Your Freedom Number: Escaping the Rat Race - Bay Area Mastermind® (2024)

So you’ve got a business and you’re making money, but have you earned your freedom yet?

Calculating your financial Freedom Number lets you know exactly how close you are to not having to work in – or even on – your business.

Before we jump into how to calculate your financial freedom number, let’s define what it means to achieve financial freedom.

Quick disclaimer: this is not financial advice, I’m not a financial advisor or attorney or anything like that. Always consult your financial, legal, and tax professionals!

What Does Your Financial Freedom Number mean?

Financial freedom is enjoying the life you’d like without needing to work. It doesn’t mean you don’t have to work, it just means that you don’t have to actively do anything to live the life you want.

Financial independence means your annual expenses are covered from your passive income streams. In other words your withdrawal rate is less than your passive income.

If you have a number of 1 or higher, you’re producing more income than you’re spending.

Calculating Your Freedom Number

To calculate your number you’ll need two numbers.

The first number you need to know is your annual expenses (or monthly expenses if you’d prefer to do it that way).

Annual expenses include everything from things like shelter (think mortgage or rent), food, and insurance to travel expenses, fun money, entertainment, and lifestyle costs.

Secondly, you need to know what your passive income is. (Obviously, stick with the same time frame either annual income/expenses or monthly income/expenses.)

Passive means the money that comes to you without you actively doing anything. This means not your W-2 paycheck or your 1099 income or anything where you’re paid for something you do.

Passive means dividends from your stock market investments, cashflow from businesses that you own or are invested in, royalties from content you’ve published like books, profits from rental property that you own (but don’t actively manage) and so on.

Your freedom number is simply the ratio between the two. Divide your annual passive income by your annual expenses and you’ve got your number.

Freedom Number = Passive Income / Expenses

Freedom Number Calculation Examples

Ready to play with the numbers and see how this works? Let’s dive into a few examples so you can find your freedom number.

Let’s say that your investment accounts spit out $3k/mo in dividends. And your monthly expenses all in are $10k/mo. Your Freedom Number is 3/10 or 0.3. In other words, 30% of your expenses are covered by passive income.

Now let’s say your business produces $10k/mo in distributable profits (like you could be totally offline in the middle of the ocean and not doing anything in the business and still make that money). With the same $10k/mo in expenses, your number is 10/10 or 1.0.

Last example: Let’s say your investments pay out $3k/mo in dividends, your apartment rentals produce $3k/mo in profit, your book produces $1k/mo in royalties, and your business investments produce $5k/mo in distributions. With that same theoretical $10k/mo in expenses, your number would be (3+3+1+5)/10 = 1.2.

Got it? So, what’s your number?

What’s a good Freedom Number?

Anything below 1.0 means you’re not passively producing enough to cover your expenses. And you’ll need to either produce more cash to cover your expenses, i.e. work, sell assets, or grow your business/investments.

Anything over 1.0 means you’re passively producing more money than you need. And you don’t need to work, sell anything, or grow your businesses/investments.

More Important than High Income or Net Worth

You’d be amazed at the number of high income earners who spend more than they earn.

I’ve met real estate agents who despite making more in commissions year over year, were still short every month on their expenses even up to the point of making $500k/year and beyond.

With each increase in income, their spending would go up, too. They were living beyond their means and constantly trying to catch up to their level of spending.

Most people think the solution to financial freedom is a higher salary. And they hope that’ll see them through to retirement. The question comes down to what you do with the salary.

Are you putting the increased cashflow towards lifestyle? Or putting it towards incoming producing assets?

Other people look at their Net Worth and try and apply “the 4% Rule” to see if they can live off of 4% of their net worth. For many, if they’re lucky to be homeowners, have most of their net worth is tied up in the equity of their house. Unless you’re planning on cashing it out and selling your home – the equity in your home doesn’t produce income.

Until your assets produce passive cashflow, they’re assets, but not productively helping you achieve your Freedom Number.

A 1% Step at a Time Plan

Are you currently spending beyond your means? What if you took just 1% of your income and put that into savings and investments before spending anything on lifestyle? That’s pretty easy to do, right? You won’t feel 1%.

After you’re doing that with 1%, can you add on 1% again and start putting aside 2% of your income to savings and investments?

You see where this is going. You don’t feel 1%, but the little 1%s add up to something real over time.

Putting 1% of your income into savings and investments is all part of “Paying Yourself First” and creating options for yourself later. Options let you choose how you get paid.

No financial advisor would ever suggest you put all your investments into one stock. That would be terrible advice.

So why would you sink everything into one source of income (your business)? More on that in a bit when we dive into Cashflow Diversification for Business Owners…

The 4% Rule Alternative

The “4% Rule” is also known as the “Safe Max Rate” or the “Bengen Rule” after William Bengen, a financial advisor who first made the rule of thumb based on the maximum safe withdrawal rate for retirement.

The idea is that your safe withdrawal rate is what you can “safely” withdraw 4% of your retirement saving each year as income during retirement.

There are two big issues with the 4% rule, though.

First, it was made by a financial advisor looking purely at traditional stock market investments, specifically a set split between stocks and bonds.

Second, this safe withdrawal rate was based on retirement savings and is only meant to last three decades, the estimated life expectancy from traditional “retirement age” to death.

If you’re looking for to reach financial independence and be financially free before retirement and be truly financially free, you’ll want to start to create passive income earlier in life. You can retire early at your current lifestyle – or better – when you’re truly financial independent.

Your CoastFI (Or “CoastFIRE”) Number

Another related calculation is following the Coast FIRE (Or “CoastFI” for short) method.

Coast FIRE involves accumulating enough money in retirement accounts to support retirement without additional contributions. Once you hit the number you’ll need to provide retirement income, you can cover just your living expenses but no longer need to save for retirement.

Early (and sufficient!) retirement investment allows your retirement funds to compound and grow, enabling retirement at a traditional age. This strategy provides “pre-retirement” freedom.

Increasing Your Financial Independence Number

If there’s one number you want to start to dashboard or track – more important than salary or net worth or portfolio value – it’s your financial Freedom Number.

So now that you’ve got your eye on the number (Good job, you financial samurai!) how do you increase it?

There are two sides to the equation.

First, reduce income consuming liabilities. These include things like:

• Debt (do you pay your credit card statements in full each month or carry and pay for a balance?)

• Rent (are you paying someone else for shelter, or paying yourself?)

Second, create and acquire more passive income producing assets.

Examples of Passive Income Producing Assets to Improve Your Financial Freedom Number

Common examples include:

• Investment properties, i.e. real estate that you own and rent out for income. These can be single family homes, multi-family apartments, storage units, AirBnBs, trailer parks, commercial properties, office space, and so on.

• Dividend producing stock market investments

• Passive commission producing sources like life insurance sales, recurring affiliate commissions, etc

• Business investments where you get paid a dividend for owning all or part of a business. This is NOT income from working IN the business! That’s called a job.

• Royalties from publishing, like from books you publish, courses you create, intellectual property that you license, etc

*Cashflow Diversification for Business Owners

For many business owners, they’re “all in” with all of their eggs in one basket: their business.

In some cases, most people mortgaged their house to fund their business, invested their retirement savings, not taken a salary, and put all profit from the business back into the business. If anything happens to the business – poof! – everything is gone.

Savvier business owners diversify and take the excess cashflow from their business and put it into longer term passive investments like real estate. Or, they start with real estate…

For example, McDonalds isn’t in the fast food business – they’re in the real estate business.

There are currently 40k+ McDonald’s restaurants in 110+ countries. Among these stores, McDonald’s owns:

• 55% of LAND under the locations (+ long-term leases for the rest)
• 80% of buildings

McDonald’s $42B property holdings are ~80% of total assets and can be thought of like apartment buildings that collect rent.

As McDonalds’ Harry Sonneborn explained to Wall Street investors:

“We are not…in the food business. We are in the real estate business. The only reason we sell $0.15 burgers is because they are the greatest producer of revenue from which our tenants can pay us rent.”

I know martial arts studio owners, dentists, and chiropractors who not only own their own business, but buy the building where their dojo/office/etc is. While they’re working in their business, not only don’t they have to pay any rent, their commercial real estate produces passive cashflow that increases year of year.

When they’re ready to retire, they can not just sell their practice, but can continue enjoying massive cashflow from their real estate and when they’re ready, sell the commercial property for a hefty sum or pass it onto their kids…

So… What are you as a business owner doing to increase your passive income and increase your Freedom Number?

*As always, we’re not attorneys or financial advisors and this is not legal or financial advice! Always consult your legal counsel and financial professionals about what’s right for you and your business.