What is financial independence?

Hearing the term – F.I.R.E – Financially Independent and Retire Early is not very uncommon, and it is also not uncommon to find people having achieved that or aspiring to achieve that. Are you one of them?

Financial independence is basically having enough assets that they can take care of your expenses for rest of your life. And that you don’t need to work again, rather working is a choice not necessity. If you have a decent source of regular income and you have control over your expenses, you may be on road to financial independence.

Being financially independent also entails being adequately covered for various unforeseen circumstances, especially health, disabilities, critical illness or death. (not saying that you should have all these insurances, but should have a plan in place at least, and it may include insurance)

Prerequisites for financial independence

Financial independence requires you to tick the right checkboxes to ensure that your assets will take care of your expenses. This may include one or more of the following.

– You have lot of money. As a rule of thumb, at least $1 Million (Approx. Rs. 7 Crore in INR terms) is considered good to begin with. Actual number may vary greatly on either side, based upon your situation and location, but $1 Million is a good nice round number! However, very few may fall in this category. But, to begin with you need to have a good source of income.

– You have some control over expenses. So, if you don’t think twice before buying stuff worth thousands of dollars (or lacs of rupees!) then it might be difficult for you to be financially independent even with a good amount of money.

– You don’t fall prey to lifestyle inflation. Which means, avoid going for bigger house or cars or luxurious goods just to keep up with the Joneses. Get them only if you really need them. Having a basic degree of control over your emotions and impulses can be helpful.

– Your money is parked in good quality assets and is diversified enough to generate a steady cashflow (via interest or dividends or rent and taking inflation into account). Ideally it should be a mix of debt and equity/ mutual funds. It is good to have a good portion in debt, because if you are financially independent, your objective will not just be capital growth (likely by equities) but also capital protection (likely by debt). Some real estate (and hence rental income) can also be a good addition to the mix if you already have a healthy mix of debt and equity.

– You need to be sufficiently insured. A term plan (assuming you have dependents) and a health insurance can be a good starting point As healthcare is one thing that can drain your expenses, the health cover needs to be really good (would recommend at least Rs. 10 Lac, if in India). You may also want to see if you need any other cover (e.g. cover for critical illness, accident, disability etc.)

Partial Financial Independence

Not everyone one may have an aggressive rate of savings which can enable them to achieve complete financial independence. This may partly be a function of not-so-high income. In such case, one may also realistically target achieving partial financial independence.

With partial financial independence, you may have passive income to cover your very basic expenses, but that may not be enough to cover all your future expenses. However, partial financial independence can enable you to choose how you work. So you may choose not to work in a 9 – 6 job but probably do what you like – e.g. teaching, volunteering, writing, freelancing. These gigs may or may not match your 9-6 job salary and perks but may still give some earnings, and a lot of flexibility. This coupled with “partial financial independence” can help in taking care of your long term expenses.

To sum it up, financial independence can be a good goal to aspire for, and achievable with right approach. However, not many people can achieve that owing to different constraints, and in such cases partial financial independence can be a good first goal.

The objective of financial independence need not be retiring (that may be too boring!), but gaining the flexibility to do what you love – and it can well be your current job!

Advertisements