What is Financial Freedom: The 101 Guide

Financial freedom means having enough passive income to never have to work for a long time, or possibly ever again.
This passive income can come from bond interest, high dividend stocks, index funds, rental properties, or other reliable sources. As long as your passive income covers your expenses and keeps up with inflation with a margin of safety, you become “work optional”.
It’s not about whether you want to work. It’s about whether you have to.
There are, of course, several different degrees of financial freedom, just like there are different degrees of other types of freedom.
Level 1: Financially Solvent
A lot of people live pay check to pay check, have credit card debt, and are basically always one misstep away from financial ruin.
The first step towards becoming free is to become solvent, meaning you don’t have any high interest debt, and you have at least 3 months of expenses stashed away for emergencies. A lot of responsible people hang around at this level but never move up to higher degrees of freedom.
People at this level have their life together but likely still have some money stress, and don’t have significant retirement savings. A job loss would be a disaster, as would any major unexpected expense.
Level 2: Financially Robust
The next level occurs when you have about 6-12 months of savings stashed away, and a growing retirement hoard in a 401(k) or other retirement account.
You may still have some student loan debt, but any debt you have is low interest.
At this level, a job loss would be a moderate problem, and you’d start eating into your net worth to get by until you find another job.
Level 3: Financially Independent
This is where you’re pretty much free, and at a very comfortable place. You’re basically independent of any particular job or source of active income.
You have many years’ worth of savings stashed away, and a big retirement hoard. You could go 10 years without a job if you wanted.
In fact, you might have multiple income streams, like from a side hustle or a two-income family. If you were to lose a primary source of income, like a job, you might not even have your net worth go down; you could trim your expenses so that other household income streams could still support your daily needs.
Any debt you have at this point is purely for investment purposes, like a mortgage.
Level 4: Financially Free
The last stage, you never have to work again if you don’t want to.
Your portfolio is large enough that 3% of it could support your basic annual expenses forever:
In other words, a 1 million portfolios with a healthy allocation of stocks can reliably be expected to produce 30,000 in annual income over the long-term that grows at least as fast as inflation. Potentially more than that if you focus on income-generating investments.
If you need 60,000 in passive income, then your portfolio should be worth much more, like upwards of $2 million.
How to Become Financially Free
Most people never become financially free because their expenses keep increasing even as their income increases.
When they get promoted, or when their business becomes more successful, most people buy nicer homes, clothes, cars, gadgets and trips. They never put hundreds of thousands of dollars away into retirement savings at a fairly young age, and never start seriously compounding their wealth.
Most disciplined hardworking folks put 5-10% of their income towards retirement, which means they can’t retire until 60+ years of age. But if you put 30-50% of your income towards retirement, you may be able to retire as early as your 30s or 40s. Then you can do whatever you want.
It’s Not Usually About Sacrifice
A lot of people view the topic of saving as a question about whether to spend money now or later. Whether to sacrifice part of the present for a richer future, or not.
That has an element of truth to it but for the most part that’s not how it works.
It turns out that one of the strongest types of happiness is flow; the feeling you get when you are engaged in an interesting activity or project. Consumption doesn’t affect happiness as much for most people.
New cars, bigger homes, better jewellery- these things give people a flash of delight but due to hedonic adaptation, that delight fades quickly. We keep returning to our baseline level of happiness whether we have one car or five cars, a small home or a big home.
So, the key is to have hobbies that produce flow. Often these are inexpensive, or they could be side hustles that actually make money. Some people may have more expensive hobbies, which may mean certain trade-offs.
Achieving financial freedom doesn’t usually have to be boring or sacrificial. It’s not about denying happiness now to have happiness later.
Instead, it’s about optimizing happiness both now and later, by re-arranging priorities and realizing that what actually makes people happy is often very disconnected from money. It’s about doing things you’re excited about; with people you love.
Having free time, feeling no financial stress, spending time with loved ones, performing interesting work and hobbies, and getting enough exercise for all those brain endorphins- that’s what makes most people happy.
Now, for folks that are truly poor, that’s a different story. Those people can’t cut spending enough to be able to save money because there’s a baseline level of expenses to get by. The best thing they can focus on is increasing their income, either by getting more education or taking risks to find opportunities.
But most people within the middle class can be saving a lot more than they are.
Five Ways to Save Money
A lot of money-saving tips focus on small things. Skip a latte here, save a couple gallons of gas there, and sure it adds up.
But focusing on the highest-impact things is where real money is saved. Trimming costs on housing, cars, and restaurants is where a small change makes a five or six-figure difference over time.
Of course, everyone’s lifestyle varies and you may be able to save more or less in any given area, but here’s an outline.
1) Save 50/month on restaurants (as little as one fewer restaurant night for two per month), and spend a bit more time preparing your own dinners, which is usually healthier and far less expensive. Cultivating a good skill to cook is priceless and rewarding, and you’ll have an extra 39k after 30 years.
2) Earn an extra 400/month on the side doing something you enjoy. Maybe it’s making crafts and selling them on Etsy. Maybe it’s doing freelance writing. Maybe it’s helping people with their taxes. Or, instead of a side hustle, maybe it’s going out of your way to get one job, promotion, or raise that boosts your salary by 400/month. Either way, this could translate into an extra 313k after 30 years.
3) Spend 5,000 less on a car every 10 years. On the first year this assumes one car, and then every decade after that it assumes two cars per decade for a household. After 30 years, that’s an extra 72k.
4) Live in a slightly more modest home or apartment, and save 300/month in housing costs and 5,000 less on a down payment. You could have an extra 256k after 30 years. Housing sizes keep expanding over the years despite how much debt people have and how little they have saved for retirement:
5) The average wedding costs over 33,000 according to the Knot and other surveys. The chart assumes you get married on year 5 and spend 12,000 less on a wedding than average. Due to that one decision to save some money on a single day, you’d have an extra 39k for retirement.
If you were to do all of those things starting at 25, and save the money into a portfolio that earns 7% per year, then you’d have well over 700,000 in 30 years on top of whatever you’re already saving in a 401(k) or other core retirement plan. And that number is adjusted for 2% annual inflation, so it’s actually 700,000 in today’s dollars (well over a million future dollars).
Many people reading this are older than that, into your 30s, 40s, 50s, or 60s or more. And that’s fine. Wherever you are in life it’s better to start now than never.