What is Financial Independence?

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Everyone seems to have a different definition of what financial independence really is. This is largely because finances are so personal that everyone has their own flavor of what financial independence means to them. We will define what some of the most commonly accepted flavors of financial independence so you can choose the one that's right for you.

Definition of Financial Independence

The closest thing to a "textbook" definition of financial independence is:

a state in which an individual or household has sufficient wealth to live on without having to depend on income from some form of employment (source)

This definition is likely the most common way people use the term financial independence. It essentially means that you no longer have to rely on a job to cover your living expenses. Some people may still choose to work, but the majority of those who are considered financially independent no longer have to work if they don't want to. 

We covered how much you need to retire in another FAQ, but most people assume that when you need to rely on 4% or less a year of your invested assets is when you can be considered financially independent. If you only need $10,000 to live a year, then your "FIRE number" is $250,000 (25x of $10,000).

Other types of Financial Independence

The definition above is one of the most common form of how people achieve financial independence, but it is far from the only one. Many other people consider being financially independent when you have an asset like a business or investment properties that throw off enough cash for you to live without withdrawing from your investments. This is different from the "traditional" method as you may not have 25 times your yearly spend invested into the stock market and instead rely on the cash that comes from other forms of investment. Let's look at a couple examples of some other ways of being considered financially independent.

Financially independent from real estate

Jack owns 4 duplexes that each make him $500 per unit per month. To do some quick math:

4 duplexes X 2 units a duplex = 8 units

8 units X $500 / month = $4,000

Jack lives in a low cost of living area and only needs $3,600 per month to live. Because his property investments are making him $4,000 he can live solely off of the income from his properties and still have $400 a month left over to invest or put into an emergency fund. In this scenario Jack would be considered financially independent.

Financially independent from passive income

Sarah started 2 websites where she blogs and sells courses. Website #1 brings in $300 a month in ad revenue and $1,500 a month in course sales. Website #2 brings in $900 a month in ad revenue and $4,000 a month in course revenue.

$300 + $1,500 + $900 + $4,000 = $6,700 per month

Sarah only needs $5,000 per month to live and has an extra $1,700 left over to invest. She is considered financially independent.

With the above examples, it is up to the individual what their risk tolerance is. In the case of Jack (financially independent from real estate) he only has $400 per month of buffer for unexpected expenses. This might be too close for some people and they would want to wait longer until they either had more assets or a large emergency fund.

There really is no "right" or "wrong" definition of what financial independence is. It is something that is personal for each person and highly dependent on one's situation. For the majority of people, they will use the income from a job to live frugally, save, and invest in the market to achieve financial independence. Most content around the web will be centered toward this type of wealth accumulation, but it is also good to know that there are other options out there. As you read and run your own numbers, keep your options open as you begin your path towards financial independence.