You’ve probably heard the phrase “financial independence” thrown around a time or two — but have you ever stopped to consider what it really means? As you work hard building your savings and growing your net worth, it may be worthwhile to consider what you need to do in order to achieve your own version of financial independence.
Here’s a look at how the industry has traditionally defined this popular phrase and how you can use it to create your short- and long-term goals.
The Most Well-Known Meaning of “Financial Independence”
Throughout the industry, most financial professionals consider someone to be financially independent once they don’t need a job to pay their bills and can live out the rest of their life comfortably.
This independence largely comes about by consistently making wise money decisions, and maximizing what you can get out of your finances.
Oftentimes this will involve owning a business, participating in the real estate market, having passive income, having multiple income streams, and any other number of strategies you may acquire throughout your life that allow you to do less and earn more.
Consider the FIRE movement. This financial movement (which stands for Financial Independence, Retire Early) has gained popularity in the last couple of decades as it encourages frugality and extreme savings and investment in order to retire much earlier than the average age.
While those that choose this lifestyle have to make many sacrifices at first, in the end they find themselves with more money, free time, and the ability to do what they love (possibly to still earn some amount of income) and to generally get more out of life.
This is just one example of financial independence. It’s worth noting that there is a discernible difference between being financially independent and scraping by. Beyond covering your expenses, you should be able to meet your basic needs and still have enough to save, invest, and plan for the future.
What Does Financial Independence Mean for you?
While the above is what the industry typically considers to be the definition of financial independence, it’s more important to consider what the phrase means to you personally.
Most young professionals have a goal of achieving financial independence, and it’s often the reason why they choose to work with a financial advisor in the first place. But unless you take a beat to determine what financial independence means to you, you may have trouble ever feeling like you’ve truly achieved your goal or reached the “finish line.”
What you consider to be a financially independent stage in life, and how you go about getting there, is going to look different for everyone. Maybe for you, it’s achieving a work-optional lifestyle that frees up time in your schedule and allows you to pursue your passion projects.
It could also mean paying off your mortgage, or all of your debt. If you’re an adventurous spirit, it could mean having the ability to sell your house and travel the country in an RV or pick up and move to another country. Even reaching a certain amount of savings could count as your personal way of achieving financial independence.
Take for instance, a Gen Y Planning client who was working 60-70 hour weeks and experiencing a lot of health issues. She had to take time off, move in with family, and focus on her health. She was making $250k a year, but it didn’t matter, as she was feeling awful most days. She ended up switching jobs and working for a non-profit.
She’s making half of what she did before but she’s also working 40 hours a week and is much happier in her new role. She was very smart to pay off her debt and build emergency savings while she was at her former employer so that she could make the transition to a lower paying job much more easily.
This is what financial independence meant for this particular client. Whatever your definition is, it should be unique to you, your long-term goals, and your personal values. Try to find something that has meaning and purpose to you, rather than how others may define it.
The Basic Components of Being Financially Independent
First and foremost, you need to know how much income you need to live on. This is where budgeting becomes extremely helpful. Oftentimes people may do guesswork in their heads or throw around general numbers, but getting specific about a values-based, written down budget will better help you achieve your goals.
Additionally, you’ll want to take a look at your annual spending. This way you can see exactly where your money is going, and from there you can determine what you need to support your lifestyle.
Remember, aside from living expenses like rent/mortgage, groceries, and utilities, you’ll want to be able to cover other essentials like healthcare costs and insurance policies such as life, disability, pet insurance, etc.
Expenses aside, build a workable spending plan that incorporates your discretionary spending (aka fun money!), brokerage accounts, retirement savings, and other long-term goals like homebuying or traveling. Of course, it’s never a bad idea to boost your emergency fund as well — or start one if you haven’t already.
With the rising cost of living and high inflation, it’s possible that one job doesn’t provide enough for you to cover your living expenses and work toward your goals. If you need to pick up additional work in order to supplement your current income, you’re actually in good company. Around 61% of millennials have a side hustle and make on average around $12,689 annually from it.1
On the other hand, if you’re in a good spot and feel fully ready to quit your job, make sure your passive income (such as Airbnb, rental income, business income, or investment income) will fully support you when you’re no longer receiving a paycheck.
If that’s the case, ask yourself if you’re going to be living off of your investments or adding to them during this time. Also, if you don’t want to be hit with a 10% penalty for tapping your retirement accounts, do you have a brokerage account or other investments you can pull from? Get clear on these types of questions before making any big moves.
It can feel a little overwhelming trying to address every facet of your financial life, and that’s okay! You can always take it one step at a time and break your to-do list down into manageable and approachable action items.
How Do I Reach Financial Independence?
It is possible to reach financial independence, but you need to work SMARTer, not harder. What are SMART Goals?
SMART = Specific, Measurable, Attainable, Relevant, and Timebound.
Start by setting SMART short and long-term goals that are detailed enough to keep you invested enough to achieve them.
Say you want to spend $5,000 next year traveling to Europe. To make that a SMART goal, the Consumer Financial Protection Bureau (CFPB) recommends addressing the following questions:
- Specific: What are you saving for? A vacation to Europe.
- Measurable: How much do you want to save? $5,000
- Attainable: Is it realistic or doable? Yes, if I spend less of my disposable income on non-essentials like shopping or eating out.
- Relevant: Is this important to you and worth saving for? Yes, travel is a fulfilling and meaningful activity for me.
- Timebound: When will you meet the goal? By summer of next year, approximately 12 months.
By starting with these details, you can decide for yourself if the goal is worthwhile, or if it needs to be reconsidered.
Not sure what goals to start with? If you have debt, especially high interest debt like credit cards or personal loans, it’s always a good idea to prioritize paying it down. And of course, saving for retirement should be one of your financial non-negotiables.
You’ll also want to work with a financial planner to set goals and get specific about what you want out of life. There are some people who, when working toward such goals, find themselves being so cheap that they miss out on some of the enjoyable things in life.
Like most things in life, balance is key. A financial planner can help you to be realistic and put real numbers on a page, which can allow you to be at ease spending money on the things that add joy to your life, rather than coming at it from a scarcity mentality.
Also, if you find yourself racing to the finish line and trying to retire in your 40s because you hate your job, it might be worth it to explore switching careers to something that’s more sustainable long term, even if you make less money.
Just like the aforementioned example of the client who cut down her hours but had more satisfaction with her life, you’ll want to make sure you’re not just trying to hit a magical number and hoping life gets better after that. Working with a planner during this type of career switch would also be beneficial.
It’s Okay If You Need Help Getting There!
To say the financial world is complicated would be an understatement. That’s why financial advisors, like us here at Gen Y Planning, are amazing resources and can provide a wealth of knowledge for you to tap into. You’re busy building your career and growing your family, you don’t have to add becoming a financial expert on top of your already full plate.
Your advisor can help you look at your budget, set SMART goals, and generally help you navigate towards achieving whatever financial independence means to you. Once you determine the destination, they can create a roadmap with achievable steps to help you reach it.
Sources:
1Zapier report: 40% of Americans have a side hustle in 2022
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