This article clarifies the distinction between financial independence and financial freedom, highlighting that independence is a foundational stage allowing for career choices, while freedom represents complete financial liberation. It emphasizes that financial independence is achieved by managing expenses and generating a surplus, whereas financial freedom necessitates substantial income growth and a solid equity base. The piece also introduces the concept and utility of a financial independence calculator in planning and achieving these goals by optimizing spending and investments.

This article clarifies the distinction between financial independence and financial freedom, highlighting that independence is a foundational stage allowing for career choices, while freedom represents complete financial liberation. It emphasizes that financial independence is achieved by managing expenses and generating a surplus, whereas financial freedom necessitates substantial income growth and a solid equity base. The piece also introduces the concept and utility of a financial independence calculator in planning and achieving these goals by optimizing spending and investments.

This article clarifies the distinction between financial independence and financial freedom, highlighting that independence is a foundational stage allowing for career choices, while freedom represents complete financial liberation. It emphasizes that financial independence is achieved by managing expenses and generating a surplus, whereas financial freedom necessitates substantial income growth and a solid equity base. The piece also introduces the concept and utility of a financial independence calculator in planning and achieving these goals by optimizing spending and investments.

Most people confuse financial independence with financial freedom. Both are exciting levels for someone starting out their career, but they are poles apart. Financial independence comes first and is relatively easier to attain, whereas financial freedom is the final destination.

Financial independence is a stage at which you can choose whether to continue your primary job. You have made just enough to cover your future expenses, giving you the choice to continue your current job or step away and follow your passion.

Financial freedom, on the other hand, is the apex of your career; it's a level where you don't have to worry about the money in your bank account. There is more than enough for you to spend in this lifetime and beyond.

Today, we are going to explore the differences between these two and explore the possibility of creating a pathway to your financial independence.

Achieving financial independence is much simpler than achieving financial freedom. To achieve freedom, you need a growing equity base, such as a flourishing business. To achieve independence, you just need to create a small surplus to cover your expenses. This is why we can engineer your way to independence, but not to freedom.

For example, if your average monthly expenses are ₹50,000, a passive income source earning ₹60,000 per month is more than enough to achieve financial independence.

Financial freedom, on the other hand, is limitless income; no matter how much your expenses rise, you still have a surplus in your bank account.

The main focal point in planning for financial independence is “control over expenses”, whereas it shifts to “exponentially growing income” for financial freedom. And you know, budgeting expenses is much easier than unlocking additional income sources.

An ideal financial independence calculator works on these inputs:

  1. Your current monthly income
  2. Your current living expenses
  3. Your current monthly EMI
  4. The tenure left for the loan
  5. The number of years by which you need to be financially independent.

Here is an example of one such calculator: https://fi.balamoney.com/

Once you fill in the inputs, you can see the output: “Target fund required by FI,” along with the monthly SIP required to meet it.

How does the calculator work?

If you have not started investing yet, then the majority of your income goes toward living expenses and EMIs, i.e., income = expenses + debt (assuming tax = 0).

The idea is to start investing now so that the new equation looks like this: income = expenses + debt + investments (assuming tax = 0). These investments, in the form of SIPs, will appreciate in value and build a corpus that could help you secure a pension.

To determine the corpus requirement, I am taking a non-conventional approach: adding your monthly expenses until retirement to the total loan outflow. The loan outflow is added to the corpus because that was the amount you were unable to invest, and you have to earn it back for optimal retirement. It is simply the opportunity cost of not investing.

Let us try out an example:

  • Monthly Income = ₹1,00,000
  • Monthly living expenses = ₹50,000
  • Monthly EMI = ₹20,000
  • Loan tenure left = 10 years
  • FI target = 15 years

Here is what the calculator says:

  • Target fund required by FI = ₹1,53,47,138
  • Monthly SIP required = ₹27,918 (at 13 per cent annual return for 15 years)

This means that out of your ₹1 lakh salary, ₹50,000 goes to expenses and ₹20,000 goes to EMI. What remains is ₹30,000, and from that you need to invest ₹27,918 to create a corpus of ₹1.53 crore in 15 years.

If your expenses + EMI + monthly SIP required exceed the monthly income, then the calculator will show the following error: “Please reduce your monthly living expenses to proceed.”.

This calculator helps you optimise your expenses or EMIs, so you have more left to invest and build a retirement corpus, and that's why I said it's a non-conventional way to plan for financial independence.

Note: The conventional way to calculate FI is to calculate the number of years in retirement (for example, 30) and then sum up all the expenses that could occur. The corpus you establish should be sufficient to cover these expenses, and you should still have a trail balance that can be transferred to your heir after your passing.

The writer is a SEBI Registered Investment Adviser (INA000021757), SEBI Registered Research Analyst (INH000025045), and author of ‘How to join the top 1% options traders club’.

DISCLAIMER: Investments in the securities market are subject to market risks, including the potential loss of principal. Past performance does not guarantee future results. Information provided is for educational purposes only and should not be considered financial advice. Investors should read all related documents carefully and consult a certified advisor before investing. Registration granted by SEBI and Enlistment with RAASB/BSE and certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors. The investor is requested to take into consideration all the risk factors before actually trading in stocks or derivatives.

The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of THE WEEK.

The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of THE WEEK.

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