Financial independence what it means and how to calculate

What does financial independence really mean?

In figures, financial independence is the moment when passive income is sufficient to cover daily expenses, without having to depend on a traditional work or someone else to support your lifestyle.

Here are some common aspects that define financial independence:

· Sufficient passive income. Financial people independent have sufficient passive sources to cover their basic or total expenses or everything they want. These revenues can come from investments on the stock exchange, rentals, dividends or other sources that generate entry without the need for active work.

· Absence of debt or effective management of them. It manages the debts responsible in a manner or, ideally, avoids significant debts that will limit his financial freedom.

· Emergency and Security Fund. Essential component of financial independence because this reserve helps you to face unexpected expenses or to cover temporary income losses. This fund protects you not to be forced to sell from your investments when the market crosses a bad moment.

· Financial planning and investments. Independent financial people plan and invest to achieve their long -term financial objectives. A high value acquisition is strategically planned and analyzed in advance.

· Flexibility and freedom to make financial decisions. This freedom is very important for me, the flexibility of making financial decisions based on their objectives and personal values, without being limited by the available money, by the debt, depending on a salary.

In essence, financial independence is the freedom to make decisions on your life without financial constraints. You can decide whether or not to continue a job/ activity without the pressure that you have payment installments or meditations tomorrow. You can start a project with the tranquility that you and your family have the covered needs, you can dedicate yourself to the activities you like, you can reduce the work program,

Financial independence does not mean retirement in the classic known sense in Romania, even if for many of us only the moment of pension is equivalent to reaching this dream, but it is the freedom to choose what you like what you need.

What is the figure of financial independence?

The calculation of the amount necessary for financial independence depends on several factors, including personal objectives, the desired standard of living and individual circumstances.

I present the two phases for the calculation of financial independence.

1. Establish the monthly / annual amount sufficient.

Here are the general steps you can follow to estimate the required amount:

· Establish the budget of annual expenses.

The first step is to know our needs. So let’s start calculating the balance of annual expenses. It should include all ordinary expenses, such as home, public services, food, transport, insurance, health, entertainment and economies.

· Determine the desired standard of living.

If we don’t know what we want we have no direction. What lifestyle do you want? Some want to continue living as during active life at work, while others want to reduce or against to improve their standard of living.

· Calculation of the withdrawal rate.

There is the general rule that the secure withdrawal rate (SWR) is between 3% and 4% per year. But it varies according to many factors such as life expectancy, risk tolerance, market conditions, the evolution of inflation.

· Consideration of great expenses and emergency reserve.

We will add the budget and the «unexpected expenses» section, such as possible medical costs or unexpected repairs. Be pessimistic when you do the estimates. In addition to the security fund that must always exist.

· Estimation of passive income.

If we already have a passive income, such as rentals, dividends, private pension, which we think they will persist at the time of independence, obviously we will consider them.

· Including social benefits and other income.

We will consider any social benefits, such as state pension or social insurance, as well as any other income you expect.

2 «Rule of 25» OR «Rule 25x». That is, your wealth of savings and investments should be 25 times the estimated annual expenses.

This calculation is based on the concept of «Safe withdrawal rate» OR «4%rule».

It is assumed that, with 25 times the annual expenses saved or invested, you can safely withdraw around 4% of this amount every year and keep your long -term standard of living, without exhausting your financial resources.

Example: if you have annual expenses of 24,000 euros (2000 euros/ month), a portfolio of 600,000 euros is necessary.

Therefore, with a return of 4% x 600,000 euros, you have a passive income of 24,000 euros per year. So you are financially independent.

The targeted performance for the assignment of the wallet should be greater than 4%, so that it keeps the step, at least theoretically, with the inflation and taxes you have to pay.

That is, if it is estimated a yield of 8-9% per year (for a wallet, for example, 80% of shares/ 20%), 4% is the withdrawal rate (the money you will remove from the wallet) and the other 4-5% should cover inflation and taxes. This is how the portfolio will pass unchanged to children at your death, but it is ok and if you allow the legacy to tell 50% of the wallet, if inflation is higher.

One of the first and most influential studies that have studied the concept of Safe withdrawal rate It has been «Trinity Study» since 1998, made by three teachers of Trinity University in Texas – Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz.

This study analyzed the effects of the different sampling rates on the investment wallets, using historical market data and has established that a collection rate between 3% and 4% should be sure to maintain an investment portfolio for a long time.

A lot can be discussed on how correct this rate of 4%is, but we are wasting time instead of focusing on the real and important purpose, on our financial independence.

Establishing the quantity that transposes your dream into concrete figures, becomes, from a vague concrete and measurable. It becomes a clear goal for which it is possible to set the concrete passages.

Success to all those who started on this path!