Financial Freedom
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Financial Freedom

Overview

Definition

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There is no final definition to the concept of Financial Freedom, especially because everybody defines it slightly different for themselves. But for an understanding what is meant by it, here are some quotes regarding the topic:
Financial independence: “you should never have to do things that you don't enjoy just for the sake of money.” – Bodo SchĂ€fer
“There are many things money can buy, but the most valuable of all is Freedom. Freedom to do what you want and to work for whom you respect.” – JL Collins
“We all dream of achieving that [
] independence, that freedom. In short, we all dream of being unshakeable” – Tony Robins
“Financial Freedom means our money is working for us rather than the other way around.” – Todd Christensen

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The essence of all the quotes can be summarized as follow: Financial Freedom means our money is working for us rather than the other way around. In simple terms: the aim is to build up enough wealth, that you can easily live from its returns. That means having a passive income, which allows you to not work actively.

Source of content: SchÀfer, B. (2018): Der Weg zur finanziellen Freiheit: Ihre erste Million in 7 Jahren; JL Collins (2016): The Simple Path to Wealth; Robbins, T. (2017): Unshakeable: Your Financial Freedom Playbook; https://www.moneyfit.org/financial-freedom-means/

The 4 steps towards Financial Freedom

1 Create an emergency fund

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From your savings you should create an emergency fund, in case your car has to be repaired or you suddenly need to purchase a new dryer, for example. It surely is a first good step for a feeling of freedom, to know that you can afford a new acquisition without major difficulties.
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2 Pay off your debt

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The second step is pay off your dept. To owe someone money is quite the opposite of independence, so make sure to never spend money you don’t have.
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3 Create a runway

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The third thing to do is called „create a runway“. Whats meant by this is, you should find out what the minimal amount of money is, you can survive a month with. Then save so much money, that you can bridge three months. You just take into account what‘s absolutely necessary like your rent, insurance and food, for instance.
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4 Start a retirement fund

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„Start a retirement fund“ means to invest your money wisely, in order to create an asset, which produces money on its own, without you having to work actively for it. You can invest your money in ETFs, for example (see next section).
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Source of content: https://www.youtube.com/watch?v=ATDYLTnGJV0; Bodo SchÀfer (2000): Der Weg zur finanziellen Freiheit; JL Collins (2016): The Simple Path to Wealth

Investing in ETFs

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ETF stands for Exchange Traded Fund, which means you can buy and sell this fund at the stock market. ETFs allow you to invest in entire markets with a single security. For example, with a single MSCI World ETF you spread your investment over around 1.600 companies from all over the world. In addition to shares, ETFs also allow you to invest in many other asset classes. ETFs simply replicate a market index one-to-one and - like a share - can be traded on the stock exchange at any time. Additionally, ETFs are transparent and traded on European stock exchanges. That’s why ETFs are perfect building blocks for private investment.

Source of image:

Source of content: Morrien, R., Engst, J. (2019): Wie lege ich 50 000 Euro optimal an? Alle wichtigen Bausteine zum sicheren und einfachen Vermögensaufbau; Domash, H. (2011): Exchange-Traded Fund (ETF) Investing: What You Need to Know

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Another advantage of ETFs is their price. It’s never been cheaper to build a globally diversified portfolio of index funds. In fact, today, you could invest $100,000 and pay just $10 in annual fund expenses - equal to the cost of two Big Macs and a large fries. The low costs are an additional reason many people invest this way.
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Source of content: https://humbledollar.com/2020/07/almost-zero/?utm_source=mailpoet&utm_medium=email&utm_campaign=another-ses-test_7

Dos and Dont’s on your way to Financial Freedom

Diversify your investments

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For investing there is one golden rule: Never put all your eggs in ONE basket. That means you shouldn’t invest all your money in a single stock. You never can say for sure if the stock price will go up or if the company goes bankrupt in the worst case. So in order to minimize the risk you have to diversify your investments. As you heard before, a simple way to do so, is buying ETFs. With just one ETF you can invest in many thousands of companies around the world.
Source of image:

Source of content: Morrien, R., Engst, J. (2018): Wie lege ich 10 000 € optimal an? Alle wichtigen Bausteine zum sicheren und einfachen Vermögensaufbau

Make a savings plan and utilize the cost average effect

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Many people ask themselves, at what time they should invest their money. And the answer is always: In any case according to the theory of the cost-average effect. It describes the consequence of spreading an investment over a longer period of time. In this case, more units are purchased when prices are falling and fewer units are purchased when prices are rising, so that the units are purchased at an average price that is higher than the cheapest price of the period, but also lower than the least favorable price. So what the cost average effect basically says is that you should not invest all your money at once, because you don’t know for sure if the price at the stock market is too high or low at the moment. It’s better make a savings plan and invest 10.000 Euros for example over ten months instead of all at once.

Source of image: Own illustration [Messerer, Leonhard]
Source of image: Own illustration [Messerer, Leonhard]

Source of content: Engst, J. & Morrien, R. (2017): Wie lege ich 5000 Euro optimal an?

Keep your hands of closed-end funds

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Closed-end funds have two main disadvantages: 1. You invest only in a single project, like for example the construction of a new office building. Therefore diversification is rather limited here. 2. Closed-end funds also have fixed terms, which means you can‘t just sell them easily when you need suddenly some money For private investors the recommendation is therefore, not to invest money in this kind of asset

Source of content: Engst, J. & Morrien, R. (2017): Wie lege ich 5000 Euro optimal an?

Start your own business

Source of image: Own illustration [Messerer, Leonhard]
Source of image: Own illustration [Messerer, Leonhard]
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Out of the 100 richest Germans, 98 are entrepreneurs. So without going into detail: The numbers show that starting an own business is a good idea, if you want to maximize your fortune. Because with an own business, you no longer exchange your time for money, like you do it in a 9 to 5 job. As a business owner you have much greater possibilities and with the right idea, your earnings are basically not limited. You not longer get a fixed amount of money for your time. That’s why in terms of Financial Independence, it can be worth a thought to go into business for yourself.

Source of content: https://www.youtube.com/watch?v=5oNcoj4G0xc; Rainer Zitelmann (2015): Reich werden und bleiben, Ihr Wegweiser zur finanziellen Freiheit

Avoid buying unnecessary stuff

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Let me at the near end of the presentation give you one last tip on your way to your Financial Freedom: One of the most important rules on your way towards Financial Freedom is to spend less than you earn and avoid debt through this. Maybe you remember Sophia. She was debt free and already was able to save a considerable amount of money. Her trick is to not buy things she doesn’t need, by simply making herself clear what the spent amount of money would be equivalent to the hours she has to work for that. By imagine the life energy as a form of payment for material things, it is easier to evaluate if you really need something or if its just a unnecessary thing you want momentarily.
Source of image:

Source of content: Robin V, & Dominguez J. 2018 Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence.

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© Chair for Strategy and Organization, Technical University of Munich