Financial Security vs. Financial Freedom vs. Financial Independence

One of my biggest challenges in writing and talking about money is the terminology. When it comes to finances, people looove complex-sounding but ultimately irrelevant terms. There are so many phrases out there that don’t really mean anything. And then there are actually-important phrases whose meanings get lost in overuse and noise.

As for the latter, three terms that I see all the time are financial security, financial freedom, and financial independence. I use them myself plenty often, too.

All three are used for any number of things, from clear, specific financial advice, to vague, meaningless marketing speak used to sell products. To me, these are three unique stages on the path to a financial life so freaking awesome your face hurts from smiling so much.

Today I want to break down, define, and compare these terms. But even moreso, I want to draw a map which will lead you through these three stages down a path of steadily increasing wealth, freedom, and power over your life.

What Is Financial Security?

Financial security is the first and most basic plateau on the climb to wealth and independence. It is attainable by absolutely everyone, and usually within a relatively short time frame (< 6 months). Some of you reading may have already reached it, simply by avoiding common bad money habits.

What it means to reach this stage is that your financial situation is stable, you have a positive net worth delta, and you are protected against most common money emergencies.

When you have financial security, you can trust that the bills are paid and all basic expenses will be covered. There is more money coming in than going out, and the difference is helping you to build for your future. You’re not immune to every possible money disaster (yet). But it’s highly unlikely that one big expense will be able to push you to financial ruin. And that’s a huge accomplishment already.

financial security definition piggy bank dominoes

Simply put: at this stage, your money still needs regular attention, but it’s no longer a constant existential threat.

Financial Security Checklist

How far away are you from reaching financial security? Are you there already? Check yourself against these criteria to figure out where you stand today, and what comes next.

Ideally, the steps on this list should roughly happen in order, but it’s okay if your situation works a little differently. Though I will say, it will always be best to focus on just one at a time.

1. Get Your Budget in the Black

You don’t need a strict written budget to succeed here, but you do want to get to a state where there’s more coming in each month than going out. This usually means cutting expenses first, but building up your income can also help.

You don’t need to have a massive surplus in order to achieve this step. If you are contributing $50 to savings, or to paying off extra debt each month without dipping into savings or taking on new debt, then you’re there.

2. Start a Basic Emergency Fund

Perhaps the most common financial disaster of all is being faced with an expense of a few hundred dollars and being unprepared to handle it.

With just a small emergency fund ($1,000-$2,000), you will be prepared for 90% of these emergencies. Set it aside somewhere that is NOT TO BE TOUCHED by regular expenses. From sudden major car repairs, to medical expenses, to who knows what else, life just goes a lot easier with a small stockpile set aside to smooth things over.

3. Insurance Check-Up

There are a lot of misunderstandings out there about what insurance is for, and when you need it. But really, there are only two factors that matter:

  • Could a certain expense (like a car accident, lawsuit, or loss of a family member) drive you into bankruptcy?
  • Is it a reasonable possibility that it could happen to you?

If so, you should have insurance against that thing. If not, you probably don’t need it. Adequate (but not excessive) insurance is a key and often overlooked aspect of basic financial security. And while you’re at it, maybe shop around and make sure you’re getting the best rate for the insurance you do need!

4. Eliminate Predatory Debts

There is no such thing as “good” debt. But all the same, there are some forms of debt that manage to stand out as garbage among trash. 

If you have credit card debt, payday loans, auto title loans (this is different from an ordinary car loan), or any other predatory debt that is designed to snowball out of control on you, then you have an emergency to deal with before you can ever be financially secure.

Put everything you can toward paying these off as quickly as you can. Refinance them into something more reasonable if it’s going to take a while (more than a few months). And let your newfound financial security protect you from ever needing to go back to these monsters again!

What Is Financial Freedom?

Building on the safety, potential, and peace of mind that financial security offers, financial freedom takes things a big step further.

What it means to reach this stage is that you have focused, worked, and learned enough about money that you now have flexibility, power, and freedom in the direction and shape of your life. You are all but entirely free of the worries of “not having enough” money to get by. It would take a truly once-in-a-lifetime event to  fully derail your wealth-building machine at this point.

But all that is really just an extension of financial security. What truly distinguishes this level is that money no longer has the same power over the decisions you make in your life. You have many diverging options from here. Options that are not available to most people. You could:

  • Quit your job and take something lower-paying but more satisfying
  • Expand your generosity and give more, either to those you know or to specific causes
  • Take a year off to travel the world and try new things
  • Invest in yourself and build your own business
  • Keep the momentum rolling and push for full financial independence (see below)

If you have achieved financial freedom, you can do any of these things. Likely more than one. 

financial freedom definition piggy bank in field

Going from financially secure to financially free will take some time, likely a few years. But again, anyone can do it. Let’s see how.

Financial Freedom Checklist

I have written in great detail about what it takes to reach financial freedom in the past. And by the way, those basic steps and mindset shifts apply to all three of these stages we’re talking about today.

Financial freedom is the phrase I use most often as a unifying term to refer to “building a kick-ass life with money.” So the basic steps there apply everywhere.

But to disambiguate from these other two levels of super-happy-money-time, here are a few specific criteria to aim for so you can decisively say, “I have reached financial freedom and that’s freaking sweeeeeeeet!”

Once again, these are not strictly in order, but it’s best to channel just one at a time.

1. Seriously Low Debt

For all intents and purposes, I would read this step as “debt freedom.” That means you own your car and no one else does. Same goes for your furniture, your degree, everything. Debt freedom and financial freedom are VERY good friends. You cannot have a free and thriving life with money while you are beholden to everyone else for it.

If you are still working through a reasonable mortgage on your main home, or what was once an insane pile of student loans, it’s okay to give yourself some grace on this one. Otherwise, and even so, working down debt with a goal of zero is a key component of financial freedom.

2. Big, Juicy Emergency Fund

For financial security, you pulled together a small emergency fund that would help you dodge the little wrenches life is bound to throw at you from time to time. Here we are bolstering that into something even more powerful.

Rule of thumb suggests a “full” emergency fund should hold roughly 3-6 months’ worth of expenses. That’s expenses, not income; those should be different numbers by now. 

On top of the most common budget upsets, a big, juicy emergency fund will also protect against larger life events such as unexpected loss of income or a totaled vehicle.

Build your emergency fund until it’s big enough to cover your living expenses for 3-6 months (exactly where within that range is up to you), but not much bigger than that. Anything beyond that mark should go toward crushing debt (step 1) or making you more money (step 3).

3. Money Making Money

Can you believe that I’m almost 1,500 words into an article about financial freedom, and the end of this sentence is the first time I’m going to use the word investing?

If you’ve spent some time around here before, you may not find it that surprising. Investing is an absolutely vital tool in the quest to building wealth. But without our other financial infrastructure and good habits in place, it won’t get us too far.

If you have achieved financial security and are on the road to financial freedom, it’s time to get investing. By the time your debt and emergency fund are squared away, you should be putting as much as you can into simple, long-term investments like index funds. Take the benefits of your work so far, and put that money to work to start making money for you. With that, you are on the path to changing your whole financial life.

4. (Optional) Last Month’s Money

Compared to the steps above, this one is relatively small to accomplish, and not necessarily… well… necessary. But it’s a little thing you can do that makes a huge difference in how much you have to worry about money. And that’s the heart of what financial freedom is, so I highly recommend it.

Set up your money routine so that the money you are spending right now is last month’s income. The income you make this month will be briefly set aside, and then be used next month. This has a few big benefits:

  • Smooth over big expenses or unexpected income drops by having a month to prepare for them
  • Break the cycle of living “paycheck to paycheck” by having everything you need on the first of the month, and never needing to wait on your next paycheck
  • Reduce how often you need to hit your emergency fund with more lead time to handle said emergencies

How do you do it? It’s pretty simple. Just save up until you have roughly one month’s income set aside. That becomes your “buffer money.” At the start of the following month, that buffer will become your money for that month, and any new income will form the buffer for the following month. For more detail, here’s a full guide on buffer funds.

What Is Financial Independence?

We have arrived at the final stage on the wealth-building spectrum: full-blown financial independence.

What it means to reach financial independence is that your continued focus, effort, and accomplishments with money have compounded to a point where you no longer need to work to survive. At this stage, your investments yield more in annual returns than you spend in that same time.

In other words, if you reach this stage, your wealth will be able to self-replicate and grow, indefinitely, whether or not you continue to work a job. This creates a wealth of new possibilities for your life that most people don’t have, like:

  • Diving into the mastery of a craft, art, or hobby
  • Dedicating a massive amount of time to charitable work
  • Moving into work that you love but doesn’t pay much or at all
  • Spending significant periods of time not just vacationing, but exploring the world
  • More time for being social, more quality time with family, full-time parenting

Sounds pretty nice, right?

financial independence definition piggy bank on the beach

FIRE Under Fire

The concept of financial independence has picked up tremendous momentum in recent years amid the FIRE (Financial Independence / Retire Early) movement. But as always, with the popularity of an idea comes resistance to it. Skeptics will say that financial independence:

  • Isn’t possible without a massive inheritance or winning the lottery
  • Is a pipe dream for lazy people who don’t want to work hard
  • Consists of nothing but struggle, sacrifice, and misery. 

These people are welcome to continue being grumpy, trapped by money, and oh – completely wrong!

The path to FIRE takes a lot of work and focus. But it’s also a joyous adventure of self-discovery and watching your life transform before your eyes. And make no mistake: people ambitious enough to reach this stage have no interest in putting their feet up and “quitting” on life. They are some of the most enthusiastic and impassioned people around.

Most people never make it to the stage, at least not until traditional retirement age. And even then, results are mixed. But it’s not because they can’t.

Anyone can do this, and that includes you. All it takes is good habits, serious focus, and patience. If you’re ready to believe that something as beautiful and miraculous as this is possible, check out the steps below.

Financial Independence Checklist

Despite this being the last and hardest of the three goals to reach, it is actually the simplest.

By creating financial security, and then reaching financial freedom, you have already achieved all the basic milestones of a healthy life with money. Chasing financial independence becomes an option only as a result of reaching those first two levels.

From there, it’s just the same three things – earn, save, invest – as enthusiastically as you can, until you hit these two milestones:

1. An Independent Wealth-Building Machine

The biggest, and only mechanical step that differentiates financial independence from financial freedom is a matter of volume. It comes down to how much wealth you have accumulated overall. Simply, you need your money to earn more money in a typical year than you will spend.

The number that is most often used here is 4%. If you can live off only 4% of your total wealth, per year, it will be able to grow at a rate that it will never run out. Some debate whether that number is exactly on point, but it works perfectly well as a rough guideline to shoot for.

Saving up to 25x one year’s expenses sounds daunting at first, I know. But this stuff accelerates quickly once you get started. And the steps you’ve already taken for financial security and freedom have put you in prime position to come absolutely barrelling down this hill. Anything else you can do to reduce your expenses, build up your income, and put it to work keeps you accelerating faster and faster.

2. Purpose

Apart from the self-sustaining wealth machine, there is really only one other thing you need to reach full financial independence, and it’s actually not directly money-related.

The ability to walk away from a job that’s not a meaningful part of your life and say “I don’t need to be here anymore” is a HUGE opportunity. But it comes with a burden. And that’s the burden of figuring out where you do want to be, what you want to contribute to the world instead.

Don’t just run away from the 9-5. Jump into something else, something that you love, that fills you up, and that brings good and joy to others. It can be another type of work, a creative pursuit, a way of giving your time to those who need it more, or so many other things. Maybe a bunch of them at once. When you’re financially independent, you can give your time to a variety of awesome things, and find huge fulfillment in all of them.

Anecdotally, I have found financially independent people to be among the happiest on the planet. But none of them does it by simply “retiring” forever. Each and every one uses the inherent power of their financial position to feed their purpose.

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Hey, I’m Sam. I created Smarter and Harder to explore big ideas, both old and new, about building a better life. My mission is to evolve the conversation about personal growth and have fun doing it.

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