How to Calculate Your Financial Freedom Number: A Step-by-Step Guide

how to calculate your financial freedom number

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What if you could wake up every morning and live on your terms? That’s the beauty of financial freedom. It means pursuing your passions while still being able to cover the everyday costs of living. You no longer have to rely on a traditional job or career; your passive income already covers your bills.

However, getting to this point isn’t just a matter of luck or chance. You need to know your financial freedom number – the amount you must invest to generate enough passive income. It may seem daunting, but it’s a crucial first step towards achieving the freedom to live the life you’ve always wanted.

Key Takeaways:

  • Financial freedom means being able to pursue your passions while still being able to cover everyday living expenses.
  • Your financial freedom number is the passive income or net worth you need to achieve financial independence.
  • Calculating your financial freedom number is crucial for setting and achieving financial goals.
  • There are different levels of financial freedom: Basic Financial Freedom, Financial Freedom, and Lifestyle Financial Freedom.
  • You can calculate your financial freedom number by determining your monthly living expenses or using the 4% rule.
  • Inflation and taxes are factors that can affect your financial freedom number.
  • Your financial freedom number can change over time, so reviewing and adjusting it periodically is essential.
  • Knowing your financial freedom number can help you set realistic goals and create a plan to achieve them.
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What is a Financial Freedom Number?

What is a Financial Freedom Number
What is a Financial Freedom Number?

Have you ever wondered what a Financial Freedom Number is? Well, you’re not alone. There are two definitions of this term, and they can be somewhat conflicting.

On the one hand, it can refer to the passive income you need to generate to cover your expenses. You would no longer rely on a traditional job to pay your bills.

On the other hand, your Financial Freedom Number could be a net worth goal you need to achieve. This would provide you with a sense of security and peace of mind, regardless of whether or not you have a steady income.

Financial Freedom Number Defined

A financial freedom number is a point where your monthly passive income surpasses your basic living expenses. This means that you have reached a level of financial independence where you no longer need to rely on a traditional nine-to-five job to cover your essential needs.

To put it in terms of a formula:

Cashflow > Expenses

FIRE Number Defined

Another way people reference their Financial Freedom Number, also known as a FIRE Number, derives from the FIRE (Financial Independence, Retire Early) movement.

It refers to the money you need to accumulate to pursue your dreams, achieve financial independence, and retire comfortably. Essentially, a FIRE number is the amount of money that generates sufficient passive income to cover your expenses, and it varies depending on lifestyle, goals, and other considerations.

Why Do You Need To Know Your Financial Freedom Number

Why Do You Need To Know Your Financial Freedom Number
Why Do You Need To Know Your Financial Freedom Number

Calculating your financial freedom number is a crucial step toward achieving financial independence. It helps you understand how much money you need to save and invest to achieve your financial goals and live the life you want without worrying about money.

Put another way; it’s a benchmark to look at, plan for and achieve over time.

For example, we put together a financial freedom plan with the help of our mentors at Cashflow Tactics to methodically buy real estate to meet our passive income goals (aka financial freedom number).

Different Levels Of Financial Freedom

Different Levels Of Financial Freedom
Different Levels Of Financial Freedom

At its core, financial freedom is the ability to live the life you want without constantly worrying about money. However, not all financial freedom is created equal.

Unlocking financial freedom comes in three levels: Basic Financial Freedom, Financial Freedom, and Lifestyle Financial Freedom. Basic Financial Freedom is about meeting your bare necessities without relying on debt.

Moving up to Financial Freedom takes it to the next level, where saving and investing for your future becomes feasible. However, the ultimate level, Lifestyle Financial Freedom, lets you break free into luxury lifestyles, travel, and indulge in expensive hobbies without any concern about cost.

By understanding these levels of financial freedom, you can set and conquer long-term financial goals.

Calculate Your Financial Freedom Number

Calculating Your Financial Freedom Number
Calculating Your Financial Freedom Number

As we discussed above, there are two ways to calculate your number.

Using Passive Income

As mentioned before, we will use the definition of how much passive income we need to achieve financial freedom.

Step 1) Figure out all your expenditures for the last 12 months

To determine your living expenses, you must assess your expenditures for the last 12 months. This includes rent/mortgage, utilities, groceries, transportation, entertainment, and any other expenses you incur regularly. Make sure to include all your costs, no matter how small they may seem.

Add up all these expenses and divide by 12

Once you have all your expenses for the last 12 months, add them up and divide them by 12 to get your monthly living expenses. This is how much you need to cover your basic needs each month.

It’s important to note that this number isn’t just about income but expenses, which means leaving out taxes while making your calculations.

For example, when I initially worked through my financial freedom plan, I determined my financial freedom number was $5500 per month.

Calculate Using The 4% Rule

Another way to calculate your financial freedom number is to use the 4% rule. This rule states that you can safely withdraw 4% of your investment portfolio each year without depleting your savings. This is more of a net worth calculation than a monthly number of passive income you need to get to.

This number was originally computed by Wade Pfau, PhD and CFA and has popularly been dubbed the “4% rule”.

To calculate the net worth, you must accumulate here using this rule, divide your monthly living expenses by 0.04 (or multiply by 25). This will give you the money you need to invest to cover your living expenses.

Factors That Can Affect Your Financial Freedom Number

Factors Impacting Your Financial Freedom Number
Factors Impacting Your Financial Freedom Number

Inflation

Inflation is a significant factor that can affect your financial freedom number. It is the rate at which the general level of prices for goods and services is rising, and as a result, the purchasing power of your money decreases over time. To account for inflation, you should adjust your financial freedom number to include an estimated inflation rate for the future.

For example, if your current expenses are $50,000 annually and you estimate that inflation will be 3% yearly, you must adjust your financial freedom number to $1,666,667 ($50,000 * 0.03).

Taxes

When reaching financial freedom, one crucial factor you can’t ignore is taxes. From federal taxes to state and local income taxes, property taxes, and even sales taxes, taxes can significantly impact your financial goals.

Consider the taxes you must pay on your income and assets to calculate your financial freedom number. Not only that, but you should also estimate your future tax liability based on your expected income and investment returns.

Remember that for many “tax-advantaged” accounts, like standard IRAs and 401(k)s, you will eventually have to pay taxes on their final withdrawl.

Remember these things, and you’ll be well on your way to financial freedom!

What I Do With My Financial Freedom Number

What I Do With My Financial Freedom Number
What I Do With My Financial Freedom Number

Since I’m not using the 4% rule, I do not worry about accumulating net worth to spend down at some point. Instead, I use my number as an amount of monthly cash flow you need to cover your expenses and any other financial goals you may have.

For me, achieving financial freedom means acquiring assets that generate cash flow. Specifically, we are purchasing turnkey rental properties for cash flow.

By focusing on generating income from assets rather than accumulating wealth, I can see a clear path to financial independence.

Can Your Financial Freedom Number Change?

Can Your Financial Freedom Number Change
Can Your Financial Freedom Number Change

Your financial freedom number (FFN) is a critical metric that helps you identify the money required to achieve financial independence. However, it is essential to note that your FFN is not static and can change over time based on various factors.

For instance, if you plan to relocate to an area with a higher cost of living, then you may need to adjust your FFN to accommodate the increased expenses. Moreover, changes in your lifestyle, such as starting a family or opting for an early retirement, can also impact your financial needs and modify your FFN accordingly.

Therefore, it is crucial to periodically review and adjust your FFN to account for any changes in your circumstances and ensure that you are on track to achieving your financial goals.

For us, we look at our FFN annually to see if there are going to be any adjustments needed.

Concluding Thoughts On Your Financial Freedom Number

Concluding Thoughts On Your Financial Freedom Number
Concluding Thoughts On Your Financial Freedom Number

Calculating your financial freedom number can be a great way to take control of your finances and plan for the future. By understanding how much money you need to achieve financial freedom, you can make better decisions about how to save, invest, and spend your money.

Remember that your financial freedom number is a personal number that will vary depending on your lifestyle, goals, and priorities. It’s essential to take the time to calculate your number carefully and to revisit it periodically to make sure it still reflects your current situation.

One of the key benefits of knowing your financial freedom number is that it can help you set realistic goals and create a plan to achieve them. You can progress toward financial freedom and stay motivated by breaking down your number into smaller, achievable milestones.

Frequently Asked Questions (FAQs)

Q: What is a Financial Freedom Number, and why is it important?

A: A Financial Freedom Number is where your monthly passive income surpasses your basic living expenses. This means that you’ve reached a level of financial independence where you no longer need to rely on a traditional nine-to-five job to cover your basic needs. Knowing your financial freedom number is critical to achieving financial independence as it helps set a clear financial goal, plan accordingly, and track progress over time.

Q: How can I calculate my Financial Freedom Number?

A: There are two primary ways to calculate your Financial Freedom Number. The first approach involves determining your monthly living expenses and figuring out how much passive income you need to cover these expenses. The second method uses the 4% rule, which states that you can safely withdraw 4% of your investment portfolio each year without depleting your savings.

Q: Can my Financial Freedom Number change over time?

A:  Your Financial Freedom Number can change over time based on various factors. For instance, if you plan to relocate to an area with a higher cost of living, you may need to adjust your number to accommodate the increased expenses. Also, changes in your lifestyle, such as starting a family or opting for an early retirement, can impact your financial needs and modify your Financial Freedom Number accordingly. Reviewing and adjusting your number periodically is crucial to account for any changes in your circumstances.