What is Financial Independence? A Hybrid Model

“It must be borne in mind that the tragedy of life doesn’t lie in not reaching your goal. The tragedy lies in having no goals to reach.” —Benjamin E. Mays

You may not realize the reason behind the name of this website.  No, I didn’t name it The Physician Philosopher because it’s difficult to say and spelling it on a keyboard makes your hands cramp (rookie mistake?).  While I am many things, two of the more interesting facets of who I am involves being a physician anesthesiologist and a prior philosophy major in college. Hence, The Physician Philosopher.

In my march since creating this site, I have maintained one overarching goal: teaching others how to use financial independence to combat the physician wellness problem that exists in our country.

This begs one very particular question… If we are always discussing financial independence, shouldn’t we spend some time defining it?

What is financial independence?

In philosophy, few things are more important than defining our terms.  The reason definitions are so important is because entire conversations can be held in agreement (or disagreement), because we have not properly defined a word in the discussion.

I would argue that one of the most important terms in the personal finance blogosphere is the phrase “financial independence.”  The irony should not be lost on you that the most important words need defining.  Doesn’t everyone agree on the most important thing?

The short answer, of course, is no.  While everyone agrees that financial independence is the number at which you are independent of a paycheck, and no longer need to work a normal job…

There are two different schools of thought when defining the math behind financial independence.  Which one aligns with my way of thinking?  Neither.  And both.  I hold to a hybrid between the two.

Let’s discuss each school of thought.  Then, we will discuss how to combine the two models to give a real life definition of financial independence.

School Number 1: The 25-X / 4% Rule Model

The most common way people define financial independence is by calculating the following math:

  1. Determine your anticipated annual spending in retirement (yes, this means you have to budget or track spending)
  2. Multiple the above number by 25

The number that results from the math above is your number.  For example, if you determined that – once all of your debt is gone – you will require $80,000 each year in retirement, then your number is $80,000 x 25 = $2,000,000.

The reason that this math works out is because there is a corollary to the “25 x rule,” which is called “The 4% Rule.”  This rule is based on the Trinity Study, which showed that you could pull out 4% of your nest egg and remain relatively reassured that your funds would last (96% chance based on a 50% stock / 50% bond portfolio).

Many people subscribe to this line of thinking, and it is certainly what is most frequently taught in the personal finance community.

However, it’s not the only way to define financial independence, and leaving it here has gotten many bloggers in trouble who still earn income from their blogs!

The Passive Income Stream Model

When I started this site, I hadn’t realized how much I would love being an entrepreneur. Medical training doesn’t really expose us to the idea.

Now a fire has been lit inside of me, and it impacts the way I view much of my life.  This business-like way of thinking has led me to pursue many side hustles.  All of which will (hopefully) produce additional income streams.

My current and future passive income streams will likely include this website, writing a book (currently being revised), a medical invention, medical expert witness work, and real estate crowdfunding.

If you need another source of possible passive income ideas, I’ll point you to one of the two posts that encouraged me to start this site: Passive Income MD’s List of Physician Side Hustles.

The reason to point this all out is that this can help to picture the other model of financial independence, which I’ll define as the following:

Financial Independence is:
The point at which your monthly passive income streams equal your monthly spending.

The concept is simple, yet important.  If you have enough money coming in to cover your monthly spending, then you have reached a point where you are no longer dependent on your W-2 paycheck.  Hello, retirement!

This is an alternative way to define financial independence.  And it certainly doesn’t follow the same math as The 25-X Model.

A classic example here is real estate.  If you have enough passive income coming from properties you own – or deals you are involved in – to cover your monthly spending, then you are financially independent.

The Hybrid Model

So, what is financial independence?

I think the debate between the two definitions is a bit of a false dichotomy.  In this debate, I think we can have our cake and eat it, too.

Let’s look at an example.  Let’s use the same number we gave in the first model: $80,000 annual spending.  The traditional 25-X model would require us to grow a nest egg of $2,000,000.

Well, if our passive income amounts to $30,000 in annual income, then what remains -$50,000 in annual spending – is what must come out of our retirement nest egg.  Given the passive income stream, we now only need a nest egg of 25-X our annual $50,000 requirement =  $1,250,000.

That’s a dramatic difference!  We have shaved off $750,000 from our required savings number due to passive income.  That’s powerful stuff.

Take Home: What is Financial Independence?

It’s amazing how a simple twist on how we define our terms can produce dramatic results in our financial planning.

Obviously, there are two inherent assumptions that are worth mentioning.  First, the larger your multiplier on your annual income (i.e. 30-X instead of 25-X) the safer you are in knowing your money will last. Second, if you are going to depend on passive income, it needs to be very stable!

When thinking about financial independence, I hope that these two models will help. Don’t feel stuck in one model or the other.  I certainly plan on using both!  It’s part of the reason that I hustle so hard.

And THAT is why definitions are important.  Philosophy for the win!

What is your definition of financial independence? Do you use one of the models above, a hybrid, or an all together different definition?  Leave a comment below.

TPP

8 thoughts on “What is Financial Independence? A Hybrid Model

  1. For me, I fall in favor of the latter camp of trying to develop passive income streams that will support my retirement lifestyle. This would be ideal as it would then allow me to never consume the capital which would then allow me to leave a substantial financial legacy to my heirs.

    If by the time I reach an age where I want to call it quits I have not quite achieved this goal, then the hybrid model is a fall back one and still not a bad option as more likely than not I will end up having more money at the end than I started out with.

  2. I think it helps to spend more time discussing what you are financially independent from. Many people think of FI as independence from a W-2 income or a “paycheck” but they may have income from a non “normal job.” Others define it is being independent from work of any sort entirely. The root of so much discussion is in these definitions.

    The latter group would probably be on board with “School 1.” Being a 25x/4%’er means you don’t actually need to make any money. You can sail with your nest egg through retirement and into old age (hopefully). The internet retirement police live in this world.

    If you think of FI as independence from a W-2 job then either the hybrid model you suggest or a straight passive income approach is more in line with that idea. All the passive income streams you mentioned take a great deal of effort and work to build. Blogging. I think about it every day and usually spend an hour or two either reading, writing are fussing with my site!

    The hybrid model you suggest is probably more of a ‘real life’ application for most people. Some income coming in from side gigs, part time work, etc and then a bunch of investments 4%ing the rest.

  3. Vicki Robins does a good job in Your Money or Your Life detailing the many ways to get to what she terms as the Crossover Point. Where all of your passive monthly income from investments, rentals, royalties, etc. suddenly grows to more than your expenditures. Financial Independence is on the event horizon of the Crossover Point.

    I like the idea of passive income that takes effort but not capital to create. In my mind, your book, website and maybe medical invention beat out dollar for dollar your investments and real estate crowdfunding.

    Loved the article!

  4. Definitions are funny. Is financial independence when investable net worth equals 25 x annual expenses or is it when passive income equals expenses. Both are correct. And you’re right, a hybrid works too.

    Terminology is funny too. Is it financial independence or is it financial freedom? Are they the same thing. Is one better (or a higher amount of money) than the other?

    The truth is, neither definition truly describes financial independence. When your net worth equals 25x annual expenses, it does work… but you are still dependent on returns from the stock market. And in the second definition, you are still dependent on your passive income sources being consistent and lasting for a long time. What if your passive income streams dry up? There is no guarantee that these will last forever.

    Anyway, I like the definition laid out by John of ESI money: Financial independence or financial freedom is when you have wealth to cover expenses indefinitely.

    https://esimoney.com/what-is-financial-independence/

    It’s broad enough to cover both definitions, and a hybrid of the two just like you mentioned.

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