DECLARE YOUR FINANCIAL INDEPENDENCE
Financial obligations, bills, EMIs and the ticking clock making you feel shackled? Don’t worry, you are not alone, and there are ways to free yourself of these constraints
Who does not aspire to be financially independent? Nobody wishes to be dependent on others for money. The bad news is that becoming a financially independent person depends on several factors and circumstances in life. Financial independence does not happen overnight; you need to put yourself on the path to it, and the earlier you declare your pursuit of it, the greater the chances of your achieving it. Use the occasion of India’s 75th Independence Day anniversary to embark on the journey to your personal financial independence.
For the uninitiated, financial independence means having enough income to meet your needs without having to work for a living. The premise being, if you are financially independent, your assets will generate sufficient passive income to pay your living expenses for the rest of your life. Another way to understand is that someone who is financially independent is not reliant on others or any employment to meet their financial needs. They can live using their assets and the income they generate.
As one does before undertaking any financial plan, you will need to draw up a roadmap to see how you can achieve financial independence. You will need to imbibe several basic and some complex financial principles unique to you. Define your unique plan and develop a tunnel vision in pursuing it. You could make a start by setting a year by which you wish to become financially independent. Figure out what your financial priorities are. For instance, someone’s priority could be becoming debtfree by the age of 45; another may want to save at least 25 per cent of their net income.
DELAYED GRATIFICATION
Have you seen the way some people act when they see something new and they have to get it immediately? Like a new phone model when their existing one is working perfectly fine; or renovating a home they had just done up a few years ago—these people have no sense of selfcontrol when it comes to spending money. They whip out the cash or credit card, feel pleased with their decision and often end up figuring out later that it had cost a bit more than they had assumed. Such a mindset about money can lead you to financial ruin in no time.
FINANCIAL INDEPENDENCE MEANS HAVING ENOUGH INCOME TO MEET YOUR NEEDS WITHOUT HAVING TO WORK FOR A LIVING AS YOUR ASSETS GENERATE PASSIVE INCOME TO MANAGE EXPENSES FOR THE REST OF YOUR LIFE
Of course, these are all generalisations. There are people out there who make savings goals for big purchases and budget for impulse purchases. But the number of such people falls in the minority category. Easy credit, living pay cheque-to-pay cheque is a way of life for many these days. Unknowingly, many individuals land up in avoidable financial situations, wherein a significant part of their income goes into managing debt. The result: they have less money to save and invest, losing out on the opportunity for their savings to grow over time.
Suppose you have the option to take a cab to work every day for a month or take public transport but go on a nice short break at the end of it. Which one would you choose? The choice of a nice break at the end of the month is obviously what many would prefer. A quiet getaway at the end of the month is tempting. However, in real life, we tend to choose the immediate benefit of getting a cab for convenience and are most likely to let the weekend getaway, which is a good 30 days away, slip.
Often, we spend our money on less useful things rather than saving and investing it. Willpower is a scarce commodity in today’s society but it can help you achieve more success, especially in personal finance. The concept of delayed gratification is a must for this. Delaying gratification is the action to resist the temptation of immediate pleasures and waiting for bigger rewards in the future. It turns out our ability to delay gratification can predict our success in life, according to several studies such as the popular ‘Marshmallow’ test.
Take, for instance, the case of three friends: Amar, Akbar and Anthony. They all graduated in the same year and started working at age 25. Amar started to invest Rs 5,000 a month from the day he started earning. Akbar wanted to have some fun with his newfound financial freedom and started investing Rs 5,000 every month once he got married at 30. Anthony went a bit further and started investing only when he was 35, well after he was married and had children. They all decided to invest this sum till they turned 55. Assuming their investments fetched an equal 12 per cent returns, the 5-year delays have offset the corpus each one of them accumulates when they are 55 (see Power of Delayed Gratification).
By delaying the investment journey by just 5 years, Akbar ends up with a corpus just under half of what Amar has built. Anthony, with his 10-year splurge, has nothing much home to write about. The lesson for all those aspiring for financial independence is to form the habit of delayed gratification when it comes to spending money. Every rupee saved and invested has the potential to help you realise your financial goals faster and also find more money when you actually need it.
While delayed gratification can help you achieve long-term goals, it is important not to overdo it. If you cut all your expenses and live extremely frugally, you might save a lot of money but you would also be miserable. After all, the goal of saving money is to live a better life, both now and later. Finding the balance between living in the moment and planning for the future is the key to a great life, similar to what independence within reasonable limits and rules means.
SETTING REALISTIC FINANCIAL GOALS
You are the best judge of your financial situation and
any amount of data can be just that as long as it doesn’t match what your needs or affordability are. For instance, for some, Rs 5,000 a month to save and invest would be a lot, whereas for others, it may be a fraction of what they can commit.
The key to becoming financially independent is setting realistic goals regarding your financial issues. These goals could include education, career, spending habits and how you save money, among others. Realistic goals are the kind that you can easily achieve, without much struggle.
If you set unrealistic financial goals, you are likely to get frustrated. Unrealistic financial goals mean that you are unlikely to achieve them. For instance, when you can save only a maximum Rs 25,000 a month, it is futile to set a plan for investing a much bigger amount towards meeting your numerous financial goals. It is better to set achievable goals than go about having them only on paper.
One should avoid creating goals that are too extreme. Suppose your goal means that you need to invest Rs 10,000 a month for the next three years but you can’t invest more than Rs 6,000 at the moment. Instead of giving up on the goal, it would be wise to make a start with what you can and build on it. You can increase your savings and investments towards this goal over time. This way of setting and working on realistic financial goals is more sustainable than going from saving nothing to saving a much higher number. Use the same approach to work on several financial goals simultaneously instead of fully channelising your savings into a single goal.
CUT EXPENSES, INCREASE SAVINGS AND STAY OFF DEBT
If you cut expenses, chances are you will end up saving more and vice versa. It is important you realise what is important for you today and what is important for the future. But do not deprive yourself of everything in the quest to increase savings. The way to increase your savings and, in turn, investments is to look for additional income streams by taking up more work. This may not be possible for everyone, but if you can get additional work without compromising your current job, it can prove to be a good way to increase your savings.
If you are a singleincome family, you could look at your spouse taking up a part-time job or one that doesn’t disturb the functioning of the house. If you both are working, one of you may consider pursuing further skill enhancement options so that it could increase your income or create additional work stream in your spare time or a completely new employment opportunity that could solve your concerns about saving more. This too isn’t as easy as it sounds, but many people have worked towards increasing their income or earnings by doing exceptionally well at work.
The habit of living within one’s means will go a long way in saving money and disciplining you in living within a budget that meets your current expenses and works on your future financial goals. Frugal living doesn’t mean you compromise on the quality of your life; it means to not get swayed by your income. Likewise, your credit card limit is not wealth; it is just readily available money that will cost you if you use it, especially if you are unable to repay the outstanding in total.
Remember, the cost of borrowing money is often more than the returns that you may earn from your savings. For instance, a bank savings account pays you under 5 per cent interest, but the cost of borrowing money from the bank for a year is a lot more than that. Borrow only if necessary and repay the loan in full and as early as possible. Loans aren’t all bad, in fact they can help you advance some of your financial goals and may even help you cre
DELAYED GRATIFICATION IS THE ACTION TO RESIST THE TEMPTATION OF IMMEDIATE PLEASURES AND WAIT FOR BIGGER REWARDS IN THE FUTURE
ate assets.
For instance, it is nearly impossible to buy a house these days without a loan. The upside of taking a home loan, especially if you plan to move into it immediately, is that it saves you from the rent you pay. You also own the asset, which over time has the potential to appreciate in value. If you account for the tax savings you can claim on repayment of a home loan, the overall benefits of borrowing to buy a house are immense. Likewise, a loan taken for one’s education or for that of a spouse or child from recognised institutions is another loan that builds assets.
Like the home loan, an education loan too comes with tax benefits on its repayment. An additional advantage is that it can help you gain knowledge which may result in increasing your earnings potential. This is a way to increase your income later in life for self and for a family member to boost the family income. Any other loan such as one to buy a car or any other electronic or white goods will cost you more when you buy it on a loan. However, if it is essential or helps you save on time or is a convenience to the family, go for it since the payoff may be better than the cost of the loan.
INVESTMENTS, RETIREMENT, TAXES
Wealth creation and dedicated retirement savings are necessary for financial independence. Eventually, once you retire—at whatever age—the money left with you should be enough to make you financially independent, for which you need to plan. The way to build wealth is by investing your savings. There are several instruments out there in which you could invest and save money. An easy way out is saving in financial instruments that are well regulated, market-linked and also indicate the risks involved when investing.
That said, all financial products and investment choices have their own advantages. The trick is in aligning the investment you choose with your goals and the risks you can take while investing. For instance, investing in equities through mutual funds or ETFs (exchange traded funds) is a smart way to go for wealth creation. Investments in these instruments are flexible—you can invest as per
IF YOU SET UNREALISTIC FINANCIAL GOALS, YOU ARE LIKELY TO GET FRUSTRATED AT NOT BEING ABLE TO ACHIEVE THE RIGHT RESULTS. THIS MAY KNOCK YOU OFF THE PLANNED PATH
your convenience and as much as you wish. Investing in mutual funds comes with several flexibilities too—you can choose the investment time-frame to match the financial goal for which you are investing and also the investment risk that you can afford to take.
There are dedicated retirement savings instruments such as the NPS (National Pension System), the EPF (Employee Provident Fund) or the PPF (Public Provident Fund) in which you could invest to save for your retirement. Then there are mutual funds as well as specific insurance policies that are dedicated towards long-term savings and investments. These have the potential to grow in value and build sizeable wealth and a retirement corpus. Having created the corpus, you need to have a plan to draw from these savings an income stream that can be used in your financial freedom phase.
You can create a combination of fixed and variable income streams. The fixed income could take care of your fixed expenses that go towards day-to-day household expenses, while the variable income could come in handy to address unexpected expenses such as for travel or a wedding. Instruments such as annuity are a good way to create a fixed income stream; however, a fixed annuity is treated as income and taxed accordingly. But when you withdraw or redeem investments from a mutual fund scheme, you could do so in a tax-efficient manner so that it does not impact your wealth.
As much as you would like to gain from wealth creation, taxes are a reality.
Depending on the income bracket you fall under, you will pay income tax on your income in your earning years. However, when you use the saved sum in retirement as an income stream, you have the option to do so in a tax-efficient manner. There are also tax savings avenues when you are earning income in the wealth creation phase that could benefit from tax savings. When planning your financial independence journey, do so taking into account taxation and how it would impact your savings as well as the actual income that you draw from them.
Considering that most of us hardly have any expertise in managing all these financial aspects on our own, it may be worthwhile to engage the services of an expert. A financial planner who could assimilate all these complex aspects and help you build a plan and help you realise your financial independence is worth hiring. You will not only have expert inputs, you will also be able to focus on your core strengths—earning—while enjoying the other aspects of life without constantly worrying over how you will manage it all. A financial planner will assess your risk-taking ability, and help you form realistic financial goals and work on achieving them for you.
A planner will also factor risk management tools such as contingency funds, life insurance and health insurance to reduce any financial impact due to risks arising out of job loss, death or a health scare. Moreover, they will also help you draw up a will to ensure your assets have clear titles and they are passed on to people or in a manner as you wish them to be transferred after your lifetime.
If you want to live like most people can’t, you have to be willing to do what most people won’t. Achieving financial independence means you can do whatever you want in life without having to worry about money. It is the privilege of being free to enjoy the balanced lifestyle of our dreams, without ‘working for a living’ getting in the way too much. It is also not about quitting work altogether, you just have to feel secure enough to be choosy about your work, and your schedule.
There will be times along the way when you want to give up because you too want to do all of the things everyone else gets to do. When you feel that way, just imagine what life will be like once you’ve become financially independent. You can do what you want to do when you want to do it. If you can stay the course and achieve early financial independence, you will find it is all worth it. ■
DELAYING GRATIFICATION IS THE ACTION TO RESIST THE TEMPTATION OF IMMEDIATE PLEASURES AND WAIT FOR BIGGER REWARDS IN THE FUTURE