Financial freedom is about having enough residual income to cover your ideal living expenses. When it comes to financial freedom, most of us may think that pure accumulation is the name of the game. And the common metric that most people including financial advisors/ YouTubers/ Finfluencers love to use to understand their financial status and how close they are to financial freedom is to simply calculate their net worth. This article will explain why net worth alone is an insufficient indicator.
Net worth is only a snapshot in time
Net worth is defined as the value of our assets minus the liabilities we owe. For example, if a person has $800,000 in assets (including their home, car, investments, and savings) and $500,000 in liabilities (including their mortgage, car loan, and credit card balances), their net worth would be $300,000 ($800,000 – $500,000).
A positive net worth may indicate an abundance of financial resources currently but it does not tell us if a person has enough cash on hand to meet existing expenses or to be able to invest in new opportunities. Conversely, a negative net worth may indicate financial difficulties, but a positive cash flow can cover living expenses and allows for more investment opportunities for future growth.
In other words, cash flow can be a more accurate reflection of a person’s ongoing financial health and how close he is to financial freedom because it reflects his ability to generate and manage cash in the present and future, rather than simply measuring their accumulated wealth at a single point in time. In the same vein, companies with high cash flow are more attractive to investors than those that simply have high net worth.
Cash flow opens us more freedom and opportunities
A positive cash flow can give one the freedom to quit his day job and still lead a financially stable life. The excess cash can be used to invest in dividend yielding stocks which establishes an income that in itself could be used in building future wealth. Apart from that, one can also have the freedom of using some of the spare cash to spend on other things such as travel and luxuries.
On the other hand, a high net worth individual might have assets that are pretty illiquid or fluctuate based on the prevailing market conditions. He might not necessarily enjoy the financial confidence that he used to when faced with market crashes and may even have to liquidate his assets at a loss in order to raise cash. Or in the event he gets retrenched or quits working, he may not be able to pay for the hefty lifestyle expenses, taxes or car loans. In such a situation there is no financial security even, let alone financial freedom.
A person can survive without any money accumulated, but he cannot easily get by without the cash flow.
Having a large net worth is useful and can give more options to create more passive income. But ultimately do not lose sight of the fact that it is only by having a larger cash inflows than cash outflows that can enable us to be financially free. If you want to stop working, you need to figure out how to close up the gap between how much you are spending and how much passive income you can be receiving. The trick is to be able to use your existing wealth to invest in income-producing assets in order to create lasting wealth. And with a positive cash flow, you will then continue to add to your net worth naturally in any case.
The greatest misconception about financial freedom I see often is the over-focus on accumulation. People tend to track their progress or level of financial success based on how much money they accumulate, aka their net worth. While having money in the bank is important, having a reliable cash flow should really be the goal.
These conflicting ideas could be why so many people think that they are on the path toward achieving freedom but never seem to reach it. They fall short of the goal because they don’t really dive into what is necessary for financial freedom and are solely focused on accumulating assets. Make #4dayweekend a reality by focusing more on generating your cashflow.
Co-Founder of The Joyful Investors and Manager of The Moneyball Portfolio. I graduated with a degree in Economics in National University of Singapore (NUS). My previous experience with traders at the Merrill Lynch enable me to realize many counter-intuitive truths about how the financial markets work and to uncover the challenges faced by many new investors. We believe that investing can be astoundingly simple and want to make financial education understandable for everyone.
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