom you want, having those upper end luxuries within reach means living in a cave doesn’t quite go far enough to be considered real financial freedom (although at least you would have escaped the rat race).
Income is the main driver of financial freedom, so long as you keep the expenses under control. Not all income is equal, and one form of income can actually keep you in financial bondage even as your overall wealth continues to grow. Active income is income you need to work for in order to earn. It is your salary or a salesman’s commission. Stop working or selling tomorrow and the wellspring goes dry. The fear of it going dry forever keeps many people “on the wheel” of chasing active income. This is where the majority get their money and why they fail to achieve real freedom. There can never be enough. Passive income, on the other hand, is money that you do not need to physically do anything to earn. It is the result of some asset you own generating the income for you. People who gather passive incomes eventually become financially free.
The ideal situation to end up with a diversified mix of passive income generating assets, with some inflation protection built in. Interest bearing deposit accounts, income generating real estate, dividend paying stocks, government and corporate fixed income securities, pensions, patents, royalties; these are all examples of passive income generating assets. They each have their own risks and during different phases of the business cycle it is best to limit exposure or even avoid certain asset classes altogether. At the moment 12 month deposits in developed currencies and most conservative fixed interest investments aren’t doing much, but the time will come again when these will produce adequate risk adjusted returns. Don’t extrapolate the current situation into the future when creating your long term strategy. Mathematically speaking, as long as your passive investments earn more each year than your expenses, your overall wealth will compound and you will remain financially free for as long as you live.
David Mayes MBA provides wealth management services to expatriates throughout Southeast Asia, focusing on UK Pension Transfers. He can be reached at firstname.lastname@example.org. Faramond UK is regulated by the FCA and provides advice on pensions and taxation.