Exjackly

While I will argue that the specifics of financial independence will vary from individual to individual, there are some commonalities.  Using these,it is possible to create a common definition.

Financial Independence is having sufficient mix of assets to both meet current financial needs and a comfortable probability of meeting future needs.

I suspect that you have noticed the qualifier in that definition.  It is an important one, because we are talking about the future.  In many cases, it is a future that could be 40, 50, 60, maybe even 70 years long.  During that time frame, a lot can happen that would not be predicted now.

Lets break that statement apart.

...meet current financial needs...

Current Financial needs is the defined part of financial independence.  It is what takes into consideration your current standard of living.  A 30-something individual with a $2500/month mortgage and 3 kids at home will have a hugely different set of current financial needs than a 70 year old widow with a paid off mortgage and good health.

Most commonly, 'current' for accounting or financial planning means the next 12 months.  That time frame works well for this definition too.  The idea is to have assets that will provide the funds needed for the next year without having to disrupt your current financial setup.

This can mean CDs that are maturing in the next 12 months, cash set aside for living expenses, or a planned sale of other assets that will provide sufficient funds.  It should not mean dipping into existing credit or taking on new debt.  Needing to do either indicates that current needs are not being met.

That situation can arise even for wealthy individuals.  The example would be somebody who has restricted stock that is worth millions, but cannot be sold, or someone whose wealth is all in real estate without cash reserves.  Essentially, the concern is that assets are not producing cash or cannot be easily turned into cash as needed.

... probability of meeting future needs.

This is the guesstimate portion.  Since nobody has yet demonstrated an ability to accurately predict financial markets decades in advance, there will always be an unknown element to long term planning.  The further out planning is being done, the more uncertainty there will be.

This is where a mix of long term assets becomes helpful.  It is possible that something could happen that will destroy the global economy.  Unlikely, but possible (generally it would have to kill hundreds of millions and shut down global trade).  There is also the chance that the US economy could eventually go the way of Zimbabwe or South America with hyperinflation that would destroy the value of the US Dollar.

Short of that, we have the capability to plan for success.  Looking at individual assets (stocks, bonds, real estate, precious metal, artwork, antiques, etc.) they will go up and down in value over time.  Fortunately, they generally do not all move in the same direction at the same time.  This allows us to build portfolios that will help reach our goals.

By choosing the right mix of investments, it becomes highly probable that a portfolio of assets can produce income and maintain (or grow) value for years and decades to come.  With a low enough draw down on that portfolio (4% or less a year is suggested by financial planners) the chance of success rises even more.

There are really 4 factors that influence the probability of success:

• Initial size of portfolio
• Rate of draw down
• Asset mix in portfolio
• Length of time assets need to last

Thus, a large, diverse portfolio, with a low draw down rate (2% or less) for 20 years has a much better chance of lasting than a smaller, concentrated portfolio with a high draw down rate (5%) for 30 years.

...a comfortable...

The last thing to discuss is comfort.  This is where the independence gets to be intensely personal.

Comfort is how you feel about the assets and likelihood of success with the plan.  Some people are comfortable with a large stock portion in their portfolio.  The historic returns offset the volatility enough that they are not afraid to see swings in the value of the portfolio.  Others are not and prefer to have a lot of bonds, precious metals, and real estate.

The idea of an 80% chance of success is enough for some people.  They are willing to risk a 1 in 5 chance that they will have to reduce their standard of living or return to earning more money.  Others will not be comfortable at less than a 99% chance of success.  Those are willing to work longer to improve the likelihood that they will not need to change their plans later.

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