It is important that everyone understands the basics of personal finance and also uses them effectively.
Any individual has two types of income. Insured income as well as uninsured income.
Insured earnings are those that will continue to flow, whether you are personally working or not. For example, rents, dividends, royalties, interest, etc.
On the other hand, uninsured earnings are those that stop flowing the moment you stop working. For example, paycheck, bonus, etc.
Similarly, there are basically two types of expenses. Fixed expenses like taxes, debts, insurance, household expenses, etc.
To achieve “personal financial freedom” we should be concerned with a flow, which we can call the flow of freedom. This is the difference between the total expenses and the insured income. On the other hand, if the result is positive, it implies continued incarceration in the debt trap.
There is a simple formula by which you can determine how long it would take for a person to achieve “personal financial freedom.”
N = Freedom Flow / AIOP x Plow
Where, N = Number of years needed to reach the freedom threshold.
Freedom Flow = Total Expenses – Insured Income
AIOP = Insured income that can be generated as a percentage of the plow. A conversion of 10% is a good reference.
Distribution = (total income) – (total expenses). This is the money available for conversion into assured income.
For example, if it is for a person,
Insured income = $ 25,000
Total income = $ 1,00,000
Total expenses = $ 85,000
PIA = 10%
So the plow is $ 40,000.
So, as it stands, the number of years required to reach the threshold would be:
60,000 /. 1x 40,000 = 15 years.
Now, let’s say that the person can reduce their total expenses by 20% and improve their AIOP to 15%, then the number of years needed for it to reach the threshold would be:
43,000 / .15 x 57,000 = 5 years.
Such is the power of this equation, which essentially means that we should
Keep the flow of freedom as low as possible. Increase income and reduce expenses.
Maximize AIOP
Maximize the plow back.
However, this formula does not take inflation into account. Better to use this as an indicative tool rather than parse it for precision.