The elusive definition of financial independence

The elusive definition of financial independence

Has Wikipedia nailed it or do we need a better, more all-encompassing definition?

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( Norbert Schafer/Getty Images)

( Norbert Schafer/Getty Images)

This Financial Independence column at MoneySense (online and in the physical magazine) has been running a few years now. Since it also spawned November’s launch of the Financial Independence Hub, I thought it would be appropriate to look at the formal definitions of financial independence (which of course I like to shorten to Findependence).

Usually, I just point readers to the Wikipedia definition, since it’s at the top of the Google search engine when you enter the phrase. The key part is “the state of having sufficient personal wealth to live, without having to work actively for basic necessities.” I’ve written about this before and you can go to the above link for the full definition, but for this particular blog, I wanted to explore other definitions.

Here’s BusinessDictionary.com’s definition of financially independent: “Individual or family that can provide for, from its own resources, at least two of the three major expense categories: housing, food, and other living expenses.”

Hmm, no mention of taxes there as a major expense category. That definition doesn’t quite do it for me. Let’s move on to the Retireby40 blog, where Joe Udo provides multiple technical definitions based on net worth, cash flow and passive income sources but no one overarching simple definition that I could discern.

His net worth definition consists of dividing your net worth by your annual expenses. “If this number is 25 or more, then you’re close to financial independence.” The number 25 works for those over 60 (which includes yours truly) but Udo cites higher numbers for younger people like himself: 28+ for those aged 50, and 33+ for those his age (40) or younger.

He then mentions the famous 4% annual withdrawal rule, although he notes that for a long retirement this might be revised down to 3%, with adjustments for inflation.

Here’s Udo’s cash-flow definition: “Another good way to define financial independence is having enough passive income to pay your living expenses. This is a bit different than FI by net worth. Some people don’t have a huge net worth, but they have plenty of passive income. If your passive income covers your living expense, then you’re very close to financial independence and working is optional.”

I think he finally hits the nail on the head when he closes with the phrase “working is optional.” Or as I say in my financial novel, Findependence Day, when you’re findependent, “you’re now working because you want to, not because you have to.”

Of course, as I have discovered in the first year of my own personal Findependence, even this simple definition isn’t 100% accurate. If you take on multiple clients and agree to contracts, you pretty much have to complete a given contract, which tends to run six months or a year. You’re reading a blog that is part of such a contract.

Some of Udo’s reader comments at the bottom of his post are also worth reading. For example, a reader named Brian wrote: “ … a person can consider themselves financially free/independent/secure when their money makes more for them in a year than they make for themselves in a year.”

Not bad, depending on how you define the phrase “their money.” I’d argue that should include not just investment income but (for older folk anyway) employer and Government pensions.

Further down, another reader gets close to the nub of it: “To me, financial independence means not having to work for money. If I get enough income from my investments that I’m able to sit at home and do nothing forever, then I’m financially independent.”

Unfortunately, that definition is pretty close to what most people consider traditional full-stop “retirement.” I’ve spilled lots of ink and electrons making the distinction between Findependence and retirement. Generally, I think Findependence can occur decades earlier than retirement but early retirement bloggers like Udo would themselves admit they’re not really “retired”–they’re self-employed entrepreneurs making money off books, websites and public speaking that tell other people how they can achieve “early retirement.” (i.e. Join the ranks of early retiree gurus with books and websites, get quoted widely in the press and clean up on the speech circuit). I’m in the same boat myself: the main difference is I get to steer the boat instead of being ordered to “row” by some corporate middle manager.”

At the Boomer & Echo blog, financial planner Marie Engen mentions my own preferred term Findependence and offers her take on it: “Financial independence means you have sufficient resources to give you the freedom of choice, to sustain a lifestyle that allows you to pursue whatever truly makes you happy–to leave a high stress job for a lower paying one that’s more satisfying, take some time off for whatever reason, go back to school, or write a screenplay.”

So what about it, readers? Has Wikipedia nailed it or do we need a better, more all-encompassing definition? Feel free to email me or post a comment below.

Editor-at-large Jonathan Chevreau runs the Financial Independence Hub and can be reached at jonathan@findependencehub.com.

 

 

 

 

 

 

 

 

 

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