Financial Independence

“Financial Independence” means different things to different people. There may not be a universal definition for it, but it helps to understand the subject a little. I often mind myself debating these concepts with friends, and this post is my way of capturing some of my key learnings on the subject…

Tony Robbins captures the essence of Financial Independence in a five-point scale

#1. Financial security. This is achieved when you have sufficient passive income to cover the very basics in your life like the rent (mortgage), bills and basic food.

#2. Financial vitality. At this level of financial independence, your passive income can allow for more things like clothes, going out and having fun, and basic holidays.

#3. Financial independence. This is the level where your passive income is sufficient to allow you to have your current quality of life.

#4. Financial freedom. At this level of financial independence you can up-step your lifestyle to the one you desire.

#5. Absolute financial freedom. This is the level where money stops being an issue and you can do anything you want.

When I first encountered this, what struck me is that for Level One itself, Robbins speaks of a “passive” income that achieves these metrics. i.e. Income generated whether you show up to work or not. This may be via investments in real estate, securities or a business that you own – not one where you trade-off your time to earn money (as in a job!)

Now, if you are currently in debt and have little savings to show for your earning years, you may think that attaining even the first level with “passive” income is an impossible dream.

Why is that?

The Times of India featured an excellent article by Uma Shashikant on the (often mistaken) advice we give to our children when it comes to their future career, and financial goals. In it, Shashikant makes a very valid argument that “what is true of the parents’ world is not necessarily true of their children’s world.”

If you are an Indian, it is most likely that your well-wishers (parents included) brought you up on a steady diet of the age-old maxim: Buy a house!

Buying a house is not always “good advice”. It actually depends on a number of factors, including:

1. Your personal Life goals
2. Your current Life stage
3. The Rent vs Buy equation in your particular city / region

But, the social pressure to do it (for most Indians) is so much, that most do not take a step back and evaluate all the options objectively.

The fact is, having a primary residence (owned by you) is not necessarily a good “investment” for you. At best, it represents an asset for those you leave behind, but comes at a very high cost that you need to bear during your lifetime.

There are a few exceptions to this, of course:

1. It can be a part of your diversification plan, if you are talking about a second home as an investment opportunity, and have the disposable income (no financing needed) to be able to afford it.

2. You would like to start “investing” in a home, even if it is located away from your desired place of work/stay, and stay in a rented property in the meanwhile, to benefit from Real Estate appreciation. This works as long as your monthly mortgage (EMI in India) is less than 50% of your monthly take-home income and the Rent vs Buy equation is no more than 1:2 (not the 1:5 it presently is for most of developed India!). If you can tick those boxes, then years down the line you have the chance to sell off the remote property and “upgrade” to the one you could not afford at the time, having met part of the investment requirement through its appreciation.

However, that is not typically the case. And, in thousands of cities across the world (including in India), it is way cheaper to rent a house than to buy one – whichever way you crunch your worksheet.

If you depend on a monthly salary for income, it makes little difference if your current house – the one you live in – appreciates in “value” by several million. With increasing income, when we “upgrade” our lifestyle, it is often accompanied by moving to an even larger (read: more expensive) home with accompanying debt. And, that is precisely why you should think – ten times – before taking up a loan that you will need to service for decades to come.

If you are not riddled with a huge debt at this early stage, and have the discipline to put away 15-20% of your (ever growing!) income in a sound Investments Plan, you have a real shot at building a corpus. Combine this insight with the Power of Compounding, and you may just be on your way to a significant “passive” income.

And, that would be worth the reward, wouldn’t it?!

 

Note: This blog post is strictly an educational and informational service, and does not constitute personalized investment advice. The commentary, analysis, opinions, advice and recommendations represent the personal and subjective views of the Editor, and are subject to change at any time without notice.

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