Note: This is part 1 of a 5-part introduction to financial independence and understanding. Make sure to read the whole series to really grasp what Money Tofu is all about!
According to Wikipedia, Financial Independence (FI) “means you have enough wealth to live on without working.”
In essence, being completely financially independent (also FI as an acronym) means that you are able to sustain your living situation indefinitely with the assets that you already own, not needing to rely on trading your time for money.
This does not mean you need to have an unlimited amount of money in your bank account, or that you can not have any income. Consider the following simplified scenarios (not taking into account inflation, taxes, growth, or anything else):
- Alice has $100 million and spends $1 million a year. Is she FI?
- Bob has $5 million and spends $50,000 a year. Is he FI?
- Carol has $500,000 and spends $50,000 a year, with passive income of $45,000 per year. Is she FI?
Given what we know about the life expectancy of humans, let’s assume that none of the people above will need to sustain their living beyond approximately 100 years. After all, the oldest person has lived to 122, and the individuals above are at least adults who have worked for a few years in society to attain the assets that they have (unless they inherited everything).
In each of the scenarios above, I would claim that they are all FI as they are able to sustain themselves with their existing assets for a full 100 years. If you do some calculations, you will see that each of their expenses per year turns out to be exactly 1% (or 1/100) of how much money they have.
The biggest difference is the amount of money. The difference between Alice and Bob illustrates that you can be FI as long as your spending is proportionate to your assets, whether they are extremely high or not. The difference between Bob and Carol illustrates that it is possible to have a lower amount of money saved up and still sustain a higher spending standard if there is passive income (more on this later) in the mix to make up the difference.
While the above definitions and examples help define the state of FI, it is important to realize that this definition is a means and not entirely the end.
Meaning Behind the Meaning
Having enough money so that you no longer need to work means you have achieved FI, but what that really means is that you are no longer forced to exchange your time for money for the mere purpose of existing on this planet. You have the final say in how and where you spend your time, escaping from a tether that most people in society are bound by: the necessity of working a job to pay the bills.
Being financially independent provides a level of freedom that few things can match. Knowing that you are not beholden to someone else in order to live your life the way you want to is really an incredible thing.
The Need for Money
You might be thinking: this is just about money. That shouldn’t be the most important thing in life, right?
And my answer is: Yes! Money should not be the most important thing in life. In 1943, Abraham Maslow published a paper called “A Theory of Human Motivation” and established Maslow’s hierarchy of needs. His framework became very popular and is often cited in sociology research today.
The 5 basic categories of needs Maslow identified are, in order from most fundamental first: “physiological”, “safety”, “belonging and love”, “esteem”, “self-actualization”, and “self-transcendence”.
The theory goes that the more fundamental the need, the higher its importance in needing to be satisfied before the next higher tier of need even enters the picture. We all have basic physiological needs such as breathing, water, food, and so forth. Only when you are no longer going hungry and thirsty will you then think about safety, including personal and emotional security.
I won’t go into detail all of the needs or Maslow’s theory here, but feel free to read more about it if interested.
Similar to the hierarchy of needs, it is not that money should be prized above all else. Rather, we must “satisfy” the monetary need and no longer be dominated by it in order to truly be free from it.
Financial Independence removes the negative effects of worrying about money from limiting your life. Only when we are FI can we really do the things we want to.
The freedoms that financial independence brings are numerous. Now that we have an understanding of what FI is, let’s explore some reasons why you should strive to achieve financial independence.
