By Ayinuola, Tunde Folorunso
What is Financial Freedom?
Freedom is the state of being free or at liberty instead of being restricted or physically limited. In other words, freedom exists when a person or entity is exempt from external control, interference and regulation; it is the power to act or take decisions without restriction.
Financial freedom is the ability to meet the basic necessity of life (food, clothing, shelter) and other conveniences of life with ease. Essentially, financial freedom describes the capacity to buy what is needed, when needed, with minimal reliance on debt or borrowing. Moreover, it could depict the state of having sufficient money to meet one’s financial obligations as they fall due without borrowing. On the other hand, it could be a state of affluence. Therefore, financial freedom is relative as it means different things to different people. For some people, it means having enough residual income to cover the cost of living. As a result, financial freedom exists where an individual can meet his financial commitments with the money available and also have a robust savings and investment plan. According to Suze Orman, a large part of financial freedom is having the heart and mind free of care for the vagaries of life. Thus, financial freedom exists when a person can make important life decisions without worrying about the future economic impact.
How to achieve Financial Freedom
Financial freedom requires being financially stable and secured. An individual cannot achieve financial freedom without a specific action plan; otherwise, such a desire can result in futility. Thus, the following action point is essential to walking in financial freedom.
- Definition of personal financial freedom goals: The first step is to set life goals in terms of monetary and lifestyle and create a plan to accomplish those goals. Setting life goals should clearly state what level of achievement a person wants to attain and at what age. Furthermore, life goals can entail a lifestyle, relationships with others, and important life choices. Consequently, setting life goals is tantamount to creating a road map that guides actions on every life issue. Therefore, life goals should be well synchronized with the individual personality and supported by proper planning. The failure to adequately plan for these objectives is simply a recipe for failure.
- Budgeting and Savings: This approach requires drawing up a budget and maintaining a personal balance sheet. Budgeting consists of establishing a plan for spending the available funds; it is an action plan to utilize the resources available to achieve life goals. Drawing up a budget creates a certain level of prudence and financial discipline. Thus, without a budget, an individual or entity can spend more than they can afford, frequently without knowing it. The need to maintain an individual balance sheet, which is a statement of assets and liabilities, is closely related to budgeting.
Assets are resources/properties that facilitate or have the potential to generate present or future revenues. On the other hand, liabilities refer to obligations that will entail future income sacrifices. For example, a building or motor vehicle can be an asset or a liability depending on whether it facilitates current or future income generation. More money should be invested in assets instead of liabilities to achieve financial freedom. However, note that budgeting is not necessarily about perfection; it is about constantly reviewing progress made and proper implementation
Popular Budgeting methods
A budget method is an ultimate blueprint that guides how a person allocates personal resources to achieve financial freedom over a while. Budget methods vary by needs; however, failure to be guided by a budget may be a quick path to long-lasting financial problems. Although there are many budgeting techniques, the few popular ones include:
- 50/30/20 budget – this system allocates 50% of net income to basic needs/essentials such as feeding, clothing, shelter, and transportation. 30% goes towards wants, such as traveling, shopping, and the likes. The remaining 20% is untouchable as it forms savings. Although this method is popular and also makes provision for savings/emergency funds, it can mislead those with high net pay to yield into the temptation of overspending on luxuries and is likely not also ideal for people with significant debts to pay off.
- Zero Based Budget: Under this method, there is a need to plan expenses by taking monthly income and allocating it to budget categories until full utilization. The ideology is to give every Naira earned a job which could be saving or debt payoff; this entails factoring all the income earned in the plan. This system promotes discipline and accurate tracking of spending. Since there is accountability for every Naira earned, there should not be any money left at the end of each period.
- Pay yourself first/Reverse Budgeting: Savings is the priority in this approach. The emphasis is to decide how much to save and spend what is left. With its focus on savings, users of this approach should have in mind short and long-term savings goals. If the plan is to buy a house or have a certain amount at retirement, start the process with an estimation of the cost of the set benchmark. Furthermore, design a monthly savings plan to meet the set goals within the expected timeframe.
- Envelope System: This system can be used in conjunction with any other type of budget approach. Under this approach, there is a budget for all spending categories for the month (e.g., groceries ₦5, 000, Transport ₦12,000), and then develop an envelope for each spending category and label them accordingly. Each envelope contains the cash available to spend for the current month. When the envelope is empty, spending in that category is complete for the month. On the other hand, keeping an excel spreadsheet can achieve the envelope system electronically. Thus this approach mentally forces an individual into a planned spending limit with this method. Furthermore, with discipline and commitment, an individual can resist the temptation of borrowing from another envelope. However, if unforeseen exigencies arise, there is a need to ensure that the next payday returns the borrowed funds from the other envelope.
- Developing a savings culture: This is another means of achieving financial freedom. One of the major reasons for drawing up a budget is to achieve specific savings targets. Experience has shown that there will always be times of abundance and scarcity. It is not appropriate to live under the illusion that “tomorrow will take care of itself,” but instead plan for the rainy days. An individual should keep around 20% of total income in savings. At the same time, for businesses, it is necessary to maintain certain reserves in the form of retained earnings. Although, there have been arguments about the erosion of the value of savings as a consequence of inflation. Nonetheless, this does not negate the significance of the three reasons for saving (transaction, precaution, and speculation) identified by Keynes (1936). The transaction motive refers to the funds required to meet daily financial needs for an individual or a business venture. Funds held in a savings account for precautionary purposes can provide an alternative to meet unforeseen requirements or circumstances. An intelligent person can use the funds held in savings to leverage a forecasted business opportunity for speculative purposes. For example, a business manager takes advantage of the anticipated price increase to buy more raw materials needed for future production.
- Financial discipline and prudence. Theseare vital considerations for sustainable financial freedom. The Proper implementation of savings and budgeting strategies depends solely on how financially disciplined and prudent you are. Prudence entails being careful and exercising good judgment; it does not connote stinginess. Keeping a high taste with no high income or borrowing money to finance “taste” or “flaunt” depicts financial indiscipline and is a recipe for penury. The principle of prudence and good judgment should guide all spending. There is a need to reach out to friends, relatives, and society as social beings. But such generosity should be within the limits of available resources and set a budget. Borrowing to express generosity can lead to unnecessary financial difficulty in the future.
- Refrain from unnecessary spending. Unwarranted expenses should be avoided or minimized for things that do not facilitate or generate revenue. There is a need to seek ways to reduce costs and prevent waste on an ongoing basis. Purchasing what a person does not need may require selling an essential property to meet future financial obligations. Financial diarrhea, which entails spending more than 50 percent of income on the basic needs of life (food, clothing, and shelter), should be avoided. Sustainable financial freedom extends beyond the ability to meet immediate physiological needs; it involves the ability to generate future revenue streams to meet recurring needs. Moreover, it is necessary to develop a maintenance culture by taking care of the properties owned. Measures to carry out regular repair and maintenance of physical assets should be in place. It is more beneficial to maintain existing assets instead of acquiring new ones.
- Commitment to Financial Investment. Financial freedom is a tripod stand comprising savings, budgeting, and investment. Knowing how to use the available resources to achieve the desired financial goals is a prerequisite to achieving a successful investment. An investment is an asset or property acquired to generate future income or capital gains. Capital gains represent an increase in an asset’s value over time. Furthermore, investment can refer to any mechanism used to generate future income, including bonds, shares, real estate, or a business. For example, when an individual purchases an item as an investment, the intent is not to consume it but rather to use it in the future to create wealth.
Effective investment requires a good understanding of how to invest (e.g., owning a business, stocks, bonds, commodities), the inherent risk/reward, and the importance of diversification. Like savings, investment involves placing money not needed for immediate use in an asset in anticipation of higher future returns in exchange for increased risk-taking. Typical investments consist of shares, bonds, mutual funds, and other securities. You will use an investment broker or brokerage account to buy and sell them. In addition, an investment could also be in the form of Real Estate, Hedge funds, and Commodities (Gold or silver, Crude oil, and agricultural or Livestock). Investments can be volatile over short periods and can result in loss of money. As a result, there is a need for a sound knowledge of investment strategy to achieve an appropriate mix through diversification. The concept of diversification involves the spread of investment across various financial instruments, projects, or assets to minimize the risk of loss of investment.
Sustainable financial freedom is an ongoing process that starts with setting goals and diligently managing available resources to achieve established goals. Therefore, it is essential to establish a budget and allocate resources between assets and liabilities. Furthermore, it is imperative to ensure prudence, discipline in spending, and waste prevention. Creating the right attitude to save money for exigencies or unforeseen circumstances is also essential. In addition, developing a savings culture and making appropriate investments will guarantee a continuous future flow of income and, therefore, generate sustainable financial freedom. According to Stephen Covey, your economic security lies in your ability to produce wealth. In other words, the idea is to think, plan and create more wealth through diligence and discipline from the resources available.
Ayinuola, Tunde Folorunso writes from Lagos