Financial freedom is a long journey
How do most people reach financial freedom? Other than very few lucky people who inherit a huge family fortune or win the lottery, most people start with earning active income from working for others, from being self-employed, or from being a business owner.
Over many years, they use their excess active income after paying for their living expenses to acquire passive-income-generating assets such as company stocks, investment properties, etc.
When their passive-income-generating assets eventually provide adequate passive income to pay for all their living expenses, they will no longer require any active income to support their lifestyle. They are said to reach financial freedom.
When they reach financial freedom, they will have the freedom to choose how they want to live their life without the worry of finances, which is the ultimate benefit of financial freedom.
Imagine it is you who has reached financial freedom. You can choose to travel more. You can choose to go on cruises more. You can choose to spend more quality time with your family and loved ones. You can choose to do more volunteering work. You can choose to spend more time on your passions and hobbies. You can choose to put more focus on your personal projects that you are unable to work on if you are engaged in active work. You can even choose to start a new career that you are truly passionate about and not for financial consideration.
Without a doubt, not having to worry about finances is so important. The freedom of choice is so powerful.
Reaching financial freedom does not mean retirement. If you love the active work you are engaged in, you can choose to continue to do so. It is entirely your choice.
Financial freedom empowers you and gives you the freedom to choose.
The “Great Resignation” Phenomenon
The “Great Resignation” phenomenon refers to a high number of workers leaving their jobs in the year 2021 without the intention of returning to employment in the US and some parts of Europe.
These workers, many of them were working in those industries such as healthcare that faced increased demand due to the pandemic, left their jobs because they were either unhappy about their career or their working conditions, or they were concerned about contracting COVID-19, or they were overworked and felt underappreciated, or they just wanted a better life outside work.
It was the pandemic that has prompted them to rethink work-life balance and their long-term life goals and eventually, this led them to leave their jobs.
If they did not have sufficient passive income to pay for their ongoing living expenses to sustain their lifestyle, they would eventually be running out of their savings without the active income. They would be forced to return to employment at some point in the future.
You see, only those who have reached financial freedom will have the freedom to choose. True freedom of choice is a sustainable long-term life choice, not a choice out of short-term frustration.
The “Lying Flat” Phenomenon
A somewhat similar to the “Great Resignation” phenomenon is the “Lying Flat” (躺平 in Chinese, which is pronounced as “tang ping” and translated as “lying flat”) phenomenon in China.
“Lying Flat” was initiated by Luo Huazhong, a 26-year-old former factory worker, in his Chinese social media post in April 2021. Luo Huazhong left his factory job because he rejected working from 9 am to 9 pm, 6 days a week, referred to as the “9-9-6” working schedule. The exhaustive 72-hour-per-week work schedule is quite commonly practised by many Chinese companies.
After quitting his job, he moved back to his hometown village and chose to live a minimalist lifestyle on just US$60 a month, have only 2 meals a day and live on his savings and income from some occasional odd jobs.
He said in his post he just wanted to do the minimum to get by with life instead of getting married, setting up a family, buying a home, and being a productive member of society.
His post resonated strongly among many Chinese youths who felt “empty” and who were unhappy and delusion about the long working hours, the high property prices, and the high cost of living in China. The term “Lying Flat” reflects their anger and frustration.
At the core, the “Lying Flat” approach to life is to reject hard work in favour of doing as little as possible to get by.
Have these Chinese youths reached financial freedom? You would not think so.
At some point in the future, the reality will force them to change their lifestyle and they will have no choice but to re-join the workforce.
To reach financial freedom, hard work is a must. Doing as little as possible will not help a person reach financial freedom.
Again, only those who have reached financial freedom will have the freedom to choose. True freedom of choice is a sustainable long-term life choice, not a choice out of short-term frustration.
The “Financial independence, Retire Early (FIRE)” Movement
The term “Financial Independence, Retire Early (FIRE)” was first used in the book “Your Money or Your Life” written by Vicki Robin and Joe Dominguez. The book was first published in 1992.
FIRE has since become a popular movement around the world promoting the goal of reaching financial freedom and retiring earlier than the traditional retirement age of 65.
The FIRE movement followers, whether as a single or as a couple or as a household unit, attempt to reach the goal of early retirement by living well below their income level, by saving aggressively as much as 70% of their income, and by investing their savings for a high rate of return.
When their investments reach approximately 30 times their annual living expenses, they may choose to retire from employment completely and withdraw up to 4% annually from their investment to pay for their ongoing living expenses. Their investments are expected to grow by more than 4% annually to offset against the expected effect of inflation so their investment capital is not expected to deplete over time.
However, an aggressive saving rate of 70% is not for many people. For people with high active income, saving 70% of active income may not be a huge problem. However, people who earn an average active income may have to cut back severely on their living expenses, thus sacrificing their current standard of living.
The question is: Can the FIRE movement followers sustain the severe cutback on living expenses over the long term? Are they determined enough to live on a lower standard of living as their long-term life choice?
Financial freedom is a sustainable long-term life choice. It is a long-term life choice you need to make to balance your current standard of living.
It is horrifying if you cannot pay for your ongoing living expenses in your old age when you no longer have the energy level or the good health to engage in active work.
Therefore, it is critical to know your ongoing living expenses. Because your ongoing living expenses need to be fully paid by your passive income streams generated by the passive income generating assets you acquire over time in your financial freedom journey.
With full knowledge of your living expenses, you can in turn determine your saving and investment goals to enable you to acquire passive income generating assets to provide adequate passive income to pay for your ongoing living expenses when you leave active work permanently.
Living Expenses
Do you know your living expenses? It is a simple question, but surprisingly many of us may not have the answer.
The only way to know your living expenses is to track them.
When you track your living expenses, make sure you capture all the expenses including:
- Weekly and monthly recurring expenses such as groceries, food, leisure, entertainment, etc.;
- Quarterly recurring expenses such as quarterly council rates, gas and electricity bills, water bills, etc.;
- Annual recurring expenses such as membership subscriptions, home content/car/roadside/health insurance premiums, strata fee, council rates, etc.;
- Non-regular essential expenses such as hairdressing/haircut, dental care, car maintenance and services, home maintenance, etc.;
- Non-regular large essential expenses such as replacement of stove and oven, TV set, washing machine, fridge, etc.; and
- Discretionary expenses such as travels, gifts, non-essential lifestyle purchases, etc.
Your lifestyle determines your living expenses. Discretionary expenses for some people may be essential for others. Some families and individuals may have relatively large leisure and entertainment expenses compared to other families and individuals.
Where you live determines your living expenses. Some countries have higher living expenses than others. Even within different regions of a country may have significantly different living expenses.
Know where your money is going. Knowledge is power.
Living Expenses = 70% Active Income?
Many financial experts suggest that most people, either as a single person or a couple, use 70% of their active income to pay for their ongoing living expenses to sustain their lifestyle.
This is implicitly assumed that most people use 30% of their active income to pay for mortgage repayments and to save for their retirement. They will be able to retire after they have fully paid for their home mortgage and have saved enough to pay for their retirement.
70% active income may not be sufficient for those people who still have outstanding mortgage repayments or for those people who rent instead of owning their own home outright.
70% active income may not be sufficient for those who want to travel more or take up new hobbies which incur additional expenses.
So, how much do you need before you can leave active work permanently? The only way is to know your living expenses and any additional expenses associated with your lifestyle after you leave active work.
Living Expenses and Retirement Living Costs Benchmark Provided by The Association of Superannuation Funds of Australia (ASFA)
The Association of Superannuation Funds of Australia (ASFA) issues quarterly estimates of living expenses in retirement. The “ASFA Retirement Standard Living Costs” serves as a very good reference benchmark for people choosing to either live a comfortable or a modest lifestyle.
What is considered a comfortable lifestyle? ASFA provides information and explanation in Figure 1.
Basically, a comfortable retirement lifestyle enables a healthy retiree to participate in a broad range of leisure and recreational activities and to enjoy a good quality of living through the purchase of discretionary items such as household goods as needed, private health insurance, a reasonable car, good clothes, a range of electronic equipment, and domestic and occasionally international holiday travel.
What are your expected living expenses in Australian dollars (A$) if you live a comfortable retirement lifestyle in Australia? The annual living expenses in the September quarter of 2021 are summarised in Table 1.
It is necessary to note that the living expenses are based on retirees aged 65-84 who own their own homes.
If you retire in your fifties you may be very socially active and may go for holiday travel more frequently, then you will need to add additional expenses associated with these social activities, entertainment, and travels to your ongoing living expenses.
If you do not own your own home, your living expenses may be different. If you have dependent children living with you, you will have higher living expenses.
Everyone is different in terms of lifestyle and living expenses. The only way to know your living expenses is to track them yourself.
The ASFA Retirement Standard Living Costs will only provide a good base-case reference benchmark.
You may be a couple and may live a lifestyle that is somewhere between comfortable and modest and your living expenses may be A$55,000 (i.e. between A$41,446 (modest) and A$63,799 (comfortable)).
You may notice that living expenses for a couple are 1.41 (i.e. 41% more) that of a single person instead of 2.0 (i.e. 100% more). That is because couples can share the costs of everything from home maintenance, groceries, utilities, car running costs, replacement of white goods and home furnishings, to travel.
Check out the Association of Superannuation Funds of Australia (ASFA) webpage for the most recent updates and more detailed information and explanation on retirement living standards in Australia.
Living Expenses and Frugal lifestyle
Lifestyle is basically an individual choice. You make the lifestyle choice. You decide how you spend to support your lifestyle choice. However, whether you live a modest or comfortable standard lifestyle, you need to be mindful about your spending so that your expenses go into sustaining your lifestyle and supporting your standard of living, and do not go to waste.
Price is what you pay, value is what you get. It is what the frugal lifestyle is about. A frugal lifestyle does not necessarily mean cutting expenses to the bare bone. A frugal lifestyle is about mindful spending or spending wisely. Mindful spending or spending wisely is about minimising the price you pay and maximising the value you get.
It is well known that Warren Buffett has been living a frugal lifestyle even though he is one of the wealthiest persons in the world. He does not live in a luxurious multi-million dollar mega-mansion. He lives in the same house he bought for US$31,500 in 1958, more than 60 years ago. He does not drive a super fancy luxury car. He even pays for fast-food lunches using coupons. Warren Buffett enjoys playing bridge, which is a very affordable hobby. Warren Buffett has shown us that being rich does not necessarily mean living luxuriously.
You may not like Warren Buffett’s way. However, you will always be able to find affordable hobbies which suit you. You can find your way to meet your lifestyle needs if you are mindful and are determined to do so.
What about getting a library card that is free, and using it to borrow books or movies you love to read or watch instead of buying them? Your standard of living is not equal to your cost of living. Make full use of the free resources that are available to you.
Have you tried walking or jogging in a park that is free or exercising in a free outdoor gym, instead of going to the gym for which you pay monthly membership?
What about walking or jogging close to a river or a lake? If you live in Perth, check out “By the Waters” blogs about many wonderful walking and jogging locations.
Just google “frugal living” and you will find many resources on the internet to help you.
Reduce waste without compromising your lifestyle
Say you are a single living a modest lifestyle in Australia and your annual living expenses are more than A$50,000. This is significantly higher than the Association of Superannuation Funds of Australia (ASFA) estimates. You should know something is wrong.
You may be spending on purchases that do not contribute to sustaining your standard of living or you are paying too much for some expenses. A lot of your expenses may go to waste. Tracking your expenses will allow you to target those expenses that you pay too much or can be cut back.
You may have too much wastage in your food and grocery expenses. Do you know about 30% of general household food expenses actually go to waste? Do you know how much of the food you pay for eventually ends up as waste rather than being consumed by you?
Have you tried bulk buy, batch cooking, or even cooking for all of a week’s meals during the weekend? The idea of making food in bulk and then storing or freezing them for consumption later will save you money from cooking less, cleaning less, washing less, and going for grocery shopping less. It is an environmentally friendly way of living.
It is unrealistic and unsustainable to give up or compromise your lifestyle for financial freedom. It will not work in the long term. However, you can reduce waste and minimise unnecessary costs without compromising your lifestyle.
Always make the right choice to only spend on purchases that have positive impacts on your life and your future.
The three biggest expenses for most of us are housing, transportation, and food. Are you living in a home that is too expensive beyond what you can afford? Remember any extra mortgage repayments you pay means a reduction in other living expenses. Are you driving an expensive car beyond what you can afford? Can you consider driving a much less expensive car than what you are driving now? You can, without compromising your lifestyle, optimise your resources to reduce your living expenses.
Future living expenses
Say you are married without a kid and are 35 years old and are living on expenses of A$60,000 annually. You plan to reach financial freedom in 20 years when you reach 55. What will be your living expenses in 20 years? The answer is no one knows for sure.
Inflation will come into play to increase your living expenses over time. No one can forecast accurately the future inflation effects.
We know the past inflations. Assuming the past inflation patterns stay the same, we can use the past inflations to project the future inflations to estimate the future living expenses.
Figure 2 shows that between 2013 and 2021, inflations in Australia fluctuate between 1% and 3%, and has moved above 3% in 2021.
Let’s use a range of inflation between 1.5% to 3% to estimate future living expenses.
Using an average of 1.5% inflation for 20 years, living expenses of A$60,000 in 2022 would be A$80,811 in 2042. Living expenses would be A$89,157 in 2042 at an average of 2% inflation, A$98,317 at at an average of 2.5% inflation, and A$108,367 at at an average of 3% inflation.
Therefore, the projected living expenses in 2042 would range between A$80,811 and A$108,367 for a range of inflation between 1.5% and 3%.
How will we know, with high confidence, our future living expenses to account for the inflation effect? How will we know what inflation factor to use? The answer is no one knows for sure.
The best way is really to track your actual living expenses continuously. The visibility of your living expenses trends over years will provide you with high confidence.
Tracking your living expenses will account for the change in your lifestyle, the change in your personal circumstances, the change in your spending habits, and the inflation effect.
The COVID-19 pandemic has moved us into a cashless society. Banking digitalisation has made tracking of living expenses much easier and simpler. Simplify your transaction account for paying your living expenses to make tracking easy and simple.
Too much work to do monthly? Then do this quarterly or half-yearly, or annually when you file your income tax. Remember, the more detailed knowledge about your spending habits the better you will be at cutting down wastage and improving your saving rates without compromising your lifestyle.
You can always find resources from a banking institution to help with tracking living expenses. As well, the Australian government website moneysmart.gov.au has very useful resources on managing personal finance.
Life expectancy and financial freedom
Even financial planning experts have different recommendations on how much to save to support your retirement or to reach financial freedom.
Some financial planners, in Australia and elsewhere, use the formula “living expenses X (life expectancy – retirement age)” to calculate the savings required to retire from active work.
Let’s use this formula for people living in Australia. According to the Australian Bureau of Statistics, life expectancy in 2020 for Australian women was 85.85 years and for men was 81.7 years.
Say, your annual living expenses are A$40,000 today, you are a male at 55 years old and you want to retire from active work permanently now. Your life expectancy is 81.7 years, rounding to 82 years. The formula gives A$40,000 x (82-55) = A$1,080,000.
Is A$1,080,000 sufficient for you to retire permanently from active work? The answer is a maybe. Why? If you don’t want to risk running out of money when you live longer into your 90s, you will need the retirement savings of A$1,080,000 to generate a sustainable annual passive income of A$40,000 (i.e. your annual living expenses) plus inflation.
If your savings consistently generate only 3% annual returns of A$32,400, you will need to draw down from A$1,080,000 to pay for your living expenses to sustain your lifestyle. You will be at risk of running out of money when you live significantly longer than your life expectancy.
The FIRE movement followers believe when their investments reach approximately 30 times their annual living expenses, they can retire permanently from active work.
Say, an Australian FIRE movement follower’s annual living expenses are A$40,000, his or her investment capital has reached 30 X A$40,000 = A$1,200,000 (i.e. 30 times his or her living expenses).
If his or her investment capital of A$1,200,000 generates only 3% annual returns consistently, he or she will need to draw down the shortfall of A$4,000 (i.e. A$40,000 – A$36,000 = A$4,000) annually plus any cost increase due to inflation. He or she will be at risk of running out of money if he or she lives significantly longer than the life expectancy.
Therefore, the key is really how much passive income is generated consistently from retirement savings and whether the passive income keeps pace with cost increase due to inflation.
You want to improve the quality of your investment or passive income generating assets to support your ongoing living expenses such that you do not worry about running out of money when you live longer into your 90s.
Remember, life expectancy is expected to continue to rise over years because of better healthcare services, and improved medical and technological advances. You may live longer well beyond the life expectancy in your 90s in the future.
Adequacy of passive income and financial freedom
Your passive income must keep pace with inflation to offset the increase in living expenses. Why? As you know, your living expenses will increase over years due to inflation.
So, what should we do to ensure the adequacy of passive income to pay for our ongoing living expenses to sustain our lifestyle when we decide to leave active work permanently?
Well, firstly we should always be guided by the first principle, which is to start saving as early as possible. Start saving as soon as you start active work. Let compounding work for you. Compounding is about using the time factor in your favour. The more time you have, the more benefit you gain from compounding. This means the earlier you start saving and investing the better is your chance of success in your financial freedom journey.
Secondly, the basic rules of wealth building never change, which is you spend less than your active income, and you save the surplus amount and invest to generate passive income. How much should you save? How much you should save is determined by a range of factors including your ongoing living expenses which are closely associated with your lifestyle, your short and medium-term financial goals and commitments, your long-term financial goals including when do you plan to reach financial freedom.
Thirdly, never believe you can time the markets right all the time. Once you set an amount that you would like to save monthly, you should invest constantly through the highs and lows of the markets. Investing constantly in the markets removes the need to time the markets.
As well, you choose the types of assets you have good knowledge about and are comfortable with the risks and expected returns: company stocks, exchange-traded-fund (ETF), managed funds, properties, term deposits, bonds, etc. Never invest in some things that you don’t understand. You must constantly learn and gain knowledge about wealth building. Nothing comes easy.
In addition, reinvest the returns – dividends, interests, rents, etc. – when you receive them. Reinvesting the returns is to let compounding works for you.
Visibility of your financial freedom journey
Financial freedom is a life-long project. Having visibility of where you are on the financial freedom journey is necessary, although not sufficient to ensure that you reach financial freedom at the time of your choice.
All of us will go through 6 stages on our long journey to financial freedom:
- Financial Dependence
- Living Paycheck-to-Paycheck
- Financial Freedom Starter
- Financial Freedom Midterm
- Financial Freedom Homerun
- Financial Freedom with Resilience
To read more about the 6 stages of the financial freedom journey, check out Financial Freedom and Passive Income blog on the mylivingmylife.com website.
Imagining this: you have been tracking your living expenses, active income, savings, and passive income every year for the last 5 years and you know your passive income has increased progressively from 40% to 80% over the last 5 years. You know you are close to financial freedom. Will you be more motivated to continue on your journey to financial freedom?
We all know our annual active income because we receive an income statement from our employer, or with the assistance of an accountant if you are self-employed or a business owner for income tax return purposes.
What about your annual living expenses and your passive income? When you file your tax return, why not gather all your financial information regarding your active income, your passive income, your annual living expenses, your savings and saving rate, and your investments (i.e. your passive income generating assets).
The information will help you determine at which stage you are on your financial freedom journey at a particular point in time.
If you do this at least annually, you will know the progress of your financial freedom journey over the years. The visibility of your progress will allow you to make adjustments to your wealth-building, will motivate you to improve your financial wellbeing, and will improve your chance of reaching financial freedom within the timeframe of your choice.
Want to read more about financial freedom and passive income? Check out my “Financial Freedom blogs”.
The farmer is not wrong if he sees ‘躺平’ as ‘living simply’ but still working hard instead of being lazy. I would like to point out that there is something which is more important than financial freedom. It is inner freedom which enables you, once you have food and basic shelter, to live simply.
In contrast, if one who is so-called ‘lucky’ and have inherited a fortune or struck a lottery, but does not have inner freedom, one is likely to waste one’s life with financial freedom. The power of inner freedom enables one to use one’s fortune wisely, which is to benefit mankind (others) and saving our planet Earth.
Everyone’s financial freedom journey is unique and different, depending on the lifestyle you desire to live, your family situation, your personal circumstance, your life goals and even your very own definition of happiness in life. Reaching financial freedom may contribute to happiness but can never guarantee happiness or the inner freedom that you talked about.