Financial independence is a state where an individual or household has accumulated sufficient financial resources to cover its living expenses without having to depend on active employment or work to earn money in order to maintain its current lifestyle. These financial resources can be in the form of investment or personal use assets,

passive income Passive income is a type of unearned income that is acquired with little to no labor to earn or maintain. It is often combined with another source of income, such as regular employment or a side job. Passive income, as an acquired income, is ...

, income generated from side jobs,

inheritance Inheritance is the practice of receiving private property, titles, debts, entitlements, privileges, rights, and obligations upon the death of an individual. The rules of inheritance differ among societies and have changed over time. Offi ...

pension A pension (; ) is a fund into which amounts are paid regularly during an individual's working career, and from which periodic payments are made to support the person's retirement from work. A pension may be either a " defined benefit plan", wh ...

and

retirement Retirement is the withdrawal from one's position or occupation or from one's active working life. A person may also semi-retire by reducing work hours or workload. Many people choose to retire when they are elderly or incapable of doing their j ...

income sources, and varied other sources. The concept of financial independence goes beyond just having enough

money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...

wealth Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an ...

. Achieving financial independence gives freedom to make the best use of time to pursue life's goals and dreams, or help the citizens of the community to lead a life with purpose. It is a state where one has come to terms with the fact of having accumulated enough, has been freed from the shackles of debt and the tendency to make poor financial decisions, and has transformed their relationship with money to make healthy financial choices. Gaining financial independence should not be confused with not having to work at all. Rather, financial independence gives the freedom to make choices at will, enabling individuals to achieve what matters the most while not having to worry about earning money. Researchers posit that childhood experiences with money play a pivotal role in shaping values, attitudes, and financial behavior. Financial independence is a subjective concept and can be interpreted differently by different individuals. Some people practice frugal living, save and invest a large percentage of income to achieve financial independence early in their career, as evidenced by people following the "financial independence retire early (FIRE)" movement, while others are in pursuit of traditional retirement. Some people may feel financially independent after accumulating enough assets to lead a modest lifestyle, while others may strive for a higher level of financial independence to afford luxuries, increased consumption, and a higher standard of living. Having a

financial plan In general usage, a financial plan is a comprehensive evaluation of an individual's current pay and future financial state by using current known variables to predict future income, asset values and withdrawal plans. This often includes a budg ...

and

budget A budget is a calculation plan, usually but not always financial plan, financial, for a defined accounting period, period, often one year or a month. A budget may include anticipated sales volumes and revenues, resource quantities including tim ...

, can provide a clear view of current incomes and expenses, to help identify and choose appropriate strategies to achieve financial independence.

Theoretical frameworks and factors influencing financial independence

Researchers have developed several theories to explain how financial behavior is influenced by values, attitudes, and biases. Parents may knowingly or unknowingly influence their children's relationship with money. These theories offer insights into how an individual or family members think and feel about money, stages of development to embrace a change, ability to resolve money conflicts, and overcoming unexamined cognitive and emotional biases to build a healthy relationship with

. These factors can have major implications on an individual's or family's ability to achieve financial independence. Researchers have tested several methods of family financial socialization to study how young adults remember their parents teaching them about money when they were growing up and if it contributed in any way to their financial well-being and helped in achieving financial independence. In case of young adults, attaining college education, having an

income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. F ...

, owning

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

, having basic money management and problem solving skills improved their ability to achieve financial independence. Identity Capital Theory suggests that young adults grow up with the ability to manage money if they have access to physical resources like money knowledge and social connections, and are also able to take responsibility for their actions and able to make their own decisions. These resources help individuals become financially independent later in life.

Psychological perspectives

One of the eight concepts of Bowen's family systems theory is the concept of triangles. An elderly couple with an insurmountable amount of

debt Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Co ...

, who are not on the same page to pay off the debt, may seek help from their child and involve them in resolving the conflict. The resultant imbalance in the system, where three people each have different opinions, can further lead to unresolved issues and derail the

plan of the child. The family projection process explains how children can end up with emotional issues by being witness to their parents' toxic relationship. Financial socialization theory and communication privacy management theory sheds light on how the feelings and attitudes about money developed and influenced by the family members in early childhood can result in marital conflicts later in life.

Behavioral finance perspectives

The Behavior Portfolio Theory governs that investors are "normal" and cannot always make rational decisions due to their cognitive and emotional biases. The field of behavioral finance defines several biases and heuristics that offer insight into individual behavior and how these biases influence an individual's investment decisions.

Prospect theory Prospect theory is a theory of behavioral economics, judgment and decision making that was developed by Daniel Kahneman and Amos Tversky in 1979. The theory was cited in the decision to award Kahneman the 2002 Nobel Memorial Prize in Economics. ...

posits that individuals value gains and losses differently; the pain of experiencing a loss of $1,000 is more intense than the joy of gaining $1,000. Investors also tend to get carried away with recent information, leading to

recency bias Recency bias is a cognitive bias that favors recent events over historic ones. A type of memory bias, recency bias gives "greater importance to the most recent event", such as the final lawyer's closing argument a jury hears before being dismiss ...

. An investor may hold onto a losing stock for long periods hoping it will increase in value in the future, indicating that an investor is loss averse. An investor may mimic trades of other investors in hopes of making a huge profit, showing signs of

herd mentality Herd mentality is the tendency for people’s behavior or beliefs to conform to those of the group they belong to. The concept of herd mentality has been studied and analyzed from different perspectives, including biology, psychology and sociolo ...

Hindsight bias Hindsight bias, also known as the knew-it-all-along phenomenon or creeping determinism, is the common tendency for people to perceive past events as having been more predictable than they were. After an event has occurred, people often believe ...

confirmation bias Confirmation bias (also confirmatory bias, myside bias, or congeniality bias) is the tendency to search for, interpret, favor and recall information in a way that confirms or supports one's prior beliefs or Value (ethics and social sciences), val ...

anchoring An anchor is a device, normally made of metal, used to secure a Watercraft, vessel to the Seabed, bed of a body of water to prevent the craft from drifting due to Leeway, wind or Ocean current, current. The word derives from Latin ', which ...

, familiarity bias,

endowment effect In psychology and behavioral economics, the endowment effect, also known as divestiture aversion, is the finding that people are more likely to retain an object they own than acquire that same object when they do not own it. The endowment theory ca ...

, similarity heuristics, affect heuristic are examples of other biases and heuristics. A couple may benefit from working with a financial therapist to resolve deeply rooted issues and feelings about money. A financial planner can help create a

and increase awareness on the benefits of

goal setting Goal setting involves the development of an action plan designed in order to motivate and guide a person or group toward a goal. Goals are more deliberate than desires and momentary intentions. Therefore, setting goals means that a person has com ...

budgeting A budget is a calculation plan, usually but not always financial plan, financial, for a defined accounting period, period, often one year or a month. A budget may include anticipated sales volumes and revenues, resource quantities including tim ...

investing Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

, diversification to help an individual or family stay the course to achieve financial independence.

Sources of income to achieve financial independence

Income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. F ...

can be classified into multiple categories. In the United States, there are three sources of income; active, portfolio, and

passive Passive may refer to: * Passive voice, a grammatical voice common in many languages, see also Pseudopassive * Passive language, a language from which an interpreter works * Passivity (behavior), the condition of submitting to the influence of ...

. The classification may vary by country.

Wages A wage is payment made by an employer to an employee for work done in a specific period of time. Some examples of wage payments include compensatory payments such as ''minimum wage'', '' prevailing wage'', and ''yearly bonuses,'' and remune ...

, salaries, material participation in trade or business constitutes active income. Portfolio income includes

interest In finance and economics, interest is payment from a debtor or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct f ...

dividends A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...

royalties A royalty payment is a payment made by one party to another that owns a particular asset, for the right to ongoing use of that asset. Royalties are typically agreed upon as a percentage of gross or net revenues derived from the use of an asset or ...

annuities In investment, an annuity is a series of payments made at equal intervals based on a contract with a lump sum of money. Insurance companies are common annuity providers and are used by clients for things like retirement or death benefits. Examples ...

capital gains Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares. A ca ...

. Generally, income from rental activities, and activities where an individual does not materially participate are considered

source of income. An individual can tap into multiple sources of income to satisfy their income needs and maintain desired lifestyle after achieving financial independence. The following is a non-exhaustive list of sources of income. * Bank

fixed deposits A fixed deposit (FD) is a tenured deposit account provided by banks or non-bank financial institutions which provides investors a higher rate of interest than a regular savings account, until the given maturity date. It may or may not require th ...

and monthly income schemes *

Business Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for ...

ownership (if the business does not require active operation) *

Dividend A dividend is a distribution of profits by a corporation to its shareholders, after which the stock exchange decreases the price of the stock by the dividend to remove volatility. The market has no control over the stock price on open on the ex ...

s from

stock Stocks (also capital stock, or sometimes interchangeably, shares) consist of all the Share (finance), shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporatio ...

s, bonds and

income trust An income trust is an investment that may hold equities, debt instruments, royalty interests or real properties. It is especially useful for financial requirements of institutional investors such as pension funds, and for investors such as retired ...

s *

Interest In finance and economics, interest is payment from a debtor or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct f ...

earned from

deposit account A deposit account is a bank account maintained by a financial institution in which a customer can deposit and withdraw money. Deposit accounts can be savings accounts, current accounts or any of several other types of accounts explained bel ...

money market account A money market account (MMA) or money market deposit account (MMDA) is a deposit account that pays interest based on current interest rates in the money markets. The interest rates paid are generally higher than those of savings accounts and tra ...

s or

loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money. The document evidencing the deb ...

s *

Life annuity A life annuity is an annuity, or series of payments at fixed intervals, paid while the purchaser (or annuitant) is alive. The majority of life annuities are insurance products sold or issued by life insurance companies. However, substantial cas ...

Notes Note, notes, or NOTE may refer to: Music and entertainment * Musical note, a pitched sound (or a symbol for a sound) in music * ''Notes'' (album), a 1987 album by Paul Bley and Paul Motian * ''Notes'', a common (yet unofficial) shortened versi ...

, including

s and bonds * Oil leases *

Patent licensing A license (American English) or licence ( Commonwealth English) is an official permission or permit to do, use, or own something (as well as the document of that permission or permit). A license is granted by a party (licensor) to another par ...

Pension A pension (; ) is a fund into which amounts are paid regularly during an individual's working career, and from which periodic payments are made to support the person's retirement from work. A pension may be either a " defined benefit plan", wh ...

s *

Rental property Renting, also known as hiring or letting, is an agreement where a payment is made for the use of a good, service or property owned by another over a fixed period of time. To maintain such an agreement, a rental agreement (or lease) is sign ...

Royalty Royalty may refer to: * the mystique/prestige bestowed upon monarchs ** one or more monarchs, such as kings, queens, emperors, empresses, princes, princesses, etc. *** royal family, the immediate family of a king or queen-regnant, and sometimes h ...

from creative works, e.g. photographs, books,

patent A patent is a type of intellectual property that gives its owner the legal right to exclude others from making, using, or selling an invention for a limited period of time in exchange for publishing an sufficiency of disclosure, enabling discl ...

s, music, etc. *

Trust deed (real estate) A deed of trust refers to a type of legal instrument which is used to create a security interest in real property and real estate. In a deed of trust, a person who wishes to borrow money conveys ''legal'' title in real property to a trustee, who ...

Approaches to financial independence

William Bengen conducted research to determine safe withdrawal rates from the portfolio and concluded that an individual can safely withdraw 4% of their portfolio savings in the first year of retirement and can adjust the withdrawal rate by rate of inflation in subsequent years. If an individual can cover their annual expenses by withdrawing 4% of their portfolio savings, the individual is assumed to have achieved financial independence. Suppose a person can generate enough income to meet their needs from sources other than their primary occupation. In that case, they have achieved financial independence, regardless of age, existing wealth, or current salary. For example, if a 25-year-old has $1000 in monthly expenses, and

that generate $1000 or more per month, they have achieved financial independence. On the other hand, if a 50-year-old has assets that generate $1,000,000 a month but has expenses that equal more than that per month, they are not financially independent, as they still have to earn the difference each month to make all their payments. However, the effects of

inflation In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

must be considered. If a person needs $100/month for living expenses today, they will need $105/month next year and $110.25/month the following year to support the same lifestyle, assuming a 5% annual

inflation rate In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

. A person's assets and liabilities are important in determining if they have achieved financial independence. An

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

is anything of value that a person owns, whereas a liability is what the person owes. Increasing savings, reducing expenses, consistently investing with a long-term horizon, and having a well-diversified portfolio can help achieve financial independence.

Theoretical frameworks and factors influencing financial independence

Psychological perspectives

Behavioral finance perspectives

Sources of income to achieve financial independence

Approaches to financial independence

See also

References

Further reading