“Financial freedom” is a buzzword with renown status. If you enter the search terms “financial freedom” or similar term variations such as “financial independence” or “passive income” on Amazon, the website spits out more than 1,000 books. For Google, the number of hits for these keywords is in the three-digit million range. In the financial blogger scene, articles on financial freedom have spread epidemically in recent years. An astonishingly large proportion of finance and money blogs revolves almost entirely around this concept and its alterations.
In this post I want to show that and why the hip term “financial freedom” has degenerated into a speech bubble and empty investment mode. Investment modes are often detrimental to those who follow them – as experience with investment products and strategies teaches. So, the question arises: Could this also apply to the harmless and positive concept of financial freedom?
Looking more closely at what “financial freedom”, abbreviated to “FF” for the sake of text economy, means in the financial advisory book market and in the blogger scene, it quickly becomes clear that the harmless-sounding FF term means pretty much nothing. This is illustrated below by identifying four fundamentally different FF variants, some of which overlap and others are mutually exclusive. The generation of “passive income” plays a role in all four FF versions, albeit in different forms and weights.
FF variant 1: Get rich quickly and easily with clever investing
An example of this FF interpretation are the financial guide books that are around. Book evolving around “Day-Trading” stings also in the same vein. They always suggest that it is very easy and an option to everybody to get rich fast. The problem: This FF-book section is teeming with absurdly unrealistic strategies for achieving wealth and prosperity. Historically, the FF concept was first stated by, the most famous among them all Robert Kiyosaki with his book “Rich Dad, Poor Dad“, who issued the first, original FF variant.
FF variant 2: Work less radically and / or retire earlier
The primary purpose of this FF version is to “regain control of one’s life” and “no longer having to exchange five days of work for two days of free time”. In the books and financial blogs, some curious recipe mixes are propagated to “breaking out of the hamster wheel”, “ending the treadmill of employee life” and to a path of a “more efficient self-management”. In particular, one should focus on pursuits that are fun, “free” and either cost nothing or are financially lucrative. A key element in this FF variant is the pursuit of early retirement. An example of this approach is the guide book “The 4-Hour Workweek” by Timothy Ferriss. Even the book titles make you smile and in fact, when reading the lyrics, there is sometimes the danger of confusing the guidebooks with satire.
FF variant 3: By starting a business for financial freedom
The representatives of this approach, compared to the previous variant is “less comfortable”, proposes with it three FF sub-goals with one stone: First, as a company founder, you have to take no advice of the previous, incompetent boss, so starting off day one you are already “freer” than ever before. Secondly, you can finally “free” your creativity and, thirdly, you will almost inevitably make more money, as the previous superior as a perpetual brake is eliminated. Three books on this FF approach are “Start Late, Finish Rich” by David Bach, “Start Your Own Business” by Entrepreneur Media and “How To Make $100,000 Per Year In Passive Income And Travel The World” by Chase Andrews. Even when reading these titles, one could temporarily be in the wrong, and assume it was about satire. The author of the first mentioned book represents the courageous thesis that the retirement from the employee’s existence for the purpose of setting up a business equate to the beginning of the pension.
FF variant 4: Save yourself in the financial freedom
Here is propagated to get out of the “consumer society”, no more “superfluous” or “pointless” products to buy anymore and generally “radically less money to waste”. In practical terms, this means permanently reducing consumer spending by 70% or more. As a result, you can afford to work much less, so for example only one day a week or only six of twelve months. This naturally results in more fun and enjoyment of life. Furthermore, it protects the environment, because you only consume what is “really necessary”. This FF approach is called “financial minimalism”, in the US the original community resulting out of this is the F.I.R.E. (Financial Independence, Retire Early) movement or so called “frugalists”. Behind it is a hidden savings system and with the so gained excess money to be invested as a path to FF. Frugalism has become the world’s dominant FF concept. The books and blogs have long since passed the limit of countability. Perhaps the most famous frugalist is “Mr. Money Mustache” in the US.
The different recipes, which are marketed around the emancipatory sounding bubble “financial freedom” are either trivial (“spend only money for really important things in life”), exclude each other (“out of the hamster wheel “Versus” get rich quick “) or are well-known, hackneyed investment pornography (“the first million in seven years “).
A doctor and financial blogger published in 2017 a clairvoyant article with the title “Financial Freedom Is An Illusion”. The blogger is right. Anyone who thinks more closely about it, must come to the same conclusion. Why does he consider FF a chimera?
Imagine for a moment, someone – let’s call him Peter – already has a great, intellectually and ethically fulfilling job with intelligent, sympathetic colleagues. Peter earns $6,400 net, which is on over four times as much as an average employee. His content Peter considers appropriate and more than adequate. Is Peter “financially free” or at least on the way to financial freedom? Maybe, maybe not. Peter’s very valuable human capital, from which he gets his high income – in a mentally and morally satisfying job – could implode overnight and become worthless. Think of a serious illness, a tragic accident or the bankruptcy of his employer. Then it would be over with the $6,400 salary today and at worst for the rest of his days. Even Peter is not really “financially free” in this perspective – and curiously, the perspective of the FF apostles themselves. He is also – as probably 99.9% of us – dependent on the continuation of some positive key factors, many of them very fragile, and in the absence of many negative factors in his life and environment.
What about a start-up as a route to financial freedom, as recommended in FF variant # 3? Starting up a business is, in the view of Gary Becker, a Nobel laureate in Economics: low-risk human capital with limited upside and downside potential from employee engagement is transformed into risky human capital with less limited up and downsides from entrepreneurial activity. Here are a few simple statistical facts: For about 90% of all start-ups, “Game Over” is called within five years. Probably a further 90% of the remaining 10% will lead to an income for the founder, which in the long term is no higher than that of a manager in the same industry, but more labor intensive, stressful and risky. What that has to do with “freedom” is not even revealed to us at second glance.
Especially funny we find the concept of “passive income”. Let’s say that Jenny, is living in a rural area, and wants to earn passive income, but one that deserves that name, not just better pocket money. Jenny is by no means aiming for an overachieving level, but “only” the already mentioned average income of an American turns around $1,600 net per month. However, it should not come from worker employment – that would be “active” income and also income that would go hand in hand with an unsympathetic boss. Jenny has therefore read in various FF books and blogs about real estate know-how. She dreams of an “apartment building”, an apartment building that she rents out and whose “passive” income she can subsequently live on. Now Jenny starts to calculate. In order to generate rental income of $1,600 euros per month, or $19,200 per year, it first requires investment capital. She assumes – a little optimistic – a long-term rental yield of 4% after taxes and costs. This results in an investment needed of $480,000. If Jenny had that as equity, the case would be achievable. Jenny, however, has only $50,000 and would have to finance the rest on a mortgage.
Each dollar of the $480,000, which is procured via a mortgage, contributes to an immediate reduction of $1,600 per month income, that Jenny envisaged for the coming 10 to 30 years. With a very cheap mortgage an effective yield of only 2% is only possible, this means initially a halving of the $1,600 to a $800 a month salary.
The moral of the story
To achieve passive income, even on the modest scale that Jenny has chosen for herself, one must be rich before. How was that going to make her becomming financially free? Not to mention that buying and running a multi-party rental house is not a “passive” occupation, but rather bourgeois-old-fashioned and uncool hard active work, often on Saturdays and sometimes Sundays as well.
On closer examination, the concept of passive income turns out to be quackery medicine, which in the best case does not help and, in the worst case, prematurely puts the patient under the ground. Wonderfully clear and sober, Joseph Hogue has presented it in his booklet “The Passive Income Myth“.
FF is a term mutilated beyond recognition by its apostles, which can mean everything and its opposite. The bona fide readers of FF books and blogs are explicitly or implicitly hyped by five illusions:
- Investment returns that nobody will ever reach;
- The statistically low chances of starting a business and the stress associated with them are pinked over;
- Deprivation and avarice are impelled to “independence”;
- The distant future is considered more important than the present; and
- Work as an employee is portrayed as a prison from which one must escape.
The functioning of the respective FF-formula is – unsurprisingly – proven by his disciples in a rather meager way – invariably by “Anecdotal Evidence”, so selectively designated individual stories. And even these isolated cases are almost never verifiable. Statistical facts and scientific corroboration? None.
Let’s come to our conclusion:
- To generate appreciable residual income, you have to be rich or put in the work before.
- Those who are not rich yet will most likely not achieve this by speculating on the capital markets – but they have to start a business instead.
- Starting a business is tedious on one hand and high-risk on the other. It also requires substantial seed capital in many industries. With much luck and hard work, the foundation for a small minority, after many years, is followed by something that can benevolently be called “financial freedom” but does not have to.
- Anyone who is dissatisfied with his current work and / or feels stressed, but not already rich and does not want to go down the hard road of starting a business, should – quite banal and old-fashioned – looking for another job or gradually work less, for example part-time employment or taking one month of unpaid leave every year.
- Anyone who wants to be “financially free” on the route of frugality must accept that it implies a substantial decline in their standard of living, both now and in the future. An unplanned side effect could be the reduction of the circle of friends and acquaintances.
One last question remains
Why do so many FF guidebooks and blogs exist when they propagate something that rarely helps, often harms or even brings about a draconian lowering of the standard of living while increasing their own wealth?
The answer is simple
these books and blogs are there primarily to generate a few crumbs of passive income for their authors.
Of course, “financial freedom” is not bad per se. Nobody has anything to say against wealth creation, be it via fund investments, via business start-up or via savings. However, when this so libertarian and innocent terminology is torn to a completely arbitrary and often contradictory rubber concept and then whisk with obvious investment pornography, not just nobody is served, but damage is done. The established financial industry has not produced a fame record in the past two and a half decades. It would be desirable if advisory book authors and finance bloggers set their own claim higher.
I am going to do it and I share my path with all of you on this blog!
What are your thoughts on this critical piece and do you think that it is possible to become financially free with a good strategy? Share your thoughts below in the comment box with the community now – thank you and F.I.R.E. away.