What is financial independence?
Achieving financial independence means no longer having to work to meet your needs. Money no longer dictates certain important decisions.
It enables you to do follow your dreams. It gives you the freedom to:
- Change jobs
- Make a career change
- Go back to school
- Work part-time only
- Start a business
Being financially independent is not synonymous with retiring. They are two different things, even though they can also go together.
It’s something we do
A person who is retiring might not necessarily have the means to do so and achieve all their financial goals. For example, they may have to retire for health reasons, but a lack of resources could force them to reduce their spending (and prevent them from travelling or even force them to move).
Achieving financial independence means having the means to do
what you want
That same person could retire and achieve all the goals they had set. Like spending the winter in Florida. That said, a person in good health could choose to keep working for enjoyment or opt for an early retirement.
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How to calculate how much you need to achieve financial independence
To calculate how much you need to be financially independent, identify what it means for you.
Picturing yourself living a life where money is no obstacle will help you estimate the resources you’ll need to accumulate in advance. The road to financial independence will depend on a number of things, such as:
- The lifestyle and standard of living you hope to have
- The compromises you’re prepared to make
- How much you’ve saved up
- Your plans
Knowing why you want to be financially independent (whether to spend more time with your family, follow your dreams, etc.) will motivate you to act on it.
Tell yourself that financial independence is attainable. However, it requires a great deal of determination and discipline.
Advice for a happy family life: Share your plans with your partner and children, if you have any, so that everyone is working in the same direction.
Calculate your living costs
To understand what financial independence means in terms of your financial resources, you’ll need to calculate your living expenses.
Living expenses: The total of what it costs you to live for a given period of time, e.g. one year.
To get a good idea of your living expenses, draw up a basic budget:
- Take your net income (after charges and taxes)
- Subtract what you save
- The result is the amount you spend each year
If you want complete financial independence, you’ll need to find a way to replace your income (often employment or investments) to cover your expenses.
How to achieve financial independence
Draw up a financial plan
Your financial plan will guide you step by step towards financial independence. It’s your roadmap.
If you want to stop working (and stop earning active income), you’ll have to earn enough passive income (interest on investments, rental income, etc.) to make up the difference.
Here are a few examples of passive income:
- Income property
- Dividend-paying shares
- Fixed-income securities (e.g. bonds)
Draw up a balance sheet
A balance sheet will help you take stock of your current assets (e.g. real estate, investments, etc.) It’s a snapshot of your net worth, or what you have minus what you owe. Assets less debts.
When you compare what you need to achieve financial independence, you’ll see the shortfall you have to make up to reach your goal.
Build an emergency fund
Building an emergency fund could really help you reach financial independence.
It’s difficult to predict unexpected events like having to stop working because of an illness or having to repair a leaky roof or car part. By setting aside an amount in an emergency fund, you’ll be able to avoid taking on new debt.
Your emergency fund should be equal to 3 to 6 months worth of salary. This amount should be readily accessible.
Manage your debts
Debts are often an obstacle to achieving financial independence. Resolving your financial problems, if you have any, will undoubtedly relieve a great deal of stress as well as help you maximize your savings.
Pro tip: Pay off the debt with the highest rate of interest first, whether it’s a student loan, a credit card, or mortgage loan.
Saving will help you make up what you need to achieve financial independence. One easy way is to set up a systematic savings plan.
For example, you could program automatic transfers to a savings account the day after your pay is deposited. In a matter of a few months, you’ll have saved up an amount that you can put into a sound investment.
Need a helping hand to manage your money more effectively? Read our article: “How to Manage Your Money Better”
The trap of a salary increase
It’s always tempting to celebrate when you receive extra money, such as bonus or tax refund, by splurging on something. The same is true for a raise.
Exercise patience and put your
extra money towards achieving financial independence more quickly.
If you were managing fine with a salary of $60,000, would you really
need to move or change
your car if your income increased to $75,000? You’ll find the
answer by reviewing your objectives and looking at your plan.
Are you familiar with the FIRE movement?
The FIRE movement (Financial
Independence, Retire Early) has been gaining followers for many
years. It’s a philosophy that advocates achieving financial
independence by choosing to live frugally and maximizing savings.
Investing your savings could help you maximize your returns and profits in your quest to achieve financial independence. Depending on your situation, objectives and investor profile, you can choose from many:
- Investment vehicles (like an RRSP or a TFSA)
- Types of investments
- Sectors to invest in (such as rental property or the stock market)
- Ways to invest (i.e. on your own or with the help of experts)
Live more simply
By picturing what it will be like to be financially independent, you’ll be able to add or eliminate certain expenses.
However, if your living expenses and budget show that you cannot achieve financial independence as quickly as you’d like, you could:
- Reduce your current expenses to increase your savings
- Reduce your living expenses later
To do this, there are so many ways of saving, such as setting a budget for groceries.
Would you like more clarity when it comes to investing your money? Read our article: “How to invest money”
Financial independence gives you the freedom to make choices based on your wants and needs. It isn’t only for the ultra rich. Would you like to discuss it with us? Contact your National Bank advisor or your National Bank Financial Wealth Advisor. Don’t have a specialist looking after your file?