Financial freedom and financial independence are two concepts that aim to explain a similar state of financial being. When setting or goals as investors, financial freedom and independence is what many have in mind as the be all end all. But what actually is the difference between financial freedom vs. financial independence?
Financial freedom means being able to spend your time and money freely without the concern for a job or other fixed income sources. Financial independence means not depending on anyone else for income. Thus, the difference between the two is the degree to which you can live life to the fullest without having to think about your finances.
In this article, we’ll talk about what financial freedom is and what financial independence is. Once both concepts are firmly established we’ll look at the differences between the two. What makes financial freedom different from financial independence and vice versa?
Some of the differentiating categories we will explore is jobs, your general lifestyle, (financial) security and retirement.
What is financial freedom?
Financial freedom is a state of total financial well-being. You have no debt outstanding, or if you do, it’s at low interest rates and can be paid off easily. When you are financially free, your lifestyle is not limited by your finances in any way.
You’ll be able to take that long vacation in Italy, sail from Australia to Bali or simply go out for some dinner at a nice restaurant (if those are things that you choose to do). My point is: You will be able to more or less live a comfortable life without having to worry about money.
You’ll have achieved financial freedom by investing in stocks, bonds, and perhaps real estate, and your passive income not only covers your monthly expenses but also grows your wealth year by year. At this point, you’ll be truly financially free.
The above graph shows the exact point at which your returns cover your expenses. However, as you can see with the current input parameters your returns and saving would continue to grow even after you hit the break-even point. This will lead to financial freedom.
What is financial independence?
Financial independence is the financial status you reach when your passive income covers your monthly expenses. You’ll be independent of other income sources (e.g. a job) but your wealth will not necessarily increase from here on out.
This means that you’ll be able to maintain the same lifestyle you have been living so far, but not much beyond that. To enjoy that long vacation in the Caribbean you’ll probably have to cut back for a few months to save up for the extra expense. Even a dinner at a slightly pricier restaurant might set you back financially a few weeks.
Perhaps you’ll also have some lower interest debt outstanding like a student loan which you have not managed to pay off completely.
The above chart illustrates when you will be financially independent. At this point you can start living off your investments and savings, however, your net worth will not continue to grow significantly year over year.
Differences between financial freedom and financial independence
Now that we have seen what financial freedom and financial independence look like, it’s time for a detailed comparison between the two.
The main difference between financial freedom and financial independence is the extent to which your passive income covers your expenses or goes beyond that, as we have seen above.
But what are some differences between financial freedom and financial independence when it comes to your job, lifestyle, financial security, investment strategy, or retirement planning?
When it comes to your day job, both, financial freedom and financial independence will have a similar impact: no longer depend on that paycheck to cover your expenses. When you are financially free or independent you will be able to cover all daily necessities just from your passive income.
However, with financial freedom, you will also have additional resources available to fund side projects you are passionate about. Perhaps you always wanted to start that online business selling scratch cards or start making your own honey.
Well, if you have achieved financial freedom you can do so basically risk-free. With financial independence, things can be a bit more tricky since you will not have that much spare passive income left are paying for food and rent.
Furthermore, financial freedom allows you to continuously upgrade your lifestyle since you will be able to reinvest the extra income while financial independence will keep you more or less at the same level; which is absolutely fine if that’s what you’re happy with.
Again, it just comes down to personal preference at this point.
In terms of financial security, the difference between financial freedom and financial independence will be even more pronounced. With income just barely covering expenses you’re living at the whim of the economic ups and downs and inflation rate.
In order to really become financially bulletproof, it requires that you can easily make it through meager times as well. Being financially free will give you that extra cushion to survive and thrive even in times of economic turmoil.
Whether you have achieved financial freedom or independence can even affect your investment strategy from thereon after. Many who have achieved financial freedom are more willing to take on slightly riskier investments such as real estate, crypto, or startup investing.
These are strategies not predominantly well suited for financially independent investors. On the road to financial freedom, you’ll want as much stability as you can get while also maximizing returns.
Once that threshold is passed, you will be free to invest some extra income in higher-reward investments and potentially expand your wealth even further.
When it comes to retirement the previous aspects all tie together: you’ll probably want to live out the comfortable lifestyle of your choice while doing only as much work as you like. Security will become a bigger concern for most investors as they mature together with their portfolio.
Investing strategy also tends to shift from equities to more fixed income options such as bonds. This way you will be able to even out the swings of the stock market when you actually are dependent on your funds.
This occurs naturally regardless of your financial status. However, financial freedom will allow you to continue to stay invested in equity positions as your additional income enable you to weather the storms of the stock market.
Financial freedom and financial independence are goals worth striving for. The true difference between the two only becomes apparent after you have hit your break-even point.
Once there, you’ll have to make a choice: maintain the status quo or continue to build your passive cash flow. If you choose the latter, you are on your way to true financial freedom.
Choosing the former is just as well. Just keep in mind that you will have to make some sacrifices.