Financial Freedom
It is the process of recognizing the value of what you own or owe and the risk involved with the decisions you make. In the section before this we discussed how good Money Management; Earning, Saving, Spending and Donating can give you a strong foundation for personal finance. However, just like the foundation of a house keeps it from falling down, it won't protect a house from fires, vandalism or high winds. Putting up a fence could help keep out others who would harm your house and in Financial Freedom we are going to look at how you can protect yourself from financial threats. To do this we will explore the four major sections:
Assets and Liabilities,
Risk and Risk Management,
The types of insurance
and watching out for Scams and Schemes.
Here we go!
What you own
& What you owe!
The first step in protecting what you own is to know what you have and what you owe. Starting with the first part, the stuff that you own (have paid for and it is yours) would be considered assets.
Assets: this is the property that a person owns that has value. To say it simply this is what you Own. If you think of your bedroom there are many things in there that are valuable. Your clothes, bed, furniture, personal belongings all have value and technically you could sell them in order to get money. However, there are also wealth creating assets. These we would call investments.
Investment: this is an asset (something you own) that you spend money on with the hopes of it creating more money in the future. If a person were to start a business that would be an example of an investment. Not only do they own it, they are profiting (making money) from it. Your pair of sneakers are not an investment because they won't create new money (you could sell them but they won't grow a new pair of shoes to sell). Other investments could be a house, antiques, stocks, bonds, and mutual funds as well as other items. We will look at this more in The Intelligent Investor.
When you have valuable things it is important to practice good Stewardship. This means recognizing the value of assets (and relationships) and putting in the work to keep them in good shape. The first part of Financial Freedom is to really to be grateful and intentional in taking care of what we own.
Next, we need to be aware of what we Owe. In the world of finances we call these liabilities.
Liabilities: this is when you owe money for something you have purchased or are responsible for. To say it simply this is what you Owe. One of the quickest ways to lose your freedom is to be in debt, because it will limit your decision making. Say you are asked by a friend to go on a trip to a theme park, but you can't because you already promised to work for you mom to pay off the new pair of shoes she bought for you. In the adult world, this could look like someone not being able to purchase a house because they still owe to much on a car loan. The important thing to understand is the difference between wise debt and dumb debt.
For example, when purchasing a house with a loan (mortgage) you are gaining ownership and gaining value (besides you have to have somewhere to live). This would be an example of wise debt, depending on the interest they charge you and how long you live there. Say you borrow $1000 to throw a block party for your friends. You buy the food, set up the lights and have a blast. However, that money is gone and now it is up to you to earn or find $1000 to pay them back plus interest (And you really didn't have to do it). This could make it hard to pay your bills and add unnecessary stress to your life.
To protect your Financial Freedom we must first recognize what we Own and what we Owe. Next, we will look at the Risks that are out there and how to handle them.
Risk?
The second step in protecting what you own is to recognize risks. Everyday when you wake up you are encountering risks. The pair of shoes you put on in the morning could result in sore feet or the jokes of friends or hallway bullies. So what does risk mean?
Risk: the chance involved in making decisions that could result in profit, advantage, danger, harm or loss. For example, when you get a new phone what is the first thing you do? Some people would download all the apps they love, others would make a phone call to a friend and others would purchase a phone case and screen protector. The trick though is knowing yourself, if you drop things often you probably want to get a case as soon as possible. This is recognizing the risk involved with having your screen exposed. It stinks to have a cracked screen and with a little forethought you could prevent it from breaking. This leads us to how to Manage Risk.
Different situations require different actions. Here are five ways of handling personal and financial risk:
Avoiding Risk: This is when a person takes steps to not be involved in a certain risk. (If a person is frightened of sharks they won't swim in the ocean. If a person is allergic to peanuts they stay away from places that serve them. If person doesn't like another worker they make sure they have different schedules).
Retaining Risk: This is when a person accepts the risk involved and instead of seeking help continues to do it. (If a person skateboards they know that there is a possibility of getting hurt. If a person buys a new computer and chooses to not get insurance they will have to pay completely for its repair or replacement).
Reducing Risk: This is when a person take steps to make the risk less. (If a person goes biking they wear a helmet and stays off major roads. If a person has health insurance they reduce what they will have to pay if they should get hurt).
Transferring Risk: This is when a person gives there risk to someone else instead. (If a person has a dog that is ruining their furniture they could give it away. If a person doesn't like mowing they can hire someone to do it for them).
Sharing Risk: This is when a person takes on the risk with another person or organization. (If a person plays on a sports team they are sharing the risk of winning and losing together. If a person has insurance they, as well as many others, are paying in to the company with the expectation that they will have a larger sum of money if an accident or emergency should occur).
Now, with each of these ways of handling risk a person needs to consider the Cost Versus Benefit. It is worth having insurance (sharing risk) on your home because if something should happen its a huge amount of money to replace to it. If a person would decide to never go in the ocean (avoiding fear) because of a fear of sharks they may miss out on something they would love, its not worth it! This leads us to our next way of protecting your Financial Freedom through Insurance!
Insurance!
The third step in protecting what you own is understanding what insurance is and which types will best serve you and your family. As was mentioned before Insurance is a form of shared risk. This means that instead of you taking all of the risk on by yourself, you have someone to count on. So what is insurance?
Insurance: This is when a company agrees to pay for the cost of damage and loss and in return you pay a monthly premium (your monthly payment).
As we mentioned in Risk you have to weigh the Cost Versus Benefit of having insurance. Today you can get insurance on just about everything, even Clown Insurance! Sometimes one of the benefits of working somewhere is that they will help provide health insurance, which is a huge monthly cost. Here are some other important words when talking about insurance:
Premium: This is the amount you are required to pay for insurance.
Deductible: This is where you agree to pay a certain amount before insurance will cover you. People do this in order to reduce their premiums. (Say you just bought a new boat and want insurance on it but you don't think anything bad will really happen to it. You could choose to have a $1000 deductible, which would greatly reduce your monthly payments. If your boat blows up you still have the insurance to cover it but you take on the risk of paying more of your own money).
Claim: This is a formal request for insurance to cover a cost covered by your plan. (If you should get in an accident you will want to contact your insurance agent to report).
Knowing these words will help you understand the world of insurance. Here are four major types of insurance that most people are familiar with:
Health Insurance: This is a type of insurance that covers costs related to medical needs and emergencies.
Life Insurance: This is a type of insurance that provides money for those who depend on the insured person. (In the case where a person dies early on and leaves behind a family that depends on them, this money can be used to cover their costs for monthly expenses, college, special events and other things they would have help provide).
Beneficiary: The person who the insurance holder wants to receive the money.
Homeowners Insurance: This is a type of insurance that covers cost associated with damages to your home. Renters insurance is similar, except that it covers cost for the place you are renting.
Car Insurance: This is a type of insurance that covers cost related to car accidents and other damage to your car. There are three major types of car insurance:
Liability Insurance: This car insurance covers the debt that a person would owe for damage to a person's property or injuries they received in an accident caused by them.
Collision Insurance: This car insurance will cover the cost of repair or replacement if a car is in an accident with another vehicle or object.
Comprehensive Insurance: This car insurance will covers damages other than a collision and even if a person's car is stolen.
In the process of protecting your Financial Freedom Insurance is a tool that will help you manage the risks. Next, we are going to look at Scams and Schemes and how they are trying to steal our money.
Scams and Schemes!
The fourth step in protecting what you own is watching out for Scams and Schemes. You get a phone call, they say you have won a free trip to the super bowl, but you first need to pay a small fee of $500. Is it really free? The next day you notice someone made a withdrawal of $1500, you've been scammed!
Scams and Schemes: this is the use of deception (lying) to steal a person's money or assets.
This is usually a part of a system of crime that takes advantage of technology and attacks the uniformed. They usually try to get a person with fear or favor. For example, your grandma gets an email from the FBI telling her to send her bank account information or she will be arrested within the hour (reality is that the FBI would never send an email like that, someone is impersonating them!). While Mike is playing his favorite online game it shows an add for free game bucks, just click on the link. He clicks on it and suddenly his computer starts freaking out, he has been hacked!
The best way to stop scams and schemes is to understand them. Here is a list of common scams (some illegal and some legal):
Phishing: this is when an scammer sends email or text ask you to give them your personal information (often impersonating a real company or organization).
Identify Theft: this is when a scammer gets your name, phone number, social security number or other information and then creates accounts and charges costs in your name.
Loan Scam: this is when a fake company promises to help you consolidate loans (making multiple loans into one), charges a fee but never provides the loan.
College Financial Aid Scam: this is when a fake company promises to help you find scholarships for a fee but never actually helps you.
Pyramid Scheme: this is an organization built on recruiting members in order to make more money. The people at the top make the vast majority of the money and the new members often just lose money.
Payday Loans: this is where a person is able to get cash before payday, without a credit (money trustworthiness) check and has extremely high interest rates. So high that most people get trapped paying for years on them.
Rent to Own Company: this is legal company that allows people rent and buy furniture, computers and many other items. The end cost of renting to own could be three to four times the original cost of a new item (not used like most of their items).
This is truly just a small list of them types of scams that are out there. An amazing resource for learning more and being aware is the FTC (The Federal Trade Commission). If you or a loved one has been scammed contact them and they can help you. When it comes to being Financially Free, watching out for scammers is not an option. Next, we will examine how Financial Freedom influences your Money Management.
Financial Freedom meets Money Management!
Here we are at the end! We have covered Assets and Liabilities, Risks and how to manage them, Insurance and Scams and Schemes. Let's take a last look to see how each of these affect money management.
Assets- When it comes to earning, saving and spending you are building up your assets (things that you own that have value). As we talked about with stewardship, it is important to spend money to care for things (washing your car, cleaning your room, fixing your house).
Liabilities- When you borrow money that has consequences. Often the solution is earning more money or spending less money. This is why it is important to save for large purchases.
Risks- The job you decide to pursue (education) and take (employment) will affect the amount you will earn. You are taking a risk when making that decision. The ways of handling risk finds themselves all throughout our spending decisions. We can reduce our risk by researching a product before buying it.
Insurance- when we have insurance we are protecting the many things we have worked to purchase and own. A lifetime of earning could be lost in an emergency without insurance.
Scams and Schemes- these are the worst because they make their living by stealing what your hard work has earned. The money that you spend on a scam could be put to good use for other things. They look to take advantage of kind hearts that want to help when donating to a charity scam.
As was mentioned at the beginning, Money Management is not enough. You need to be intentional about staying Financially Free. If you have enjoyed this you maybe interested in the process of Investing. You can learn more in the section called The Intelligent Investor. Thank you reading!
