Why You Need a Freedom Fund

What would you do if money was not a concern? Travel the world? Start making music? Enrol in a painting class? Devote all of your energy to the side project you’ve been passionate about for the last 4 years?

If your bills were covered, would you go to work next Monday? Most people I know wouldn’t. But few of us have this option – don’t rock up on Monday and we’re told not to bother coming in on Tuesday. With rent to pay, bills outstanding and for some, a family to feed – losing that job seems disastrous.

If you haven’t already heard, the end of jobs is nigh. The world is now rewarding individuals willing to take a punt at starting a business and as painful as it is, punishing those that aren’t ready to adapt.

It’s claimed that 69% of Americans have less than $1000 in savings. We hear similar stats coming out of Australia, UK, Europe and elsewhere. Psychologically, would you be confident quitting your job and starting a business with less than a grand in the bank? I know I wouldn’t.

What is a Freedom Fund?

Imagine if at all times, you had cash on hand ready to cover life’s unexpected consequences. Expensive car trouble is a stressful time for someone with no savings, let alone losing a job.

A freedom fund is a fancy name for a combined “emergency fund” and an investment portfolio. There’s a whole community of people out there that use these in pursuit of retiring early. Enter:

The “FI/RE” (Financial Independence / Retire Early) ethos can be simplified into:

  • slash your spending and work out what your desired lifestyle costs each year
  • pay off all debt and never get into it again
  • maximise your savings
  • keep an emergency fund for any unforseen costs
  • invest your savings into low cost index funds and bonds
  • maximise any tax free investment vehicles (401k, superannuation)
  • once 4% of your investment portfolio (freedom fund) meets your yearly lifestyle costs, retire

While this is a very logical plan, results are mixed. Some of us can delay gratification for long term goals, others get FOMO and it all falls in a steaming pile.

Instead, I’m using a freedom fund to help achieve both retirement through delayed gratification, but also facilitate adventures along the way.

Slash Your Spending, Minimize Your Liabilities

Let’s cut the bullshit for a moment.

  • Do you need that $150mo cellphone plan?
  • Is that new pair of adidas Yeezys really going to help you to pull?
  • How much better does your $300 dinner taste over the $75 meal?
  • Do you think a truck, sled, motorbike, downhill mountain bike and 3 sets of skis might be excessive?
  • Flying economy sucks, but do you actually have the money to spend on a business class upgrade?

It’s not that you can’t have or do nice things, but we’ve been trained to want it all. If you don’t yet have millions, you’ll need to sacrifice a little. Spend some of what you earn on the things you really care about and forego the rest.

There’s also a misconception about what an asset is. Assets are items considered to have value and are available to meet debts and commitments. That is, they have an inherit value and are likely to generate an income. They cost nothing to own.

I, like many, was raised with the words “assets” and “home” used in the same sentence. Wrong. While buying a home is something many of us dream about, it’s a similar decision to buying a nice car – it’s a lifestyle choice, a luxury item, not an asset.

A home is a liability – it generates no income, you have government taxes/rates after purchasing, insurance payments, probably interest repayments on your mortgage, time and money to spend on upkeep. Logically speaking, buying a home is for suckers or the wealthy.

Your goal is to keep your monthly living expenses as low as possible while still retaining your happiness.

Maximise Your Savings

To save as much as possible, you only really have two options:

  • cut your spending even more
  • earn more

While I do advocate a lifestyle that doesn’t involve frivolous spending of money, there’s a point where it’s just not worth saving an extra $8 per week.

Earning more doesn’t have a limit. Take an extra shift, start a side business, learn something valuable and ask your boss for a raise.

The trick here is to avoid lifestyle creep. Get paid more, spend the same amount and save the rest.

Emergency Fund

Often referred to as a “rainy day fund”, an emergency fund is money that is set aside to cover unexpected financial surprises that life will inevitably throw your way. By keeping cash on hand, these unexpected events are much less stressful and most importantly, don’t have to be put on a credit card.

Common emergencies that people face include:

  • job loss
  • medical or dental emergency
  • unexpected home repairs
  • car troubles
  • unplanned travel expenses

How much you choose to keep in your emergency fund depends on your age, liabilities and risk profile, but if you eliminate debt, 3 months of living expenses seems to be the accepted minimum.

The Freedom Fund

With spending reduced, debt eliminated and a stash of emergency cash, it’s time to begin investing.

This is where I begin to deviate from conventional FI/RE wisdom. Most early retirees are looking to continue working their day to day job until the day they retire. I’m personally looking for enough safety to enable me to take greater risk in business.

For many people, this money has a greater psychological effect than anything else – it’s likely you’ll always end up making money when you change to something new, but having the money available will help you make the jump.

What you are trying to do, is create your own infrastructure. Watch Anton Kriel explain this (start at 50:16 until 58:50):

How Much Do I Need in My Freedom Fund?

Say you want to become a digital nomad. You’re going to start a digital business while travelling low cost countries. What is it going to cost you for 4 flights a year, accommodation in your desired countries, 3 meals a day, high quality internet access, some entertainment money and anything else you need?

Everyone’s individual needs and tastes change, but if you’re on a budget, USD$15,000pa can land you a comfortable life in South East Asia.

Cost of Living / 4 * 100 = How Much You Need in Your Freedom Fund

In the above scenario, you’re going to need USD$375,000.

Where does 4% come from? Based on the research of actual stock returns and retirement scenarios over the past 75 years, William Bengen found that retirees who draw no more than 4.2% of their portfolio in the initial year, and adjust that amount every year for inflation, stand a great chance for their money to outlive them.

That is, you get ~4% per year, forever. Please remember however, there are no guarantees.

Of course, if you want to retire on $250k per year without lifting a finger, that’s also possible – you’ll just need $6.25 million in your freedom fund instead. Working and saving is probably not the best strategy here – but that’s a conversation for another time.

What Should My Freedom Fund Invest In?

Traditional FI/RE crew opt for:

  • “buying your age” in government bonds (for example, 30% of your total portfolio if you are a 30yo)
  • buying the rest (70%) in either an SP500 index fund, or if you’re overseas, a global stock market index fund.

Your options depend entirely on your risk profile, how open minded you are, if you’re optimizing for tax, when you want to retire, if you want your investments to be 100% passive, or provide a greater return.

As I outline in my article “The 40% Rule“, investing in websites is a way to get that same $250k per year with $625k instead of $6.25 million.

Investments may include:

Regardless of what you choose, you’re looking for it to spin off enough income each year to cover your living expenses. This may be paid out to you in distributions, or you may have to sell a portion of your portfolio each year depending on your asset allocation.

Should I Build My Freedom Fund in a 401k or Superannuation Plan?

If you want to use this income before your home government’s dictated age of retirement, it wouldn’t be a wise choice to go with the tax-minimized option of additional 401k or superannuation deposits.

Tax concessions can lure you in, but if your intention is to use the income or assets before you retire, it would be madness to lock it up until you are 60… 65… 68..? As Western governments are squeezed and as we live longer, it seems inevitable this age will continue to increase.

Now You Can Focus on Your Business or Other Pursuits

With the safety net of your freedom fund beneath you, it’s now much easier to quit your job and have a go at running your own business. If everything goes pear shaped, your bills are paid and there’s still food on your table.

If you’re entirely content with living a frugal lifestyle and devoting your life to your passion, that is also an option.

Most importantly, if you are happy to continue working, you can do that too. Only now you have an extra $15,000 (or whatever amount you choose) per year in income.

That’s the benefit of a freedom fund – it’s there to be used however you like, whenever you want. This year it may fund a 6 month backpacking trip without work, or you may re-invest all income to give yourself more the year after, or it may pay for your food/rent while you start an online business.

There are no rules – you have the freedom to choose what to do with it.

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