Everybody wants more and more of it. While “it” being money cannot buy happiness, it is essential for happiness. Understanding financial freedom and planning for full or partial financial independence can become quite a chore, but many today are attracted to it for various reasons. Among its benefits are obvious ones like a steady flow of income without having to work for it. In contrast, the others are less obvious benefits like gaining ‘financial wellbeing’- mental peace and the ability to provide for others and help them if you feel like it. Millennials today want this freedom and want it fast. If achieving financial freedom in 7 years or less is your goal, here are some pointers for you.
The primary and basic conception of financial freedom
Financial freedom is understood as being able to do things whenever you want without the worry of their costs in the back of your head. Whether it’s impulsively buying an expensive watch, buying organic vegetables without looking at their prices or having peace of mind at the age of 45, people understand the concept of it very differently from others. The simple philosophy behind this is: your life’s needs and lifestyle don’t warrant the same things as the next person.
Contemplate what defines financial independence for you thoroughly. To nudge you in that direction, a suggestion would be to think about what you want life to look like in seven years or so. What amount of income would sustain you and your family in 7 years? Do you want a house or car of your own? What areas will account as significant expenditures for you- schooling, hospital bills or a wedding? How many times do you want to travel in a year?
You might want to make a note of all this separately as targets to be achieved.
The essence of financial freedom to for the people
A goal requires a purpose. Let me put things into perspective: younger people crave financial freedom so they can pursue more recreational activities like travelling. Similarly, a middle-aged person might want to work fewer hours. Whatever your reason may be, listing them out is imperative to the planning process. These will serve as reminders throughout your journey to financial freedom and will remind you why you started and why you shouldn’t stop when the going gets tough.
Can anyone ever be too young to start?
This is a trick question. The answer is no, and you are not too young. The earlier you start, the more you’ll have to invest monthly to reach your goal. Starting in your late teens with even a small amount of money can have you partially independent in 5 years with proper planning and maintenance behaviours. It gives you a lot of flexibility so you can retire at 30 if you wish or keep working because you enjoy your work (not because your work pays you!). So start your financial reservoir young. Now coming to the actual pointers:
- Change how you think about money
You need to stop looking at money as the ‘root of all problems’ or that ‘money makes people bad’. Moving away from such firmly held beliefs, that may not be entirely true does have a psychological effect: it consciously or unconsciously opens up more opportunities for you to make money and feel less cynical about the prospect of managing your finances as a whole.
Spend time educating yourself about money. Read books, newsletters and newspapers to get an understanding of money, finances and the economy. Morgan Housel explains the psychology behind money here. Understand how money works and how you can make money work for you. Change your mindset from that of a consumer to that of an investor and identify the difference between your wants and needs.
You might want a laptop but do you need it or can you perform the same work on your PC? Your needs are things without which your life is disrupted, and your wants can often lead to frivolous spending. Lastly, know that instant gratification will not ensure long term success in financial freedom. Resist buying into whims now, and your rewards will multiply long-term.
- Invest in yourself first
This involves making yourself a skilful human resource through education or learning more skills and knowledge in your area of interest. You can do this by getting into a right college, completing valuable certificate courses, etc. This will ensure a better income when you enter the job market. Don’t worry if you do end up with student loan debts, and they will eventually be paid off once you get a good income.
- Budget religiously
Calculate a target you want to hit to achieve independence. Now put down your income and all your expenses from your rent to your Netflix subscription on an excel sheet. From here, individuals should see how much money is saved in a month how to save to reach their target. With a goal of 7 years or less, you should be looking at 80% of your income going into savings. Once you have your numbers, you can set things into motion.
- Pay off mortgages, loans and debts
Debts eat away at your savings, so try to pay them off as soon as you can. There are two approaches to this- taking on high-interest loans first is statistically advisable. Still, many use the ‘Debt Snowball’ way and tackle low-interest loans first to motivate and build momentum to get to the big ones. Now, you can start saving up.
- An Emergency Fund
Something most people forget to do is save for a rainy day. Investing all your savings is unwise because it can have you borrowing during unforeseen circumstances. A lesson from the current pandemic: things that can go wrong will go wrong. Leaving about 6-12 months of your salary for this is sufficient. How you do that is up to you- some keep it at home and others in a fixed deposit. With what is left, invest the amount and avoid thinking about it for at least a few years.
The importance of Understanding Compounding and Investing
The savings you make must be invested for them to grow. When you save without investing, inflation rates will reduce the value of your money steadily. Investing isn’t about making significant decisions, but it is about making consistently fewer mistakes. Imagine you invest Rs. 10,000 at an interest rate of 10%. In 7years time, it will multiply into almost double the amount. Hence, don’t underestimate the power of compounding.
With the savings you have, you can invest them into low risk or no risk options like fixed deposits, recurring deposits and Post Office Savings. Low-risk options will give you significantly fewer returns than what medium risk options will give you. If you plan to invest in a low-risk option, I suggest you use this RD Calculator to see how much money you will get at the end of your maturation term (say seven years) with interest.
Coming to deciding on medium risk choices, there are choices like mutual funds and stocks. If you choose mutual funds, you can use this predictor by Edelweiss to help diversify your portfolio. It will help you choose which mutual funds to invest in based on a risk assessment and your need to save, reach a target or cut on taxes. While bonds are safer than stocks, the ROI on stocks is better in long-term but volatile in short-term.
How much should one invest in bonds and stocks primarily depend on your choice of strategic asset allocation concerning returns:
- Ultra Aggressive for returns of 9% or more
- Moderately Aggressive for returns of 8% or more
- Moderate Growth for returns of 7% or more
- Conservative when your focus is preserving your capital and not getting high returns
A rule of thumb is to maintain 100 or 110 minus your age in stocks and the rest in bonds. This means at 20, you should aim for 80% in equities and 20% in bonds. As you grow older, it is often advised that you steer clear of stock index funds because of market downturns and risk. You can also consult a financial advisor to help you regulate how much of your investments go into bonds and stocks in your financial portfolio, keeping in mind the seven years you have to get returns for your investment. Choosing high-interest deposits which can be rolled over after maturity is what you should aim for. This will allow your money to multiply from itself and grow.
Consider saving funds in Retirement Accounts
If your sole purpose is to save enough to retire, you could consider saving your funds in a retirement account. Some of these come with tax deductions, which means putting your funds here reduces your taxable income and you can save a little when you pay your taxes each year.
In India, most pension accounts are EEE (tax-exempt on investment, return and withdrawal) or EET (exempt on investment and return but taxable on withdrawal). Some viable options for people in India are Employees’ Provident Fund and Public Provident Fund where the investment is tax-free up to 1.5 lakh and withdrawals are tax-exempt too. The interests are decided by the Government every year, and the rate is 8.50% for 2019-2020. National Savings Certificates are also comparable to 401k pension accounts in the USA but aren’t very popular in India yet.
Lay emphasis on acquiring assets & not liabilities
When you buy something, make sure it adds value to your income in some way. For example, if you are trying to save up, buying a car to rent out is more advisable than buying a car for yourself. That way, the car you buy will contribute to your income rather than take away from it. Similarly, buying property to rent out is a good idea rather than buying a property you want to live in. It is quite essential to conduct in-depth research before finalising big purchases.
One could sign up to various real estate newsletters and spend 2-3 months researching before purchasing a property. Now is the time to talk about something many financial experts don’t mention: have multiple streams of income. If you are looking at a short span of seven years to achieve partial or full financial independence, you need to make most of your productivity. Find freelancing work that you can do part-time or run side hustles (some people have up to 6 sources of income with a full-time job!).
After a few years, you can completely switch to being a freelancer too. The freelancing market is highly competitive because the amount you earn per hour at work is relatively lesser than how much you could earn per hour freelancing based on your skillset.
Live a frugal life
This does not have to be a life without any luxuries. Once your income increases, you might be tempted to make purchases with hefty price tags, or you might ask yourself, “If I can afford this, why shouldn’t I buy it?” Giving up a few things now can lead to much space to do as you please later on- this may include that Netflix subscription or your dream laptop.
A lifestyle beneath our means is understated but necessary because the goal you want to achieve is costly, and will become costlier if you choose to make bad decisions. Spending money is directly proportionate to saving money and, therefore, people should spend it wisely. If you find yourself slipping, automate your savings, so the investment amount you’ve decided per month is withdrawn from your salary account to other accounts.
How does financial independence let you retire early?
Is it okay to retire early? How many earnings will you need to retire early? Of course, you may want to work for a more extended period but have you thought about retiring early and having a peaceful job? Financial independence almost requires you to invest 70% of your annual income into saving or investment to retire. There was a movement started in 1992 “your money your life “, many people start working at an early age and get tired of working and want to live their other dreams.
When you start working, try setting out small amounts into permanent and temporary savings, try not to spend too much on unwanted fantasies, you may use temporary savings for important events of your life. Still, the other part of saving which is permanent that investment should be made for like 20- 30 years investing in LIC, mutual fund, shares may give you proper retirement plans and benefits too by which you may be able to retire young.
Such plans and policies help you invest at a level where you get higher returns and initial amount on every stage of particular age and tenure of years. Financial independence is achieved by not spending unnecessary money, tremendous savings, and proper investments and planning for your better life and your goals, career goals play an essential part if you want to retire early and independently.
An overview of the matter
Living from paycheck to paycheck is an idea long-gone- financial freedom gives you a safeguard against the volatile economy and makes you realize you don’t have to always work for money. In a nutshell, financial independence is possible in 7 years or less provided. You are willing to plan appropriately and put in the hard work into making it happen.
