From Alexander Weis and Gerd Kommer
“Financial freedom” is a trending buzzword. If you enter the search terms “financial freedom” or term variations such as “financial independence” or “passive income” on Amazon.de, the website spits out more than 1,000 books on the subject. On Google, the number of hits for these search terms is in the three-digit million range. Articles about financial freedom have spread epidemically in the financial blogging scene in recent years. A surprisingly large proportion of finance and money blogs revolve almost exclusively around this concept and its variations.
In this article we want to show that and why the hip term “financial freedom” has degenerated into a speech bubble and empty investment fashion. Investment fads often have a detrimental effect on the assets of those who follow them - as experience with investment products and strategies shows. So the question arises: Could this also apply to the harmless and positive concept of financial freedom?
If you take a closer look at what “financial freedom” (hereinafter abbreviated “FF” for the sake of text economy) means in the financial advice book market and in the blogging scene, it quickly becomes clear: the harmless-sounding FF term means everything – and its opposite. We illustrate this below by identifying four fundamentally different FF variants, some of which overlap and others which are mutually exclusive. The generation of “passive income” plays a role in all four FF versions, albeit in different forms and weightings.
FF variant 1: Get rich quickly and effortlessly through clever investing.
An example of this FF interpretation is the financial advice book “The Path to Financial Freedom – The First Million in 7 Years” by Bodo Schäfer. The book “Day trading for beginners – financial freedom through success on the stock market” by Thomas Dahlmann also takes the same approach. This is quite simply and openly about getting rich quick. The problem: This FF book category is full of absurdly unrealistic strategies for achieving prosperity and wealth. Historically, the FF concept of Schäfer and his American predecessors (the best known including Robert Kiyosaki with his book “Rich Dad, Poor Dad”) was the first, original FF variant.
FF variant 2: Work radically less and/or retire earlier.
This FF version is primarily about “taking back control of your life” and “finally no longer trading five days of work for two days of free time.” In the books and financial blogs, a strange mix of recipes is propagated for “breaking out of the hamster wheel”, “ending the treadmill of being an employee” and “more efficient self-management”. In particular, you should focus on activities that are fun, “freeing” and either cost nothing or are financially lucrative. A core element in this FF variant is the pursuit of early retirement (cooler: “Early Retirement”). Two examples of the approach are the advice books “Successful Financial Freedom While You Sleep” by Elisabeth Raynor and “Financially Free – How I Managed to Live Without Money Worries at 45” by Monika Reich. The book titles alone make you smile and in fact when reading the texts there is sometimes a danger of confusing the advice books with satire.
FF variant 3: Financial freedom by starting a business.
According to the representatives of this approach, which is “less comfortable” compared to the previous variant, it hits three FF sub-goals with one stone: Firstly, as a company founder you no longer have to be told anything by your previous, incompetent boss, so from day one you are “freer” than before. Secondly, you can now finally “free” your creativity and thirdly, since your previous boss is no longer a constant brake, you will almost inevitably earn more money. Two books on this FF approach are “Retiring at 28 – Financial freedom in just a few years” by Lars Joppich and “Passive income through T-shirts. Earn money online step by step” by Theodor Schäfer. Even when reading these titles, one might at times be mistaken that it is satire. The author of the first book mentioned boldly argues that leaving employment in order to start a business should be equated with the start of retirement.
FF variant 4: Save your way to financial freedom.
The idea here is to get out of the “consumer society”, to stop buying “superfluous” or “pointless” products and to generally “waste radically less money”. In practical terms, this means permanently reducing your consumer spending by 70% or more. As a result, you can afford to work significantly less, e.g. B. only one day a week or only six out of twelve months. This naturally results in more fun and enjoyment of life. You also protect the environment because you only use what is “really necessary”. In this country this FF approach is called “financial minimalism”, in the American original “frugalism”. Behind this lies brutal savings as a path to FF. Frugalism has now become the dominant FF concept worldwide. The books and blogs on this subject have long since passed the limit of countability. Perhaps the most famous is Frugalist Mr Money Mustache in the USA.
Interim conclusion: The different recipes that are marketed around the emancipatory-sounding speech bubble “financial freedom” are either trivial (“only spend money on really important things in life”), mutually exclusive (“get out of the hamster wheel” versus “get rich quick”) or are well-known, hackneyed investment pornography (“the first million in seven years,” etc.). [1]
The Düsseldorf doctor and financial blogger Dr. In 2017, Holger Grethe (www.zendepot.de) published a clairvoyant article entitled “Financial freedom is an illusion”. Grethe is right. Anyone who thinks a little more carefully must come to the same conclusion. Why does he think FF is a chimera?
Let's assume for a moment that someone - let's call him Hans - already has a great, intellectually and ethically fulfilling job with intelligent, likeable colleagues. Hans earns 6,400 euros net, i.e. four times as much as an average German employee (measured by the median employee income). Hans finds his salary to be appropriate and more than adequate. Is Hans “financially free” or at least on the path to financial freedom? Maybe, maybe not. Han's extremely valuable human capital, from which he derives his high income - in a mentally and morally satisfying job at that - could implode overnight and become worthless. Think of a serious illness, a tragic accident or the bankruptcy of your employer. Then the 6,400 euros would be over – today and, in the worst case, for the rest of his days. Hans is also not really “financially free” from this perspective – and, curiously enough, this is the perspective of the FF apostles themselves. Like probably 99.9% of us, he too is dependent on the continued existence of some central positive factors (many of them very fragile) and the absence of many negative factors in his life and his environment.
What about starting a business as a route to financial freedom, as recommended to us in FF Mutation No. 3? From the perspective of Gary Becker, a Nobel Prize winner in economics, starting a business means: low-risk human capital with limited upside and downside potential from being an employee is transformed into high-risk human capital with less limited upside and downside potential from being an entrepreneur. Here are a few simple statistical facts: For around 90% of all new businesses, this happens within five years Game over. Probably another 90% of the remaining 10% results in an income for the founder that, in the long term, is no higher than that of a senior executive in the same industry, but is more labor-intensive, stressful and risky. What this has to do with “freedom” is not even clear to us at second glance.
We find the concept of “passive income” particularly funny. Let's say Maria, living in a rural area, wants to earn passive income, but one worthy of the name, not just better pocket money. Maria is by no means aiming for an overly ambitious level, but “only” the already mentioned average income of a German of 1,600 euros net per month. However, it shouldn't come from employment - that would be "active" income and also income that would come with an unsympathetic boss. Maria therefore read up on real estate know-how in various FF books and blogs. [2] She dreams of an “interest house”, an apartment building that she rents out and can then live on from the “passive” income. Now Maria starts to do the math. In order to generate rental income of 1,600 euros per month, i.e. 19,200 euros per year, she first needs investment capital. It assumes – a little optimistically – a long-term rental return of 4% after taxes and costs. This results in an investment amount of 480,000 euros. If she had that as equity, the case would be broken. However, Maria only has 50,000 euros and would have to finance the rest on credit. The consequence: Every euro of the 480,000 euros that is obtained through a loan contributes to an immediate reduction of the 1,600 euros per month that Maria is aiming for, for 10 to 30 years. With a very cheap loan with an effective interest rate of just 2%, this initially means halving the 1,600 to 800 euros per month. The moral of the story: In order to generate passive income, even on the rather modest scale that Maria has chosen for herself, you have to be rich beforehand. What was it like to be financially free? become? Not to mention that purchasing and managing an apartment building is not a “passive” activity, but rather, in a very old-fashioned and uncool way, means hard, active work, often on Saturdays and sometimes on Sundays. [3]
On closer inspection, the concept of passive income turns out to be quack medicine that, in the best case, does not help and, in the worst case, brings the patient underground prematurely. Caleb Hill presented this wonderfully clearly and soberly in his little book: “The Passive Income Myth”. [4]
FF is a term that has been mutilated beyond recognition by its apostles and can mean anything and its opposite. The gullible readers of FF books and blogs are explicitly or implicitly foisted with five illusions:
- investment returns that no one will ever achieve;
- The statistically low chances of success in starting a business and the stress associated with it are glossed over in a rose-tinted light;
- Deprivation and stinginess are dressed up as “independence”;
- the distant future is valued as more important than the present; and
- Working as an employee is portrayed as a prison from which you have to escape.
The functioning of the respective FF formula is - not surprisingly - proven by his disciples in a rather poor way - without exception through "anecdotal evidence", i.e. selectively selected individual case histories. And even these individual cases can hardly ever be verified. Statistical facts and scientific support? None.
Let's come to our final conclusion:
- In order to generate significant passive income, you have to be rich beforehand.
- Anyone who is not already rich but wants to be rich will most likely not achieve this by speculating on the capital markets - they will have to start a company instead.
- Starting a business is difficult on the one hand and risky on the other. In many industries, it also requires considerable start-up capital. With a lot of luck and hard work, the founding of a small minority will, after many years, result in something that can be benevolently called “financial freedom” but does not have to be.
- If you are dissatisfied with your current job and/or feel stressed, but are not already rich and do not want to go down the difficult path of starting a business, you should - in a very banal and old-fashioned way - look for another job or gradually work less, e.g. B. through part-time employment or by taking one month of unpaid leave each year.
- Anyone who wants to become “financially free” via thrift must accept that this will result in a substantial decline in their standard of living – immediately and in the future. An unplanned side effect could be the reduction in your circle of friends and acquaintances.
One final question remains: Why do so many FF advice books and blogs exist if they propagate something that rarely helps in increasing one's wealth, is often even harmful or is accompanied by a draconian reduction in living standards? The answer is simple: These books and blogs exist primarily to generate a few crumbs of passive income for their authors.
Of course, “financial freedom” is not inherently bad. Nobody has anything against building wealth, be it through fund investments, starting a business or thrift. However, if this terminology, which seems so libertarian and innocent, is worn down into a completely arbitrary and often contradictory rubber concept and mixed with obvious investment pornography, not only is no one served, but damage is done. The established financial industry has not produced a glorious track record over the past two and a half decades. It would be desirable if advice book authors and financial bloggers set their own standards higher.
Endnotes
[1] A small calculation example for Bodo Schäfer's specific FF goal of "the first million in seven years": Anyone who initially invests 100,000 euros needs an average return of 39% p.a. a. (after taxes and costs) to get to a million in seven years. Apart from the fact that such a return in seven consecutive years has only been observed with Alice in Wonderland, the question arises as to where the initial 100,000 euros will come from. If you start with less, the return must be even higher.
[2] Real estate as a source of passive income plays a prominent role in many FF concepts. Presumably because they can be partially financed through external financing and because many people naively believe that they can successfully select, develop, finance and manage real estate projects.
[3] Sure, Maria could outsource this to a property manager. After all, she wanted “passive” income and didn’t want to argue with annoying tenants on the weekend. But then the equation could be: 1,600 euros minus debt service minus administration costs = 0. One consolation: the loan will (probably) be paid off in 25 years.
[4] It may be of secondary cultural and historical interest that Marxist class fighters called for the ban on “passive income” 150 years ago. What was meant was the “unemployed” income of the bourgeois capitalists. The recently active squatters in some major cities in Germany think similarly.
literature
Grethe, Holger: “Why financial freedom is just an illusion”; blog post; Internet reference: here (Page last visited on May 17, 2018)
Hill, Caleb: “The Passive Income Myth”; The secret to using what they don’t tell you about passive income to gain financial freedom (Financial Freedom Series); 2016.