Financial Freedom is a term that means different things to different people. But to simplify, can we call it the stage in one’s life when money is no longer a source of worry? This again means different things to different persons. A very rich man may be financially sated. An ascetic may also be in the same situation. So let me stop splitting hairs. Let us use this term with reference to people who are not born with a golden spoon (enough wealth for a few generations) and have to work for a living and make their way up the money tree. I suspect most of us will fall in this category.
When does one reach financial freedom? I would say it is at that point in time when you stop initiating new savings and investment plans to create wealth. You are at that stage where things seem to be going well and you no longer have to worry about that extra lunch bill or that unplanned holiday or a sudden medical emergency. You may still be working, but you are at peace with your financial situation. Now your worries are more tuned towards which stock to dabble in, which car to buy or which cause to support. Let me exclude from this discussion, the noble persons who have simplified life and are absolute minimalists and therefore don’t have financial goals.
Financial freedom is a wonderful thing to attain. From my personal life, I can only say that I got there thanks to equities and real estate. And patience. Holding on to investments for twenty years and more lets compound arithmetic do its job. In this article, I’ve tried to share learnings from my personal experience on attaining financial freedom.
As one goes through life’s journey, there are many financial milestones. Some of them are totally avoidable, but not for those who conform to societal norms forced on them by tradition and customs. Most of the milestones may be fully avoidable, but then, not many will choose to ignore social pressures, even though no one is going to help you in any way.
To get to financial freedom, you will need to begin the journey with financial planning. Savings is the first step. When you transform savings into investments, it helps you get to financial freedom a bit sooner.
Let me not get tangled up in excel sheets. Instead, let me talk about what kind of risks we assume in our investments as we progress along our earnings cycle. And some thoughts on the kind of assets we should be looking at.
The Early Earning Years
In this stage, the first (and easy) thing to do is to open a PPF (Public Provident Fund) account and plough money into it regularly. It is probably the investment with the lowest risk and as of now is tax exempt on maturity. If you can spare the money, start with the maximum permissible amount in PPF. Ideally, continue this for 25 years.
The next investment I would suggest is a monthly SIP in an index ETF. As your income rises, put in higher amounts in the SIP. This is the vehicle you should look to for real wealth creation. If you are very savvy about the market, invest every month instead of an automated SIP. I have generally found that buying the ETF directly often gets a lower price than what an automatic SIP does.
This will go a long way towards funding your retirement, provided you start with the first paycheck. What I find is that most people put off their savings and investment plans for too long after they start to earn. Compound interest works in favour of an early start. The sooner you start, the less money is needed to be invested to reach financial freedom. The accompanying excel illustrates how much the start date matters in deciding your accumulated corpus.
Importance of start date in deciding your accumulated corpus (Excel Download)
While you invest towards long term goals, it is important to keep, at any time, in bank fixed deposits or in liquid funds some cash that will take care of a year’s normal expenses. Some may think six months is enough. It depends on your sleep habits.
Where stocks fit in
As your disposable income grows, you can consider putting away something in direct equities too. To build a portfolio of potential winners, the rule is to invest decent amounts per investment and not to sell them for twenty years, unless the basic premise on which you invested, changes. Or if there is fraud.
For example, if you think that a new product or technology is such that it can be scaled up over time and you can find out that the promoter/management is not bad, you can put in some money. But it has to be that money which will not cause you pain, if it goes to zero. Finding multi-baggers is a matter of luck. You may pick ten stocks and two may become that. But this subject demands a seperate discussion. (You can read more about multibaggers here along with a real life case study of a multibagger).
And other assets
So what other assets should make it to your portfolio? I personally think, contrary to conventional wisdom, that real estate and gold should also be a part of one’s investment journey. One house ideally with a home loan in a good location is a minimum. As your income rises, your loan liability will look smaller. Thus there is no harm in stretching yourself when you are young. India does not provide you with enough stock of rental homes that one can do away with owning a home.
Even if you think your parents have given you a home, you should consider buying another in a good location. This is because a second home can solve most of the retirement worries. It can give you rental income (hence the stress on location) or can be sold after retirement.
Gold? Go for an ETF or other paper gold. How much? Say around ten percent of your savings/investments on a regular basis.
I do not know enough about cryptos or NFTs so will not comment on that.
Employees Provident Fund or EPF is a statutory saving that is thrust on every employee. I personally think it is a good savings route, so if you can, do not disturb it and let it give you something on retirement. Recently the government has made interest on EPF contributions beyond Rs.2.5 lakh per annum as taxable which somewhat reduces the past attractiveness of this vehicle. Further, in today’s economy, in the era of contract labour, not everyone will have the benefit of a statutory PF.
Health is probably the single biggest concern one should have. Even if your employer covers you for health insurance, I would urge that everyone take a separate policy, early in life. At a later stage, you may change jobs and the cover will vanish. Health insurers will not cover what they refer to as ‘pre-existing’ conditions. This makes a strong case for buying an independent health insurance policy as early as possible.
Once you retire, you may not find it easy to buy a policy. You could start with a modest policy of five to ten lakh rupees. Over time, your cover will grow and you can go for top-ups later in life. Health insurance is an expenditure. It is not an investment. So do not crib about it.
This is a very controversial subject. If you have dependents and not enough wealth to take care of them, a term insurance policy is a necessary expenditure. Buy for as much as you can afford. Once you feel that you are financially secure and that you have provided for your dependents, you can simply stop paying. Do not buy an insurance policy disguised as an investment. Money back, endowment etc are destroyers of wealth. A mutual fund is a far more efficient investment vehicle.
Mathematically, one can do without life insurance. It is a price one pays for the fear of early death. So, let us consider it as a necessary expenditure and make it efficient. One day, when a ‘negotiable’ term policy is available, it would be worth considering.
How much is enough for financial freedom
Different excel sheet practitioners will give you different numbers. This will depend on your lifestyle expectations. Some people are never satisfied and will go on saving, forgetting to have a life. There are ants and there are grasshoppers. In general, one needs a house to stay. Money for daily living. Money for lifestyle comforts. And a cover for health. Of course, there is this monster called inflation. So what you think is enough, will probably become clearer to you as you near your retirement.
Use the ‘rule of 72’. If you are 30 and at current prices need Rs.50,000 every month (beyond your house and health), and think inflation will be six percent per annum, this 50K will become 100K per month when you are 42 (double in 12 years) and 200K when you are 54, or 400 K when you are 68 and 800K per month when you are 80! At 30, it is difficult to visualize the math.
Along your investment journey, you will have your societal lifestyle costs- car, childrens’ education, their marriage and regular social or customary events. Putting down everything in an excel sheet is useful, if you are not the fuss-budget type. Often, we cannot change what we earn. We can probably adjust our lifestyles and change what we save and invest. One trap to avoid is to change the risk profile or risk laddering of our investments simply to get a higher return.
Estimating returns is a tough thing and is not in our control. I would urge people to read this old classic “The Richest Man in Babylon”. While it is a period book, the principles are no different today.
The ONLY borrowing one should ever do in life is to take a housing loan. Any other borrowing is a path to financial ruin. Credit card debt, personal loans, loans against shares, properties etc will land you in a soup. Sometimes, one is compelled to borrow for some family emergencies. But the outcome is never good.
In my view, the worst kind of borrowing is to borrow for the marriage of a child. I have seen families getting ruined by this. They are forced to sell their homes as the loan repayment pressures build up. While people are sentimental about spending on final rites/rituals, I find that it can be debilitating for many. At my parents’ obsequies, I realized that the money spent on these rituals far exceeded anything I had spent on them when they were alive! But social pressure and fear of the unknown do push us hard.
Often, many people cannot say ‘no’ when a family member or a friend asks for money. And often, some of it will not come back. Personally, I ask myself one question before giving an answer. “Will it hurt me or bother me if the money does not come back?”. If the answer is “yes” then I do not give money. Does not matter if that relationship is lost. Never lend money if you are the worrying type. Another bit of wisdom learnt from life. Never give money without consulting your spouse. It is important that both of you have the same attitude to money.
The lifestyle questions
No financial plan can be enough if our lifestyle demands are beyond our earnings. No recommendations here, except that ‘it is your life’.
In a country that has no social security, we have to think about our non-earning years. In today’s circumstances, the post-working years can sometimes be as long as the earning years. The joint family system has been confined to the pages of history. All families are ‘nuclear’. It is each one for herself/himself.
Seek help early
It is good that you speak to and engage a financial advisor as early in life as possible. Stick to the advisor. And do not grudge paying fees. They will give you guidance and perspective on savings and investment. Even if you are working in the financial services sector. Ideally, I would engage an advisor who does not have any product to sell. The road to financial freedom is simple. Starting early can save you considerable agony in later years.