Financial Freedom Formula
How much money is enough? In this article, we intend to help you answer This question and estimate how much wealth is sufficient for you. In English, there is a not-so-polite term for this amount of money, which is called “f* you money.” It’s the amount of wealth that, once reached, you can say those two words to your bosses and quit your job! This situation, in which you reach a level of wealth where you no longer need to work and can live off the returns from your assets, is called financial freedom.
Many of us spend our lives earning income and accumulating wealth without ever answering the fundamental question of how much money is enough. Note that there is no obligation to quit your job once you achieve financial freedom. Please stay with Aseemoon.
Financial Freedom Meaning
Achieving financial freedom means having enough passive income to cover your living expenses without needing to work actively. This allows you to focus on personal interests, hobbies, or other pursuits without financial stress.
Everyone defines financial freedom based on their own goals. For many, it means having a financial cushion—comprising savings, investments, and cash—that allows them to enjoy a desired lifestyle. It also includes having a nest egg for retirement or the freedom to pursue any career without the pressure to earn a specific salary.
7 Levels of Financial Freedom
According to Grant Sabatier in the book Financial Freedom(+), there are several levels to achieve financial freedom:
The First Level – Clarification
Financial investments, budgeting, and strategizing require similar preparation. The first step in Sabatier’s 7 Levels of Financial Freedom is clarity, meaning understanding your current financial situation and increasing your financial literacy.
The only three things you need to determine are:
- How much money you have (assets, material value, securities, investments, and savings)
- How much debt do you have (student loans, credit cards, mortgages, lines of credit, etc.)
- Your financial goals (how you want to live)
Once you have identified all of these, you can begin tracking your expenses and creating a budget.
The Second Level – Self-Sufficiency
After understanding where you are and what your financial destination is, the most minimal state in which you can begin financial freedom is self-sufficiency. Self-sufficiency means that you can cover your current expenses with your current income. In this state, you may not have any particular assets or savings, and you are simply waiting for your monthly paycheck to cover your expenses.
The Third level – Breathing Room
The Fourth Level – Stability
At this level, you have saved enough to cover at least six months of living expenses. For example, if your average monthly living expenses are 2,000 dollars and your income is 3,000 dollars per month, once you have saved 12,000 dollars, you are at the fourth level of financial freedom. At this level, you may still not be able to say those two golden words and quit your job, but you will undoubtedly refuse many tasks and have more negotiating power for a raise or even a job change. You have saved enough for six months of expenses, so you can quit a job you don’t enjoy and take up to six months to find your ideal job.
The Fifth Level – Flexibility
When you have saved enough to cover two years of your expenses, you have reached the fifth level of financial freedom. Upon reaching this level of wealth, you will have a great deal of flexibility in your economic decisions. You might decide to leave your job for a year and focus on learning a new skill. You could consider starting your own business or even creating a side business with this capital, which could generate significant additional income for you.
The Sixth Level – Financial Independence
At this level, you have accumulated enough assets that the inflation-adjusted returns from your investments can cover your living expenses. For example, after working for 3 to 4 years, you might have saved enough to invest in a mix of index funds that grow over time. The returns from these investments could cover your rent and basic living costs, allowing you to rely on that passive income instead of your salary to meet your expenses.
Level Seven – Abundant Wealth
Your final destination after step six is a point where your assets greatly exceed your needs. For example, say that over the years, you have built up investments in stocks, real estate, and other income-producing assets. Now, after covering all your expenses, you still end up having a big chunk of income left over. You can easily retire early, travel around the globe, or do whatever interests you without worrying about the money. At this level, one has achieved financial freedom.
Now, let’s go back to the first question:
How much money is enough?
To answer this question, you need to calculate the expenses of your ideal lifestyle. This amount depends on your way of living. If your perfect life includes living in a mansion and driving expensive cars like a Maserati or Porsche, you may be far from achieving financial freedom! On the other hand, if you aim for a comfortable but not overly luxurious life, you might be able to reach this level of wealth within a reasonable time frame.
To determine how much money is enough for financial freedom, you can use a straightforward formula based on your annual expenses. This method is commonly referred to as the Financial Freedom Formula and is often associated with the 4% rule from the FIRE (Financial Independence, Retire Early) movement.
Steps to Calculate Your Financial Freedom Formula
1. Calculate Annual Expenses: Start by listing all your monthly expenses, which typically include categories such as:
- Housing (rent or mortgage, taxes, insurance)
- Utilities (electricity, water, internet, phone)
- Food (groceries, dining out)
- Transportation (car payments, insurance, fuel)
- Health (medical expenses, insurance)
Sum these expenses to get your total monthly expenses, then multiply by 12 to find your annual expenses.
2. Apply the 4% Rule: To find your Financial Freedom Formula, multiply your annual expenses by 25. This calculation assumes that if you withdraw 4% of your investments each year, your portfolio can sustain itself through growth and income generation.
For example, if your annual expenses are $60,000, your Financial Freedom Formula would be:
Considerations
- Debt Management: Paying off debts can significantly lower your required Financial Freedom Formula. For instance, eliminating a $2,000 monthly mortgage could reduce your target by $600,000.
- Investment Strategy: The performance of your investments will influence how quickly you can achieve financial freedom. Regularly investing and taking advantage of compound interest can accelerate your progress.
- Lifestyle Choices: Your desired lifestyle will dictate your expenses and, consequently, your Financial Freedom Formula. A more frugal lifestyle will require less capital to achieve the same level of freedom.
By following these steps and understanding the implications of your financial choices, you can set a clear target for your financial freedom journey and work towards achieving it.