Raymond Kerzérho September 5, 2023 Personal Wealth Financial Freedom for All Financial freedom is often associated with early retirement. Many people know Freedom 55 and the FIRE movement (Financial Independence Retire Early). Several sources report that FIRE proponents sometimes save as much as 50% to 75% of their employment income. Even though FIRE’s staunchest supporters argue that most consumer spending is frivolous, such saving rates resemble more financial slavery than financial freedom. As food deprivation does not sustain weight loss, depriving oneself of reasonable consumption is not the key to financial freedom. Furthermore, individuals who accept the FIRE definition of financial freedom as gospel may get discouraged by the enormity of the task. In this article, I outline five types of financial freedom accessible to most individuals. Financial freedom defined So, what is financial freedom? I suggest equating financial freedom to financial well-being. Research from the University of Bristol Personal Finance Research Centre (PFRC) proposes the following definition: “A state of being wherein a person can fully meet current and ongoing financial obligations, feel secure in his financial future, and make choices that allow enjoyment of life.” Four critical financial well-being elements are identified: 1. Being in control over day-to-day and month-to-month finances; 2. Having the capacity to absorb a financial shock; 3. Being on track to meet your financial goals; and 4. Having the financial freedom to make the choices that allow you to enjoy life. Financial Freedom #1: Sound Working Capital An important concept in business is the working capital, i.e., the liquid assets necessary to meet current expenses. This concept applies to individuals as well. While an emergency fund (discussed later) helps absorb life’s big bumps, working capital deals with the small bumps. This should not be taken for granted, as one in four Canadians is unprepared to absorb a $500 unexpected expense. Having sufficient working capital means having enough money in the bank account to pay regular bills without having to borrow in the short term. It probably amounts to always holding one or two months of expenses in cash. This type of financial freedom does not only concern low-income individuals; high-income earners can also get overwhelmed with bills. People tend to spend more as income increases. Thus, making more money does not always resolve budget issues. For those who start from zero, sound working capital is an achievable first step toward financial freedom. Evidence shows that budgeting helps control expenses, even if tracked loosely. Furthermore, detailed knowledge of assets, debt and spending patterns is correlated with positive financial decisions. The bad news about budgeting is that it is an unpleasant exercise. The good news is that once the first budget has been prepared, updating it is easier. Don’t look for a silver bullet to reduce your expenses: sound budget surpluses may come from modest savings on various items. The idea is to reduce costs while maintaining a similar quality of life. Good working capital liberates one from everyday financial stress. Financial Freedom #2: Appropriate Insurance and Emergency Fund Once you’ve dealt with the small bumps on the road, it’s time to look at the big ones. The big bumps can be weathered using a quartet of solutions: casualty insurance, life insurance, disability insurance and emergency fund. This starts with having sufficient insurance on your property and vehicles. Life insurance is essential if your family depends on your income. Disability insurance covers you and your family against the impact of major health hazards on your employment income. If you need life insurance, you probably need disability insurance too: according to the US Social Security Administration, experiencing a disability before normal retirement age is 89% more likely than death for men aged 30, while for women, disability is 193% more likely. Some people prefer to use a line of credit as a lifeline rather than an emergency fund. I would only recommend that type of solution if you were confident of resolving these situations quickly. Households that are more financially knowledgeable are more likely to report having emergency funds. The typical recommendation is to hold enough funds to cover two to six months of expenses. The right amount depends a lot on your situation: job security, health-related issues, and other potential sources of economic shock. If your situation requires a large emergency fund, don’t get discouraged. A smaller emergency fund is better than none. Financial Freedom #3: Happiness at Work One thing I find sad about the FIRE movement (at least its most extreme version) is that it appears to attract individuals who aren’t happy at work. As we learned from modern finance, human capital (the present value of all future employment income) is a significant component of individuals’ portfolios. Planning to retire early means relinquishing several years of employment income. Your human capital may be worth the effort to reinvest in it. Research suggests that the rate of return of an additional year of schooling in the US ranges between 11% and 15%. Studying for a more interesting career path could lead to greater happiness, a longer career, better compensation and enhanced human capital. Happiness at work is often associated with well-paying jobs and non-monetary rewards such as individual autonomy, new learning opportunities and a better work-life balance. Happiness at work should be considered a form of financial freedom accessible to most people. Financial Freedom #4: Prepare for Post-Career I don’t believe financial freedom equates to a fully funded retirement at a young age. You don’t need to be fully ready for retirement to be financially free. And you don’t need to be wildly rich. But you must be on track to be prepared by retirement time. Do you regularly save and invest enough to provide for your post-career income? Have you accumulated enough so far? At what age do you plan to retire? To what type of retirement lifestyle do you aspire? Would you work part-time or freelance in retirement? If you are unsure as to whether you’re on track, the Government of Canada provides a great retirement planning calculator. Financial Freedom #5: Manage your Post-Career Finances If you are already in your post-career, you need a plan to stay on track to financial sustainability. From a financial perspective, post-career brings relief in many areas: you don’t have to worry about employment, human capital or retirement planning issues. But post-career also raises new challenges: the risk that your retirement income may not keep up with inflation and the risk of outliving your savings. To manage these risks, many experts agree that it is preferable to adapt your spending to the changes in the value of your portfolio rather than spending a fixed amount per month or year. Ideally, your withdrawal strategy will optimize your after-tax retirement income. In retirement, financial freedom is about spending enough to live well while having enough capital for the rest of your life. I would also recommend planning to meet the higher cost of healthcare down the road. Most people can aspire to some degree of financial freedom Financial freedom is not one big goal. It has many facets and can be acquired methodically in small steps. Its benefits include a sound balance in your consumption (not overspending, but also not depriving yourself), low money-related stress and a sensation of control of your financial life. Financial freedom is not only related to income but also to behaviour. High levels of financial well-being are generally associated with active saving and avoiding borrowing to cover regular expenses. Share: Facebook Twitter LinkedIn Email CIRO Advisor Report