In the last article we saw that it is possible to achieve financial freedom. We will see now how exactly to achieve it and plan for the execution. We have to accept that realities are always different from the ideal solutions and are also difficult to achieve but not at all impossible. Some factors will not be in our control and hence it is important to understand the worst case scenarios and possible paths to achieve financial freedom. We'll divide our plan for financial freedom in 5 steps.
Step 1
Payoff all your debts and loans before starting your goal of financial freedom. This is the most basic requirement as compounding is working in favour of banks and lenders and therefore against you. Only and only if the money borrowed is growing at a rate more than the interest paid to banks/lenders, it works for you.
Step 2
Decide the important factors that decides your financial freedom. They are :-
1. Your expected monthly expenses once you are financially free.
2. The tenure (year) by which you expect to get financially free.
3. Your current income and the stability of that income.
4. Financial Instrument in which you will invest.
5. Your savings that you will invest in the financial instrument that will not bother you for your emergency situations.
Step 3
Understand the different financial investment options and risk associated with them. Below are the financial instruments for continuous small-bet investments from least risky to most risky.
1. Public Provident Fund (PPF) ( returns 7-8.5%, lock-in 15 years)
2. Bank Recurring Deposits ( returns 5-8%, no lock-in)
3. Pension plan through NPS ( returns 5-12%, lock-in till age 60)
4. Liquid Funds (SIP) ( returns 7-9%, no lock-in)
5. Equity Mutual Funds (SIP) ( returns 0-15%, no lock-in)
6. Stock Market Investments ( returns 0-30%, no lock-in)
Step 4
Do the maths and decide on the important factors. Let's take an example of Rahul (30 years old), who sets his goal of financial freedom of 15 years from now and has a salary of 40k per month (4.8 lakhs). He lives with his wife and his average monthly expenses is 20k.
To find the investment option, we need to be sure if he can pay his expenses after 15 years. Let's consider the average inflation to be 6% i.e his expenses are growing at 6% annually.
When Rahul will turn 45 i.e 15 years from now, his inflated expenses will be roughly 5.75 lakhs. As expenses for kids will also add up, lets increase the expenses by 40% for safe margins that will be roughly 8 lakhs.
We need a investment option that will provide Rahul at least 8 lakhs rupees as interest every year after 15 years from now so that he is financially free.
Rahul starts his PPF and starts investing 1.5 lakhs annually at a interest rate of 7%. He finds this attractive as he is saving tax on this amount. He will make a corpus of 40 lakhs from this after 15 years.
As his salary will also appreciate and he is determined to get financially free, he works hard and manages to save more 2.5 lakhs every year for last 10 years before financial freedom. He starts investing this amount monthly as SIP in a Equity mutual funds with CAGR (compounded annually) returns of 10%. He knows the risk associated with stock market and believes that over long-term indian companies have bright future. He will make a corpus of roughly 45 lakhs from this in the last 10 years.
So, after 15 years he will have corpus of 85 lakhs on his invested amount of 43 lakhs.
Rahul needs around 10% interest on his corpus of 85 lakhs to manage his expenses of 8 lakhs. Rahul does not want to take risk on his hard earned money and finds that there is no such instrument that will give consistently 10% interest every year.
He choses a LIC Jeevan Akshay life annuity scheme where he will get 6.5 lakhs annually for life time (52k monthly). He is happy to budget his life in those expenses. Rahul gets retired at age of 45.
Step 5
Remember to have reserves and surplus for emergency situations and surprise huge expenses in your life. Your finances are like any finances of a business i.e only the ones who are prepared to handle the worst survives over long-term. Covid-19 pandemic (2020), Housing crisis recession (2008) and Tech bubble (2000) is a great learning example for all of us.
Step 6
Follow First 5 steps diligently. It is not a 100m race but a marathon and the goal is to be a finisher, get on the other side and achieve the financial freedom. It is not necessary that you will achieve your planned goal but because you have put consistent efforts towards the goal you will be in a much better financial position than expected.
Thank You. Will come up with more articles on detailed information on each financial instrument.
Note of caution
The more the risky investment, the more is the probability that you will lose money. It is very easy to consider oneself daredevil risk taker but only the one who lose the money has experienced the real value of risk. To give an example, if you invest Rs. 100 and due to some reasons the stock investment corrects by 80%, your invested value becomes Rs. 20. From here, just to reach back to the earlier investment of Rs. 100 you need a spectacular 500% returns. One should always consult a expert or financial advisers before investing into risky assets.
Also, one thing to remember is that never compromise on quality for better investment returns. It is like a choice between Yes Bank and HDFC Bank. Yes Bank may give you better returns but history tells us what happens with such banks.
In the investment options 1-3 you will not lose the principal amount you invest, interest may be reduced in worst case. But in case of investment option 4-6 you may also lose the principal amount as well.
The more aggressive goals you set, more risky investment you have to opt for and more capital will be the need.
There will be other factors that will play role in your life, hence it is wise to consider those properly for your calculations.
Comments
Post a Comment