Your First Step Toward Financial Freedom: Define It

Steven Covey[1] said that we need to begin with the end in mind. Anthony Robbins said we need to know our outcome. And history has shown that people with written goal will have more chance to become successful. But nevertheless , having a goal that is fixed, in writing and have been thought over is definitely much better that a goal that is abstract and only in your mind.

For example: if someone asks how much money need to have before considered financially independent? Person A say: “a lot of money”, Person B say: “$1 miilion per year passive income”. Which one is easier to visualize, an abstract definition from Person A or Person B?  Of course from person B.

This is the very first step to achieve Financial Freedom. This step does not require any money and it can be done and finished within the next 15 minutes. You just need a pen and paper to determine your monthly cost/overhead, your combined annual income and then monthly cost to fund your lifestyle. Also we have designed online software that will help you calculate and simply print your milestone “Toward Financial Freedom“.

This step is absolutely crucial to start your financial freedom journey. Why? By having this milestone, your goal is no longer MOVING TARGET. It’s fixed and written black on white. You can put it on your file, paste it on your wall, etc and become your tangible goal. You are no longer shooting in the dark, you have real figure number as your target.

5 Levels Toward Financial Freedom

There are 5 milestones that help you achieve financial freedom. You need to get to Level 1 before go to level 2 and vice versa. The levels are:

1. Level 1 – Financial Protection
2. Level 2 – Financial Security
3. Level 3 – Financial Independence
4. Level 4 – Financial Freedom
5. Level 5 – Absolute Financial Freedom

Level 1 – Financial Protection

Financial Protection is achieved one you have 6 months worth of cash to meet all basic needs to survive without anybody need to go to work. So, if something bad happened, you have full 6 months to back to your feet again but continue your life as it is. So, what you need to define your level is your monthly cost or overhead.

This include all basic living cost: food, clothes, transport, all bills, insurance, home maintenance, credit card repayment, mortgage, basic entertainment, etc. But no holiday, no saving or other major purchase included. Only everything that needed to continue ‘normal life’

Example: John and Jane requires in average $3000 per month to meet all basic living cost. Hence their level 1 – financial protection is 6 x $3000 = $18.000. So, once they have $18,000 in the bank, they can survive for 6 months without having to work but can still be able to live as normal.

Level 1 – Financial Protection for John and Jane is $18,000.

Do not put this money in term deposit or the like. Put it on your daily saving account or any account that accessible from your ATM card. You might consider have stack of cash from this money. This is pure for emergency only.

Level 2 – Financial Security

Financial Security is achieved once your investment can produce 12 months worth of all basic living cost. This is not your income from work, but only from your investment such as: profit from share market, profit from your investment business, interest from your term deposit, your rent income from your positive cash flow property, etc. This is a passive income that provide you with financial security

Example: With $3000 mothly cost, then John and Jane’s investment need to produce $3000 x 12 = $36,000 profit per year before they can get Level 2 – Financial Security status.

Level 2 – Financial Security for John and Jane is $36,000 per year passive income

What sort of investment can produce this kind of passive income ?

• Cash interest. With 5% interest from your term deposit, $100,000 deposit can produce $5k per year, hence to produce $36k per year, they need to have $720,000 in a bank.
• Share market strategy. With typical 15% return from share market strategy, $100,000 portfolio will produce $15,000 per year. Hence $36k can be achieved if they have $240,000 as their portfolio.
• If you own profitable business that can produce 20% of return, then $36k can be produced if you have invested $180,000.

Of course you can do combination from all of them. The higher the return, the less capital needed to achieve the goal.

Level 3 – Financial Independence

Financial Independence is achieve if the investment can produce profit equal to your combined annual salary / current earning. So, at this stage your total income is basically doubled. In other word, income from your investment have produce the same amount of money that you can get from salary or work.

Example: John and Jane have total combine annual salary of $90,000 per year. Then their investment income need to produce $90,000 as well before they can hold Level 3 – Financial Independence status.

Level 3 – Financial Independence for John and Jane is $90,000 per year passive income

Level 4 – Financial Freedom

To achieve Financial Freedom (Level 4), the investment / passive income need to produce not only whatever you get from Financial Independence, but also 12 months worth of all the cost needed to cover the living cost plus all lifestyle and luxury item. All from your investment income. So, at this stage you can cover all the living cost plus lifestyle cost just from passive income derived from your investment. You still have additional earning from your salary / work. But obviously you no longer have to work again.

This additional lifestyle/luxury item can be calculated using the interest payment as if we get a loan to get hold of that item. (i.e: controlling vs owning, see the article)

Example: John and Jane have 3 lifestyle items that they really want to have once they have financial freedom:

1. $200,000 boat. With 8% interest, the monthly repayment will be: 8% x $200k * 1/12 = $1334 per month
2. Charity $1000 per month
3. New house of $1.5 million. Monthly repayment: $10,000 per month assuming 8% interest
4. Total these 3 items above is $12,334 per month/$148008 per year plus $90,000 = $238,008

Level 4 – Financial Freedom for John and Jane is $12,334 per month passive income

Level 5 – Absolute Financial Freedom

Your investment income have absolutely covered all your expendentiure beyond your imagination. Absolutely everything that you can buy with money in the world. For quantitive sake, let say at least you have 3 times the amount from Level 4. Hence :

Level 5 – Absolute Financial Freedom for John and Jane is $37,002 per month passive income

The Capital

The capital needed is really depended to the return expected from the investment. Say if the return of investment of cash is 5%, share market is 15% and business investment is 20% and John and Jane decide to invest 20% of their money as cash, 50% as sharemarket investment and the rest is business investment, then the capital neede for each level is as follows:

	Passive Income	Return	Capital Needed			Passive Income	Return	Capital Needed
Level 2	$36,000		$318,000		Level 3	$90,000		$795,000
From Cash	$7,200	5%	$144,000		From Cash	$18,000	5%	$360,000
From Share Market	$18,000	15%	$120,000		From Share Market	$45,000	15%	$300,000
From Business	$10,800	20%	$54,000		From Business	$27,000	20%	$135,000
	Passive Income	Return	Capital Needed			Passive Income	Return	Capital Needed
Level 4	$238,008		$2,102,404		Level 5	$714,024		$6,307,212
From Cash	$47,602	5%	$952,032		From Cash	$142,805	5%	$2,856,096
From Share Market	$119,004	15%	$793,360		From Share Market	$357,012	15%	$2,380,080
From Business	$71,402	20%	$357,012		From Business	$214,207	20%	$1,071,036

To reach your ‘critical mass’ of capital the soonest, you need to use the power of compounding interest. That means you always invest back all the profit from one period to the next periode. i.e: $10k investment with 10% return will have $1k profit. All of this profit and capital (total $11k) is invested to the next period that yield $1.1k profit, and vice versa.

What’s Next

Now that you have understood the meaning of the 5 level above, it’s time for you to calculate your own number. Remember you just need 3 data: monthly cost, annual income and monthly cost for lifestyle/luxury item. Then just use “Toward Financial Freedom” to calculate and print your pledge.

Then you have taken your first step toward Financial Freedom. Congratulation !

Recommended Readings:
[1] “7 Habits of Highly Effective People” by Steven Covey
[2] “What I Didn’t Learn AT School But Wish I Had” by Jamie McIntyre. The digital version of this book can be obtain legally and free of charge by clicking here. Some minor modification to enhance the definition has been applied on this article but did not change the big picture of the understanding.