What does money mean to you? Why is it that we are taught to set aside and save money from our income? Are we building wealth for wealth’s sake?
Wood is a material that can be cut into pieces and, with the right ingredients and planning, it can be used to build a home for a family. The same piece of wood could also be burned in a bonfire for a party. It all depends on whose hands it’s in.
In the same way money is a tool that we can use to build for the future or spend away. If we buy things today that we don’t need, one day we may have to sell the things we do need in order to stay afloat. There is a purpose for the money that we earn, whether we realize it or not. It is therefore very important to manage our money prudently and link it to our life goals.
Achieving Financial Independence:
What would you do if you could do anything? If you woke up tomorrow and realized that all your bills and dues were paid forever, how would you spend your days? Would you volunteer full time? Spend more time with your friends and family? Would you more actively pursue your hobby of photography? Whatever is the answer, financial independence will enable you to be the master of your own time. Being financially independent is an important life goal. It means having dignity and security – it means not having to depend on anyone else to look after us financially – it means not having to work for a paycheck anymore.
How do we achieve this independence? There is no secret, but I will point you to the field of Economics to understand the keys to unlocking this path. If we think about our personal economy, we have many needs but limited resources to meet them.
Economics Made Simple:
What are the resources a family has at its disposal? These can neatly be divided into three buckets: land, labor and capital. Land is the property we own. Labor is the income from the work we do, or our “mehenat ki kamayi”. Capital is any other investment we have: these can be financial investments or even the investments we make in continuing education to upgrade our knowledge and skills.
What are the needs that we have? They fall into three categories: past, present, and future. The past are expenses you are paying, for something you have purchased earlier. For example, an EMI on a phone or car you bought a few months back. Your present needs are your normal everyday expenses, the “ghar kharcha”. The future needs are money that you will require after some time. This could be a house you are planning to buy, the future cost of your children’s education, any medical procedures you may be saving for and so on.
Let’s take an example of a young professional who is just starting out her career. Today her needs: past present and future are being met from the “labour” of her salary. If she has planned well, she will be investing her income to build up her “land” and “capital” for the future. She may be investing in SIPs or in deposits to ultimately buy a house. Or she may be setting money aside to take a professional course that can help boost her career.
At some point, her investments will start to pay her back with income. Her property may start earning rent, her investments may start to pay dividend, her fixed deposits may pay her interest. If she continues to reinvest in herself, at some point the passive income she gets from “land” and capital” will be sufficient to fund all of her needs. This is the point at which she reaches financial freedom. Now she has the choice not to work anymore and the income from her assets can pay for her expenses.
Directing your “future” funds into land or capital slowly over time can help to build up income sources to eventually replace your income from labor. This is crucial and without it, financial independence is simply not possible. You may need to take a hard look at how much of your income is going toward past or present needs. Create a monthly budget that helps you to map your expenses. This will give you a breakup of your spending and will help you identify where you can cut down so that you can save more. Prudent advance planning will also help you to plan for future purchases.
This framework helps us put investments into perspective. The point of investing is to store up land and capital that will provide you with sustainable income. Focusing on that can help you weigh your choices. Where are your income streams coming from today? If you stopped working, how much income would your current land and capital investments produce for you every month? What are some ways you might be able to make more out of the resources you currently have?
Investing to Achieve Goals: Learning from the Game of Cricket:
You now have a goal of financial independence; you can break it down to a target value and a time horizon. How will you invest to achieve this goal? I will use an analogy from cricket! For a team that is batting in the second innings, there is also a target number of runs and a number of overs within which to meet them.
When planning the batting line-up, it is very important for the captain to first consider the defense. If your team gets all out in the first 10 overs then there is no chance that you will win the match. You need a Rahul Dravid like “Wall” to ensure that you are still in the game. Similarly, in investing, you need to first ensure that you protect against emergencies that may pull you down financially. Keep a fixed deposit equal to nine months’ expenses, adequate health insurance to pay for medical procedures, a term insurance to protect your loved ones from the loss of your income and pay off high interest debt. These will give you and your family peace of mind and put you in the driver’s seat of your own financial life.
Next up is the offense. You may choose to save your money in the bank and in fixed deposits. This is good and equal to the singles and doubles that batsmen take; necessary to play the match but may not be the match winners. The match winners are the fours and sixes; and in investing they would be your equity mutual funds. But you have to be careful with these: when going for a four or six, you could also very easily get bowled or caught out. Careful and prudent planning using a judicious mix of ones, twos, fours and sixes will give you the winning combination.
Retirement is generally thought of as an age beyond which we will not work. However, we also need to ensure that we have enough money to last our lifetime. Medical advancements mean that people live longer than ever before which makes the retirement age a moving goal post. It is never too late to start saving and creating a path toward financial independence.
