This week I attended a cash flow and debt management masterclass as part of my continuing professional development. These are areas that I am passionate about and two areas that are often neglected by clients despite being foundational to long term wealth creation. At the very start of the day, to set the scene, we discussed the importance of cash flow and debt management and one of the identified benefits was to assist clients to become financially independent. The facilitator then asked the group, “What is financial independence?” to which there were varied responses across the group.

For some context, the group was made up of advisers from all over Melbourne and each catering to different client demographics so it’s not surprising that each adviser had a different perspective on financial independence. The agreed upon definition was that financial independence is being able to meet your financial commitments without worry. I think this definition is not sufficiently aspirational and I don’t think it would resonate with many people. Don’t get me wrong, being able to repay your bills as they fall due without having to juggle money or forego lifestyle goals is a step in the right direction but not true financial independence. Allow me to clarify.

Financial Difficulty

This represents living pay-cheque to pay-cheque and often struggling to meet your financial commitments. This would also be characterised by those who need to consistently seek extensions on paying bills, those who seek out pay-day lending to help manage their cash flow, and those who have limited (or no) emergency funds.

Financial Comfort

This represents being able to meet your financial commitments without worry. This would be those who have a cash flow buffer and sufficient emergency funding. Generally they would not need access to short term credit – using credit cards for convenience but repaying them in full monthly. As their commitments fall due, they are able to pay them in full and on time (if not early). Critically, while cash flow is well managed, these people are still reliant on their income as they do not have sufficient financial capital to meet all their ongoing needs indefinitely.

Financial Independence

As you may have inferred from the explanation of the previous stage, financial independence is more about accumulated wealth and how these people source their income rather than whether or not they can meet their ongoing cash flow requirements. These people have sufficient passive income or financial means to meet their ongoing living costs and would include self-funded retirees for example. The key distinction is that in this stage, people have decoupled their financial security from their labour or capacity to work to provide for their ongoing needs.

A little bit of pedantry?

Some may look at my distinction between comfort and independence and simply see it as nit-picking but I think it is actually more fundamental than that. As I said before, I see those who seek financial independence as aspirational and to build wealth to allow you to retire from work (if you choose) as a worthwhile but challenging endeavour. I also see the difference between the three stages not so much as a financial distinction (although that may often be the case) but moreso as a difference in mindset, particularly for those who are seeking to move from one stage to another. They key to success is in the mindset and, as a result, the actions taken to achieve that goal.

I also think the stages as I have outlined them hint at the different steps and financial skills required in the different stages. To illustrate, someone currently in financial difficulty would benefit from strategies around cash flow management and perhaps better debt structuring. Whereas someone in financial comfort would benefit more from wealth creation and asset structuring strategies.

Of course, this is still a fairly generalised framework but I think it is a better and more useful model than the simplistic definition proposed in the workshop I attended.

How does this framework apply to your situation and/or clients? What steps are you taking to move to the next stage of your financial future? And does this framework help clarify your goals? Let me know in the comments.

Categories: Musings

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