In casual conversation, you’ll frequently hear people use phrases like “financial independence” or “financial stability.” Nearly everyone I know in my personal and professional networks aspires to some degree of financial freedom or independence. However, I’ve discovered that due to hazy definitions and even fuzzier statistics people have in their heads regarding what these terms signify, financial well-being continues to be obscure and out of reach. As a result, the first thing I want to do is clear any misconceptions and explain what financial independence and freedom really mean.
The most important thing to grasp about financial independence is that, regardless of how much money you make, you can only ever obtain it by producing non-earned (passive) income, or a return on your investment in the form of capital. Or, to put it another way, making money do the work for us instead of the other way around!
Now, I was trying to determine “what’s the number”? In other words, how much money are you going to need to: 1. monetary safety; 2. monetary stability; and 3. monetary independence? I therefore made the decision to attempt explaining and estimating the hypothetical cost of each of these 3 degrees of financial well-being over the course of a weekend. Here we go!
1. Financial Protection
Making sure you and your family are covered no matter what short- or long-term financial challenge may befall you or the economy is the minimum level of financial wellbeing and the first stop on the route to financial freedom. Here is how you may tell if you and your family have financial security:
You have enough cash on hand to cover your essential living costs for at least three months and ideally two years. Therefore, if your monthly essential needs were $3,000, you would require a minimum of $9,000 and ideally $72,000 in liquid assets.
You have a life insurance policy in place that would enable your dependents and family to sustain their standard of living in the event of your demise.
If you become incapacitated in any manner and are unable to work and support your family, your disability income protection insurance will safeguard you and your loved ones.
Your level of disability insurance should be directly inversely proportional to your level of savings. A mix of savings and/or disability income should ideally be in place to cover 24 months’ worth of basic living expenditures, so if you have, say, three months’ worth of liquid capital set aside, you should seriously consider purchasing disability protection to cover the remaining 21 months. As a general rule, aim to have 60% of your income covered by insurance. Disability insurance typically costs $30 per month per $1,000 of coverage (for those under 30) and up to $100 per month (for those over 50).
Second: Financial stability
Financial security will have been attained when you have amassed a sufficient amount of capital through your various investments, which, when invested in a safe environment at an 8% rate of return, provides you with enough money to cover the following living expenses forever without you having to work again should you choose. For the sake of this illustration, we’ll make certain numbers suppositions.
Mortgage payments on your personal residence up until it is paid off, such as $1,500 every month
Family food expenses, such as $500 per month
Utilities, such as $250 per month for gas and electricity
need for transportation, say $250 per month
$300 per month for insurance on your health, disability, and home.
Taxes, such as $200 monthly property taxes
Your total annual living expenses would rise to $36,000, or $3,000 each month. In order to reach financial security, you would therefore require a critical mass of capital totaling $450,000 (which, when invested at an annual return of 8%, would yield $36,000).
This formula, in my opinion, is very useful for anyone attempting to achieve financial security since it distils financial security into a defined figure and eliminates its hazy, subjective implications. For more details Mortgage Brokers Melbourne