According to psychology, there are three conditions needed for lasting happiness. They are connection, competence, and autonomy.
Connection means having relationships with those around us and feeling part of a community. This community could be three people or it could be three hundred. Being connected with others has been shown to improve our well-being and incredibly enough our life expectancy (check out The Village Effect by Susan Pinker).
Competence is defined as “taking on challenges and experiencing mastery”. It’s working on challenging problems, mastering a craft, and creating stuff to put into the world.
Autonomy is the freedom to do whatever we want whenever we want. It’s having control of our time.
When we have these three conditions in place, it’s a beautiful recipe for happiness.
So how does personal finance fit into this puzzle? In other words, how do we use money to better master these three conditions?
The most popular idea is early retirement. Save a ridiculously high percentage of your income and retire in 10 years or less. That way you’re guaranteed to have complete control of your time (autonomy) and can spend it working on whatever you like (competence) while hanging out with whoever you want (connection). This satisfies the three conditions above quite well.
But it’s entirely possible to achieve early retirement and be miserable. You might have control over your time (autonomy), but if you spend it living a lonely life (no connection) without working on anything meaningful (no competence), the end result won’t be happiness.
On the flip-side, it’s possible to have a traditional job and be completely happy. If you have complete control over the projects you work on and a flexible schedule (autonomy), you find the work you do meaningful and you’re good at it (competence), and you work with people you’re friends with outside of work (connection), you actually have all the ingredients necessary for a happy life.
We Need “Flow”
The problem with the above scenario I just described for the traditional job is that most of us don’t actually have complete control over our work or our schedule, and odds are we aren’t best friends with the people we work with.
This is why early retirement is such an appealing idea for many people. The idea of having enough money to never work again sounds like a gift from above. Most of us have been crammed into a 40-hour, commute-heavy, deadline-filled work environment for so long that we have learned to associate work with drudgery and dullness.
But what most of us forget is that doing work we enjoy can actually offer a huge boost to our happiness. Psychologist Mihaly Csikszentmihalyi wrote a wonderful book called Flow, which explains how doing work we enjoy can enable us to enter a “flow state”, which is a highly focused mental state that brings us deep satisfaction. By working on projects we care about and find meaningful, we can experience this flow state and find a ton of satisfaction in our work.
The problem is that most of us don’t have the financial freedom to step away from work we hate and step towards work we love. But gaining this freedom might not take as long as you’d think.
A Mix of Active and Passive Income
Financial independence is having enough passive income to cover your expenses. Many people think this is the best way to achieve maximum happiness, and in many cases this may be true. But I’d argue that there is a way to achieve maximum happiness with a mix of passive and active income.
For example, consider a family of four that lives on $40,000 a year. To be financially independent, they need roughly $1 million (25 times their annual expenses).
Perhaps both parents work stressful 9-5 jobs and earn a combined $100,000 per year. After taxes they take home maybe $75,000. This means they have $35,000 left over each year to save and invest. According to the Early Retirement Grid, they’ll achieve financial independence in a little over 18 years:
But what if they just discovered the concept of financial independence, they’re in their early 30’s with two young kids and don’t want to work full time for the next 18 years? This is an example where complete financial independence might not be the best way to maximize their happiness.
Instead, this couple might be better off working for 3-5 more years, building up a stash of $150,000 – $200,000 and transitioning to part-time work or starting their own side business. During the 3-5 year window they could start working on a side business on the evenings or weekends so by time they leave their full-time jobs they have a nice foundation built for the business.
Even if the part-time work or business doesn’t work right away, thanks to their savings they have plenty of time to figure out how to earn money without immediately needing to seek out full-time jobs again.
Find Your Mix
For many people, complete financial independence can be the best route to achieving the three conditions for maximum happiness. Namely, high-income professionals and people who master the art of frugality can achieve F.I. in only a few years.
But it’s just a fact that some people are in situations where they’re not able to save a huge percentage of their income and achieving F.I. is significantly harder. For these people, just having enough savings set aside to pivot to a new job, work part-time, or start their own business is actually a better (and faster) route to achieve maximum happiness.
Recently I tweeted out my thoughts on this:
It’s great to have passive income, but if you can create a work situation where you earn active income and enjoy it, you can experience autonomy, connection, and competence all without being financially independent. And for many people, this is much faster and easier to achieve than complete financial independence.
There doesn’t exist an income formula that works best for everyone. Whether it’s 100% passive, 100% active, or something in between, there are all kinds of blends that can enable you to live a happy life. Just know that it’s possible to achieve maximum happiness without achieving 100% passive income. Active income is not the devil.
Find the mix of active and passive income that works best for you.
Zach is the author behind Four Pillar Freedom, a blog that teaches you how to build wealth and gain freedom in life.
Zach's favorite free financial tool he's been using since 2015 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
Although the bulk of his net worth is invested in index funds, his favorite place to invest in individual stocks is M1 Finance, a site that allows you to build a custom portfolio of stocks for free.
His favorite way to save money each month on his recurring bills is by using Trim, a free financial app that negotiates lower cable, internet, and phone bills with any provider on your behalf.
His favorite micro-investing app is Acorns, a free financial app that takes just 5 minutes to set up and allows you to invest your spare change in a diversified portfolio.
His favorite place to find new personal finance articles to read is Collecting Wisdom, a site that collects the best personal finance articles floating around the web on a daily basis.
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