What is financial independence and why are more people talking about it?
Financial independence (or financial freedom) is the financial state where you have acquired enough passive income (through investments), that you don’t ever need to work again in your lifetime, to earn your living.
World-wide, the concept of FIRE (Financially Independent, Retire Early) has gained a lot of traction, but financial independence is a relatively new and less understood concept in India.
To become financially independent is fairly simple. It is not rocket science. But many a times, not doing the wrong things is more important, rather than just doing the right things. What I want to share today below are three mistakes that can have serious consequences on one’s quest to achieve financial independence. While they may be repairable, the damage caused to the journey can be severe.
Taking debt to buy a house too early
Many of us tend to buy a house early in our financial career; typically within the first 8-10 years. This is a combination of social pressure, the need to “settle down and have an own place”, as well as the pain of having to pay rent for a house not our own, when one can pay an EMI and own it. But apart from the emotional benefit that one gets on buying a house (“one’s own place”), there are many benefits for not going for this.
Early in our careers, our lifestyles are still evolving and more often than not, what seems to be nice and cozy at age 35, needs an urgent upgrade at 45.
Houses also deteriorate and beyond a certain age, start losing value, especially once newer properties are available in the same vicinity.
Last, and most important, whenever one decides to buy a house, we stretch to our maximum possible limits across both incomes in terms of EMI that we can pay and loan we can take. What this does is that it usually leaves no excess which can be saved towards growth assets.
Taking a loan to buy a house early in life ends up usually in us not being able to save enough when we are young and depriving our savings of the benefit of compounding. A simple example (annualized return of 12 percent assumed) to illustrate this point – Rs 10,000 saved every month over 20 years from ages 30 to 50 (ie. Rs 24 lakh capital), gives you Rs 98 lakh as a corpus. But Rs 40,000 saved every month over 10 years from ages 40 to 50 (ie. Rs 48 lakh capital), gives you only Rs 92 lakh as a corpus.
To worsen matters, you are left with an asset that hasn’t grown as much, requires regular maintenance, gives very little in terms of net rental yields and isn’t even the place where you would like to live for the rest of your life.
Concentrate too much on one ‘preferred’ asset class
Many customers we see at the age of 40-45, while seem to be on the way to financial independence, have too much concentration in a particular asset class. When it comes to investing, too much of the same is definitely not a good thing.
In one case, the family’s entire investment portfolio consisted of multiple houses. As their financial goals (children’s foreign education) neared, it became painfully clear that it is not easy to liquidate these houses to fund the goals. More importantly, due to real estate having been in a bad cycle now for many years, a large amount of capital could not gain from the benefit of compounding.
In another, the customer was “risk-averse” and hence preferred bank fixed deposits to market-linked investments. But in order to get that extra 1-2 percent, the customer invested huge sums in a particular cooperative bank, which all of a sudden shut shop. A large part of the customer’s net worth was wiped out, as a result.
It is always a good idea to have an asset allocation that is specific to your personal needs, and following the same. This will take care of 2 things – following your asset allocation will make sure you reach your goals, and even when a couple of asset classes underperform, the portfolio at an overall level averages out. Even within an asset class, adequate diversification helps mitigate unwanted risks.
Having the wrong priorities with money
While the first two are more “incorrect decision” mistakes, this one is more behavioural. You may get the first two right, but many a time you take decisions, maybe impulsive, that ends up putting the brakes on your core financial goals and financial independence journey.
For instance, an impulsive decision to upgrade the car to the new model in the market. For this, you might postpone this year’s savings for the children’s education goal to next year, with the thought that this lag can be caught up. What people miss is that the loss of even one year in an 8-10 year compounding journey puts immense pressure on both savings and return expectations. Just ask the batsman who plays out a maiden in the 43rd over of a 50 over cricket match, in a must-win chase.
Similarly, not putting in place the right protection nets to ensure that savings do not get depleted due to a sudden mishap. We see many customers who think life insurance is a waste since “nothing comes back” in the end. What they fail to realise is that they are living without a safety net in the very risky trapeze act, called Life. One slip is all it takes for the financial independence journey to come to an undesirable halt.
Financial mistakes are usually of two kinds – repairable and non-repairable. Investing mistakes are largely tactical, and largely repairable. Planning is far more strategic and hence mistakes made here can have a much larger adverse impact on one’s financial journey. At the foundation of any financial independence journey, lies a well-constructed and monitored financial plan to achieve the same.
Examine the above mistakes and find out whether you have made any or more of them. If the answer is yes, your financial independence journey may be in jeopardy and you need to quickly course correct in order to reach your destination, safe and sound, and in time.
