Becoming free from unwanted constraints has been a major motivation and an overall guiding principle in my life. But what exactly do I mean by “free”? And how “free” can we ever hope to be? In my first post on the matter, I want to introduce the important topic of Financial Freedom, and illustrate my point in the context of the four main types of professional paths.
So what is Financial Freedom?
It is your degree of freedom versus your source of income, the level of living standard your income is able to afford, the safety of your source of income, the amount of external dependency (in particular with respect to other people) you have towards securing this income, and your level of debt.
The above will largely determine how much time you can spend on things that matters to you personally (as opposed to on someone else’s interests), and also how independent you are from other people.
So in essence, you are financially free when you have enough income to support a very good living style, when this income is very secure and do not depend on the goodwill of any particular person, and when you have no debt.
Another way to view it, is to check how you stand on the Fuck Off test: what is your ability to walk away from your current situation while withholding your current living style.
To illustrate these points, let us review some important working profiles with increasing degrees in Financial Freedom.
1. The Unemployed
At the lowest degree of financial freedom, you do not have any source of income. You have many needs, but very little means. If you’re there I’m sorry for you, and I have only one thing to say: kick your ass and go find a job. There must be something you can do out there, in order to secure some income in a legal way.
2. The Salary Worker
At the next degree of financial freedom, you are dependent on the goodwill of one or more people in order to earn your life. At least, you have a source of income, which give you the means to do things. But your own life only starts when your job is over for the day. You are now spending 10 to 12 hours a day, or more, to work towards your boss’s interests, instead of spending the same time to work towards your own. Of course, you could be fired any time, so you have to accept all the nonsense that the corporate world has invented to “manage” you, including:
- regular working hours
- asking permission to leave
- overtime hours
- “bell curve” (quotas) evaluation and bonus
- and myriads of other HR regulations which usually promote passive behavior rather than entrepreneurial spirit and creativity.
Clearly, working office hours in a corporation (or other salary job) does not comply with my definition of freedom. On the Fuck Off test, you are faring poorly: if you said Fuck Off to your Boss and walked away, you would be in trouble – or going for another job, which is more of the same.
Which doesn’t mean it’s necessarily a bad thing to be in a salary job. After all, I have been myself in one for the last 25 years. There are upsides also: you get a reasonably safe salary, and you learn the professional working standards. You also get some inside knowledge of the industry you are in, and you get to meet people. These will be great assets to have the day you’re ready for the next step up.
It is however essential, when you are there, to keep an eye on the big picture, to manage to regularly free up some time for your own plans, to be able to save money towards these plans, and to work out a path to the next level.
Freeing yourself from the needs of a 9 to 5 job (or more like 8 to 6), is a great way to reclaim your own use of your calendar hours, and to start working constructively towards your own life objectives.
3. The Entrepreneur
The next level of freedom is when you do not directly depend on someone else to create the condition of your income, or your income itself.
As an entrepreneur, things are better than as a salary worker, in the sense that the company and its employees are now working for *your* interests. You are now spending the same 10 to 12 hours a day (or more) towards increasing your income – and so are your employees. You may not have any income yet, but at least you do not depend on the goodwill of a Boss who could fire you any minute, and you use your personal time to do things that matter to you.
Are you free yet? Well, there are still some constraints. Although you do not have to follow stupid HR regulations, you now need to set some of these, for others to follow, because now some of these 12 hours a day will be used to manage other people – and that’s usually means managing trouble. Although you do not depend on a Boss to have a work, you now depend on customers. You are now chasing those who said they would pay, because you already engaged funds to purchase your inventory. Your income is not necessarily secure, and in the beginning you may not even have one. Your employees could decide to leave for a better job. And you may also have some investors looking for their dividend, or their coupons. But at least, you now stand a chance to get somewhere.
Things get better though, when (if) your venture reaches a certain maturity and stability. You now have some steady inflows of cash, and a company and employees that work to make you become richer. When your income is enough to provide you with your desired living style, you have now reached financial freedom. So if you reached that stage, you are pretty good.
However you’re not completely free of dependencies at this stage. You still have a business to run 70 hours a week. And you are still dependent on your customers, on the health of the economy and on the well being of the industry in which you operate. These latter problems can be mitigated by diversifying wisely:
- Make sure you do not depend excessively on one or two big customers.
- Make sure your income is generated on a wide a geographical (and economical) basis.
- Initiate some new businesses in different industries.
But there is another, even better possibility, which is to sell your business and consider the investor way.
4. The Investor
At the last stage of financial freedom, you do not depend on a Boss, or on employees, or on customers, to generate income. Your own money is working for you, to generate more money. This is the logic of capitalism, it is the system in which the world is based, so if you have a chance you should definitely aim to take advantage of it.
Instead of getting dirty hands himself, the investor takes stakes in one or preferably many ventures, and delegates the management of daily operations to professional business managers. As a stakeholder in these businesses, he still is entitled to a share in these businesses income. It’s all the benefits of having a business, without the inconveniences.
There are two main ways an investor can take a stake in a business, namely an Equity stake (a participation in the ownership of the company), and a Loan or Bond (a contract to lend money to the company).
There are pros and cons to each form of investing. In the event of company bankruptcy, the company assets will be liquidated, and the money generated from liquidation will be used in priority to repay the debt holders, which means that, in theory at least, the corporate bond or loan is a safer investment than equity.
But the main way an investor can mitigate risk , and a principal advantage over an entrepreneur, is by diversifying his portfolio of investments. If the investor is participating in 50 business in equal amount, and one of these goes bust, the investor has lost 2% of his investment. By contrast, an entrepreneur is essentially an investor that has invested 100% of his money in the equity of only one company (his own). If this company goes bust, the entrepreneur has lost 100% of his investment. Similarly, if one company in the 50 didn’t pay a dividend this year, 49 others did, and the investor still gets a decent income.
The investor way is safer than the entrepreneur way, and without all the worries of managing a company. On a Financial Freedom point of view, this is now very good. If you hold a portfolio of 50 stakes in 50 companies, the whole employees of the 50 companies are now working towards your interests; the 50 CEOs of the 50 companies are coping with all the worries of running the business; and in the meanwhile you can just sit and relax.
No wonder that this is the way followed by all the wealthy people of this planet. They may not even manage their investments themselves – most of the time they just appoint a portfolio manager to do it for them.
Debt
How about personal debt?
In Accounting, debt is called “liability”, and for good reason. Debt is someone else’s claim on the income that you haven’t earned yet. It means in the future a part of all your earnings will have to be used to repay it. Think about it as some sort of slavery: you will have to work for someone else’s benefit.
Never get fooled by how easy it is to borrow money. It may be convenient to meet your current needs right now, but ultimately, it is not your money, and you will have to pay it back sooner or later, even if it means tears. From the Fuck Off test point of view, you are doing poorly: you can’t just say fuck off to your creditors like this without consequences.
If you have to borrow, it is always in your interest to borrow the least amount possible, and with the shortest term possible. Whatever the rate you borrow at, interests compound quickly over time and will shoot up the actual cost of the project very quickly, the higher the term of the loan. The below table shows how a 4% annual interest on a 100,000$ loan, compounds over the years:
Fixed Interest Loan vs Term Length
| Term | Principal ($) | Annuity ($) | Total Interest ($) | Amount repaid ($) |
|---|---|---|---|---|
| 1 year | 100,000.00 | 102,179.89 | 2,179.89 | 102,179.89 |
| 5 years | 100,000.00 | 22,099.83 | 10,499.13 | 110,499.13 |
| 10 years | 100,000.00 | 12,149.42 | 21,494.17 | 121,494.17 |
| 20 years | 100,000.00 | 7,271.76 | 45,435.28 | 145,435.28 |
So… if you borrowed 100k for 20 years, you end up repaying 145k. Food for thought! So, use debt wisely, and seek to repay it as early as possible if your goal is to be financially free.
Conclusion
So where am I getting at?
Doing some meaningful improvements to your life – in whatever way – do take a lot of time. If you’re in a 8 to 18 job (“the Salary Worker”, it is going to be harder to succeed at that, simply because you are spending 10h a day working on someone else’s interests: you will therefore need to find the extra time (and energy!) elsewhere – your evenings, your weekends, your vacation time… Achieving anything just becomes mechanically harder! By contrast, the Entrepreneur way is better since you are harnessing other people’s working power to fulfill your objectives.
As a Salary Worker, you are getting a fixed salary… But in exchange you also have to accept your Boss’s rules, and you’re dependent on his goodwill to keep your job. It seems fair game… But in practice you also have to accept a lot of crap. Everyone who held a salary job for some significant time, will immediately know what I mean. The Entrepreneur and Investor way are much better from this point of view, since you are the one who make the rules. It doesn’t mean, though, that these latter two do not have their share of worries.
On the other hand, getting started as an Entrepreneur or Investor will require an initial capital. Not everyone will have the initial capital required (although… there are way to getting the necessary finances). Also, many people will also feel that being a Salary Worker is a reasonable compromise – they will accept a “average” path and the constraints associated, in exchange for a tranquil lifestyle and a fixed monthly pay. But I also have met many who just “ended up” there not by choice, but by following the path of least resistance. That’s why I say that it’s important to keep an eye on the big picture!
In the end, it is all a question of choice. Ultimately, if you have to choose, make sure you are making an informed decision!
Yours,
