Never Retire
Posted By tsauthor on October 9, 2010
If your monthly expenses are, say, $2,000 and your passive income is that same amount then are you financially independent? The answer is: it depends but probably not.
First let me explain two terms so we are on the same page here: Earned income is money you receive from employment; whether self-employment or as an employee and for the sake of defining earned income, it makes no difference.
Passive income is any money received as a return on an investment such as interest earned on savings and stock dividends. This type of income is passive in the sense that it is not received in a direct exchange of your labor for money. Some would argue that there is no such thing as passive income but for the sake of discussion we need to define the two terms and, so, there it is.
To achieve total financial independence, one would need enough passive income sufficient to pay the bills every month, month after month after month. Living paycheck to paycheck is not a sound long-term financial situation but neither is living too close to the limits of your passive income.
In the parameters of the question I pose to begin this discussion, $2,000 in monthly passive income and $2,000 in monthly expenses, such a financial situation would only, technically-speaking, be defined as financial independence; it would be, however, the equivalent of living paycheck to paycheck.
And the quality of your passive income is also an issue. In order to plan for financial independence, you need to first determine your ?number.? Your number being, like they say in the ING Bank commercial, the amount you need to finance your retirement or, for our purposes, your financial independence.
But what really determines your financial status, that is, whether you are FI or not, is the amount of passive income you receive from the money that your number represents. And, for the sake of planning, we need to either know our annual rate of return or assume an average annual return; either number, then, when extrapolated will tell us the amount of our annual passive income. But those two numbers will not be of the same quality and so the quality of your planning is, likewise, not the same.
Some sources of passive income allow for more precise planning than other sources of passive income. A guaranteed return from an invest wherein the capital is federally insured is a higher quality return than is the return on an investment where your capital is at risk and the rate of return not guaranteed; which means that, if your nest egg is invested 100% in long-term bonds issued by the Federal government, the quality of your planning is very high.
On the other hand, your planning cannot be as high a quality when your return is not guaranteed and your capital at risk; for example, when your money is invested in the stock market or real estate.
Some of us who are working towards achieving FI are OK with that; we are basing our financial independence on the hope that we can achieve higher returns by assuming more risk. But the weak link at which that planning breaks down is that we plan to make future withdrawals based on an assumed rate of return and not a known and guaranteed rate of return.
The risks of such a proposition are obvious, right? If the stock market declines and the value of your account goes down with it, can you then withdraw any amount from that account ?safely?? If you were to do so, you would be spending capital and further depleting the account balance.
And what happens to your plan at this point? If the total of your capital is invested in a mix of safe and at-risk investments, and you were assuming a total average return, all your planning is now out the window and so is your status as being financially independent; unless, of course, you had a comfortable cushion between income and expenses.
So, what is my point? Only that total financial independence is not only expensive but will be tough to maintain in the future. The answer? The answer is earned income. And that is why in my book, Thank God It’s Wednesday, I promote the concept of the four-day weekend even for those who are financially independent as a means of continuing to grow your savings and increasing the odds in your favor that you will stay financially independent for as long as you live.
Wallace R. Curiel is the author of Money Well Spent, The Debt Whisperer, and many other books available at amazon.com and other online retailers. You can see his complete list of titles at http://www.tmgbooks.com including Thank God It’s Wednesday and more articles on financial independence, real estate, and personal financial management. You are invited to visit his blog: http//www.financialindependenceextreme.blogspot.com.
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