What’s the difference between financial independence and financial freedom?
Google “what is financial freedom” and you will learn that “financial freedom is having enough savings, investments, and wealth to afford the lifestyle you want.”
Now Google “what is financial independence” and you will learn that “financial independence is having enough savings, investments and wealth to live the life you want.”
Between those two vaguely similar definitions lay a thousand more variations offered by financial coaches, self-help gurus, podcasters and experts and a thousand more variations driven by popular surveys and vox pops.
It’s now reached a point where the two concepts are now used interchangeably because they almost mean the same thing.
So here’s what we’re proposing.
What is financial independence?
What we’re offering is to frame them differently where financial freedom is a number and financial independence is where your finances are working for you and, as a result, you’re living independently from financial stress.
Therefore, we believe financial independence includes three parts:
- Your day-to-day finances are running on a budget where your bills are being paid off in full and on-time.
- You have enough money for emergencies.
- You are building wealth towards not having to work anymore.
And the day from which you achieve all three becomes your financial independence day.
Here’s why we like this definition of financial independence
It’s real and makes sense
Financial freedom says “You need to save and invest and get to $5 million so that the passive income covers your bills and you have enough for your lifestyle.” Knowing about all my bills and lifestyle ever is as abstract a concept as $5 million.
By focusing on financial independence as having three aspects, we’re able to make the concept tangible and something that can be worked on right away. And what these three concepts do is highlight the different ways that money needs to work for you — both in the short term and the long term.
Money doesn’t make sense when we’re told to focus on only one thing.
For example, investing platforms and websites that talk about financial freedom will tell you that “All you need to do to achieve financial freedom is save small amounts every day.”
But how do I know if I can do that with what I’m currently earning? Should I not be worried about my bill next month first? So I should not care about my bills next month because I should focus on the long-term instead — that doesn’t make any sense.
Budgeting apps on the other hand will tell you that all you need to do is decide on a number that you want to spend on and stick with that. But how am I supposed to figure out whether what I’m doing right now is working correctly? And what about thinking about my future? It doesn’t make sense that I should only be worried about right now, is it?
By breaking down financial independence into three separate, smaller goals, it becomes a more tangible concept rather than a gigantic meaningless number.
Long term works together with the short term
We like our definition of financial independence because it talks about money working differently in the short-term and differently in the long-term.
In the short term, we're talking about immediate needs: Bills being paid off, groceries that need to be bought and savings for a holiday. In the long term, we’re having to think about what to invest in and when to start. Because we think about the short-term and long-term differently, we also treat money differently. We think about “short-term money” differently from “long-term money”.
It’s this balance of the long-term with the short-term that makes financial independence a more tangible, sensible concept.
It doesn’t oversimplify complicated concepts
Money may be a lot of things but it is not simple. There always seems to be multiple ways to do anything, whether it’s investing, saving or budgeting. You can recognise when someone is oversimplifying something when they start by saying “All you have to do is…” For example:
- All you have to do is invest 20% of your salary to achieve financial freedom.
- All you have to do is set a budget for yourself and stick with it.
- All you have to do is build wealth of 25 x your current salary and you will achieve financial freedom.
If any of it was actually based on “all you have to do” then a lot more of us would have done it by now.
Financial independence works through these complicated concepts in a methodical way. It works through the idea that you have to take small, daily, meaningful steps first in order to get to the result you want.
And while the process is definitely complicated, the steps that we can take on a daily basis are not.
What are the 3 steps to financial independence
1. Budgeting: Manage your bills
The first step towards financial independence is to make sure that your day-to-day finances are working correctly. In other words:
- Are you saving for your bills
- Are you paying off your bills
- Are you making enough money to save for and pay off your bills
Budgeting or bill management is defined as being able to answer all three questions with ‘Yes.’ And remember, if the answer to Question 3 is ‘No,’ then there are only two real, sustainable solutions on offer: Either make more money or cut some bills.
2. Build an emergency fund (Hint: Check out Safe Spend)
Once your day-to-day bills are running smoothly, i.e. money is being saved for them and they’re being paid off on time and in full, is when you can focus on the next step: Saving for (insert your favourite metaphor) — whether you call it an emergency fund, a rainy day fund, an unexpected bill fund or a life’s thrown me a curve ball fund.
The emergency fund can take whatever form you’d like for it to take — it could be a credit card you never use, an envelope of cash at the back of your cupboard, a bank account that you put money into every day, or it could be the amount of money leftover after your bills are accounted for.
There’s no single answer to how much money you should keep in your emergency fund. Historical timelines of books and blogs suggest anything between 2 weeks to 3 months worth of your salary.
As a starting point, make sure to keep your Safe Spend above $0 and build from there.
3. Start investing to grow your long-term wealth
Investing is not just about understanding what to invest in and how much to invest in. You also need to commit to investing for a number of years. You will probably not see the fruits of your efforts for the first 3 years of your journey, so you’re going to need a lot of patience.
That’s why we mentioned the concept of short-term money vs long-term money earlier. Being patient for years while building wealth for the long-term requires a different approach compared to paying the bill that’s due at the end of the month.
And that’s why we believe that this is an important part of understanding financial freedom because money is always a balance between the short-term and the long-term. The short-term is urgent while the long-term requires a lot of patience. The same tools can’t be used for the short-term and the long-term so money needs to be treated differently.
The take-home from today is this: While financial freedom is about one big, almost unreal number, financial independence is about having a sense of control.
If you’re in control of money and your money is working for you (and not the other way around), that’s when you’re living independent from financial stress.