Living life on your own terms without needing to work a 9 to 5 is liberating: with no boss controlling your PTO, you’re free to enjoy your time as you please. But is this financial independence or financial freedom? Or is it both?
The answer is it could be both, could not – it depends!
Often times financial freedom and financial independence are used interchangeably but they do have different meanings.
If you’re confused, don’t worry because in this article we’re going to talk about the key differences between financial freedom and financial independence.
By the end, you will understand how each of these financial goals can fit into your life. We will start by defining each. Let’s get into it.
Financial disclosure: this content is for informational purposes only and is not to be considered professional advice.
What is financial independence?
When looking at the difference between financial freedom and financial independence, we have to start by defining each term.
The definition of financial independence is the status of having enough income or wealth sufficient to pay one’s living expenses for the rest of one’s life without having to be employed or dependent on others.
In other words, you have enough income to pay for your lifestyle without having a job for the rest of your life. Your income typically comes from the assets you’ve invested in.
The term financial independence is the first part of what’s called the FIRE movement.
FIRE stands for Financial Independence Retire Early. The way financial independence is talked about usually refers to the way the FIRE movement looks at financial independence. And that is math.
But not the kind of math that makes your brain hurt, it’s very simple.
Financial Independence according to the FIRE Movement
What is the meaning of financial independence according to the FIRE movement? It all comes down to a formula. You will have achieved financial independence by the use of the following formula.
Your annual expenses x 25 = financial independence
For example, let’s say my annual expenses is $50,000.
$50,000 x 25 = $1,250,000.
I would be financially independent when my assets reached 1.25 million. This is because I would safely be able to withdraw $50,000 every year for the rest of my life without relying on being employed.
Very simple. But easier said than done!
I’d like to note, that this is a very simplified explanation of financial independence according to the FIRE movement. There are many nuances that play a factor in whether withdrawing $50,0000 per year for the rest of your life is sustainable such as the state of the economy and inflation but for the sake of discussing the definition of financial independence, we will keep it simple.
Your financial independence number is found using your annual expenses as an input into a mathematical equation. The total is a set number that says all my expenses are taken care of for the rest of my life without relying on employment income.
What is financial freedom?
We covered financial independence, now let’s talk about financial freedom.
When we compare financial independence vs financial freedom, freedom has a more subjective meaning. What is considered financial freedom varies depending on who you ask. The reason for this is that just like personal finance, financial freedom is personal.
Here’s a definition I like: financial freedom is a state of mind in which you have psychological freedom and financial confidence.
Let’s take a look at what this looks like practically.
This could mean if your car breaks down, you have the ability to afford it without stress. It’s a minor inconvenience because you have the funds set aside to pay for it.
You have the ability to choose a job that you’re passionate about without worrying about the salary because you have enough money to fund your expenses and lifestyle.
When you go on vacation you don’t worry if you can afford it because you have the financial means to cover the cost without working extra hours or putting it on a credit card.
Financial freedom is about having choices. It’s a mindset. A feeling.
It’s about not having to worry about money because you have the financial means to make choices that bring you the most value without worrying about price.
When you don’t have enough money to live the life you need, it brings on a lot of stress. But when you have financial freedom, a lot of those money stresses dissipate. This “having enough” whatever that means for you bring the financial confidence that you can handle anything that comes you’re way because you’re prepared.
What is the key difference between financial freedom and financial independence?
We’ve defined both terms, now let’s talk about what the key difference is between financial freedom and financial independence. People use them interchangeably because they do often mean the same thing.
Financial freedom vs Financial Independence
When we look at financial freedom vs financial independence, Financial independence has a more definitive definition based on a mathematical equation, whereas financial freedom focuses more on a subjective mindset and feeling.
The reason they overlap so much is that depending on the situation both could be true.
If your car breaks down and you have the financial means to fix it without it being beyond a minor inconvenience you could be both financially independent and have financial freedom.
If you have enough assets to cover your expenses for the rest of your life, you would be financially independent.
If you had enough financial means to cover these expenses but don’t have enough to cover your expenses for the rest of your life you would have financial freedom but not financial independence.
From this perspective, you can see that financial freedom is a pre-cursor to financial independence. You can feel the benefits of having choices in your life without being chained to your 9 to 5 and have financial confidence and feel a sense of psychological freedom that you can handle whatever comes your way well before you reach financial independence.
How do you calculate your financial independence number?
Calculating your financial independence number is a process but essential in your journey to financial independence. There are certain numbers that are really important in the equation that you want, to be honest with yourself about so you get the most accurate depiction of your lifestyle.
A good way to do this is to take 6 months of your bank statements and take the average of them. Multiply that by 12 to get your annual expenses.
Then multiply your annual expenses by 25. The 25 is not a random number, it’s used because we assume a 25-year retirement.
This will give you your FI number.
Every time you have a major life change you will want to update this number like getting married, having kids, or moving to an area with a different cost of living as these changes will affect your calculations.
Find out what your financial independence number is using this financial independence calculator!
What is your financial freedom number?
As I’ve mentioned, financial freedom means something different to everyone. But a good way to measure your financial freedom number is 5 times your annual expenses.
If your annual expenses are $50,000, then your financial freedom number would be $250,000.
But this is just a formula if you want a way to quantify your financial freedom.
Remember that financial freedom is the mindset of psychological freedom and financial confidence. If you feel free of money stress and have built the financial means to cover your lifestyle and any unexpected emergencies, you have reached financial freedom.
Is financial independence financial security?
It’s safe to say if you have financial independence that you have financial security.
But if having financial security doesn’t make you financially independent.
So what’s the difference?
Financial security is having enough financial assets to cover your expenses, emergencies, and retirement without having any concern of running out. (Investopedia)
If for example you have no consumer debt but pay a mortgage, have an emergency fund that covers 6 months’ worth of expenses, and are on track to reach your retirement goals, you have financial security.
So much of our stress comes from money concerns, but when you have enough, many worries go from disaster to minor inconveniences.
If you were to suddenly lose your job, it would not completely turn your life upside down because you have an emergency fund to rely on.
Financial security is about having everything you need to flourish in your financial life.
Financial independence is having everything you need to flourish in your financial life, for the rest of your life without relying on employment income.
How to reach financial freedom
The path to financial freedom is rewarding and will teach you so many things about what you truly value and enjoy. In order to get there, you will want to focus on the following things to build a foundation for success.
Build good financial habits
Good financial habits start with your spending. Every person who has reached financial freedom lives within their means. This means they never spend more than they make.
They spend money on things that ar truly important to them and don’t overspend on anything they can’t afford.
Many of us have a tendency to overspend, I know I did. If you do that’s okay! It just takes conscious effort but with time and patience, you can become a more conscious spender.
Having a budget is also a must for building good financial habits. A budget doesn’t have to be super complicated. You just need a way to track your overall spending so you know exactly where your money is going and where you want it to go.
Millionaires spend more time managing their money than the average person. Don’t be afraid to get comfortable with your numbers!
Get rid of debt
Achieving financial freedom requires you to get rid of high-interest consumer debt. These are your credit cards and personal loans.
Getting rid of debt is a must because it’s the biggest killer of wealth. The beauty of compound interest is that it multiplies your money over time but, unfortunately, it does the same for your debt, making it harder to climb out of the longer you wait to take care of it.
If you have of any credit cards or loans to pay off you’ll want to tackle this as soon as possible.
Investing
This is the fun part of the financial freedom process. You want to invest as much as you can comfortably afford each month to your investments to begin building your wealth.
When you first start the growth happens slowly at first but with diligence and patience, once you keep contributing month after month your efforts will begin to snowball and you will grow your wealth in no time.
There are many different ways to approach investing. The FIRE movement suggests investing in index funds as the path to financial freedom but real estate, building a business, and cryptocurrency are great alternatives to building wealth as well.
Experiment and find what works for you, everyone is different. Contrary to what many people believe, there is no one way to build wealth.
Multiple income streams
Having multiple sources of income is very important, especially if your income is modest. Having income come from multiple sources outside of your job is what helps build your wealth strategically: it’s what accelerates your wealth-building process.
And the faster you build your wealth the sooner you can reach financial independence.
What does this look like practically?
This could look like getting a side hustle.
Some people get side hustles and use the money exclusively to pay down their debt. Then once they complete their debt payments, they funnel all the extra money that went to their payments to fund their monthly investment contributions.
Not every source of income needs to produce a ton of money, it could be something as simple as the cash you receive from cashback apps. That is considered a source of income.
Other examples of income streams include dividend investments, rental property income, online business income, and investment interest income such as peer-to-peer lending or real estate crowdfunding.
To recap, we’ve covered the difference between financial freedom and financial independence, how to calculate your financial independence number, and how to get started towards financial freedom.
Living life on your own terms is a worthy goal of pursuing. It will take a lot of discipline and sacrifice but it’s yours if you’re willing to put in the work.
What Exactly is the Difference Between Financial Freedom and Financial Independence?
Cassandra is a personal finance blogger who helps millennial and gen-z women level up their money game for financial freedom.
