Financial independence (FI) means having enough financial assets that you could live the rest of your life without working. Bloggers frequently use the FIRE acronym which stands for [become] financially independent and retire early. Such a life might be pictured as living off capital gains from one’s investments without reducing the principle, much like how a university or non-profit foundation lives off its endowment in perpetuity (albeit, often subsidized with tuition, sales, donations, etc.).
If FI means not touching the principle, this means you could live to 100 and your original investment would still be there (even when adjusting for inflation). This requires a combination of frugal living and large amounts of accumulated assets. You might be able to achieve FI with just a quarter million in assets if they live in a low-cost-of-living area, behave frugally, and invest in the stock market at-large (e.g., an S&P 500 index fund). Although there is luck involved (e.g., what the market does), one can certainly influence their income, investing, and spending. (On the other hand, if one chooses to avoid stocks entirely, it would be difficult or impossible to achieve FI with bonds or Treasury bills, due to their low propensity for growth.)
The key to FI is accumulating (and investing) lots of capital. But first, why would one want to be financially independent? A big reason is the freedom it gives you. Employees who have paid off their mortgage might not be as worried about angering their bosses. Achieving FI doesn’t mean you must stop working, but rather that if you continue to work, you do it on your terms.
Of course, if you are living paycheck-to-paycheck with burdensome consumer debt (e.g., student loans, credit cards), you are quite far indeed from FI or even basic financial security. But, everyone starts somewhere. There won’t come a time in your life when you suddenly won’t need money again. Even prisons have stores and commissary accounts. Looking backward at financial mistakes may discourage you from ever taking productive actions, but the best time to start is always now rather than later (and yesterday if you could have, but as we know, yesterday has passed).
The key to financial independence seem simple, because it is. In fact, the key is the same, whether you are paying off $20,000 in credit card debt or building an emergency fund. Debt represents negative capital—spending more than you earn. Therefore, paying off debt is the same as accumulating capital, except you started from below zero and what you are “accumulating” is relief from the obligation to pay debt.
However, the key is much easier to talk about than actually execute. This is because beneath the key exists a whole framework of habits and behaviors (the Behavior Gap, as Carl Richard labels it). To get out of debt, you have to change the behaviors that got you into debt. Recognizing the importance of psychology is essential to developing the framework that will put you on the path toward FI and beyond. For instance, even if your bank pays no interest on a savings account, putting your emergency fund in a separate account, rather than commingled with your checking account, increases your propensity to save. Even though credit cards offer perks like extended warranties and rewards, sticking to cash reduces your inclinations to spend. Even though paying debts with the highest interest rate first saves you more money, paying the smaller debts first may increase your motivation to continue.
Therefore, while the outward, externally visible key to financial success is to accumulate assets, the inward-facing key is to manage one’s behaviors. This is why budgeting can be such a powerful tool. A budget is an external aid to manage your behavior. Jesse Mecham writes that the process of cataloging your expenses is the key part of changing your behavior. Carl Richards writes that the process of building a financial plan gives you clarity about your financial future. Although both of these processes produce deliverables, the deliverables themselves are not the solution. You can’t just be handed a budget or financial plan—even one tailored for your demographics (e.g., age, income, etc.)—and expect this will change your behavior. Change takes time, effort, and structure. Although many characterize FI as a mindset, the change in mindset might be caused by the framework rather than preceding it. And, without a framework, a change in mindset might accomplish nothing.
This is big-picture stuff. Many decisions that occur at lower levels are important too. I will write about both in future articles.