The Road to Financial Independence
What is Financial Independence?
According to Wikipedia, “Financial independence is a term generally used to describe the state of having sufficient personal wealth to live indefinitely without having to work actively for basic necessities”. Either we gather enough assets to sustain our expenses or generate a passive income that is able to support our chosen lifestyle.
You may have millions and still not financially free. Someone who has a passive income of P10,000 a month and spends only P9,500 a month can be considered financially independent. On the other hand, if someone generates P90,000 a month on passively but has expenses of P100,000 a month cannot be considered financially free. He would still need to work for the P10,000 difference.
Why do we need to be Financially Independent?
Most of us, if not all wants to retire early. Personally I want to retire on my early 40′s. Others prefer to do so on their 50′s or 60′s while some are forced to retire due to old age but whatever our retirement age is, you’d still be spending for your everyday needs.
If we are not financially independent, how can we provide money for our daily expenses? We’re lucky if we have children who are successful in their careers and can support us on our financial needs. What if they are not? He will have a family of his own, children to support and educate. If we have the option to be independent financially, why not be?
Steps to Financial Independence
1. Learn to save. We often hear this, save money so that you will have something to use in the future. But more often than not, we don’t. Either we don’t have the knowledge, or we didn’t have the discipline to do it.
Our usual approach to saving is Savings = Income – Expenses. I for one am guilty of the same belief. The moment we receive our paycheck, we allocate it to all our expenses. Monthly rental fees, bills, utilities, food and fare. Whatever left will be considered as our savings. And more often than not, nothing will be left.
There is however, a better equation of saving which is
Expenses = Income – Savings.
This concept tells us that we must pay ourselves first above anything else. One of the most commonly used strategies in saving is the 80-20 Rule or Pareto’s Principle. In this approach, we should save 20% of what we earn and allocate the remaining 80% to all our expenses. It is a very good rule to follow but if 20% is a big amount to you, you may opt to start on a lower amount, 5%, 10% or 15%. The important thing is we must be able to religiously follow our saving strategy. You can always increase the percentage as you get more comfortable.
2. Free yourself from debt. There are usually two kinds of situations that can get you into debt. First is because of events like losing a job or having medical issues. These are events that are not entirely for us to decide. And in order for us to deal with these, one has to take debt. Another situation which is one of the top contributors of debt is the casual usage of credit cards to make big or small purchases. There have been lots of stories about people being broke because of credit cards.
Situations like job loss and medical issues are sometime inevitable and can lead to having unavoidable debt. Debt can be minimized by changing our lifestyle or sacrificing some of the less important stuffs to stretch the budget.
When it comes to avoidable debt, the basic reason of having it is purchasing things that you don’t really need or can live without. Buying things for entertainment and on impulse can be a source of debt. Casual purchase through a credit card is also a notorious cause of being in debt. Most credit card users are buried in debt because their income is not sufficient to for their monthly payment dues.
Credit cards are not bad. They are especially helpful if used wisely. Learning how to budget your monthly income can help you avoid being in debt. Discipline is the key.
3. Create an Emergency Fund. In life, you should expect the unexpected, and this is why you need an emergency fund. The best you can do is to prepare for emergencies that require having access to additional money and having an emergency fund is the ideal solution. Financial emergencies can come in the form of job loss, significant medical expenses, home or auto repairs; it can be anything you don’t expect. When these situations come, we don’t want to rely to credit cards or loans which will simply compound the problem.
Experts agree that an ideal emergency fund should be 3 – 6 months worth of your monthly expenses. Depending on your situation and whether you have dependents to support, will determine what amount is best for you. The reason you want to have 3 – 6 months worth of expenses saved up is because the most common reason for the need of an emergency fund is due to a sudden loss of income. They are assuming that in 3 – 6 months, you’ll be able to find another suitable job.
If you still have no emergency fund or find it hard to start saving, the key is to start small. Accumulating a month’s worth of savings take time, let alone three or more. Set your immediate goals small and manageable so you will have better chance of reaching them. Slowly increase your goals until you reach the amount you need.
You should keep your emergency funds in savings account as they are easy to use and are more accessible (ATM). Remember that emergency funds should be easily liquidated and must be accessible at any time of the day. You can also opt to put a part of it in TD’s or Bonds that have short maturity periods.
4. Insure yourself. Insurance is the most undervalued investment vehicle but this is also one of the most important. Insurance will give you assurance and security that whatever happens to you (knock on wood), you won’t be leaving you loved ones behind empty handed.
It’s very quizzical that some have their P3 M house, BMW or plane travel insured but not their selves. You should realize these things are replaceable but you who generate income are not. If you were to die, could your family or dependants pay for your funeral, organize the financial affairs, service pre-existing debt and continue their current standard of living without you? This is why life insurance is important.
There are lots of insurances available for you to choose from. It can be a term life insurance which is for a specific period of time, a whole life insurance which remains in force for the insured’s whole life, or a VUL which can be a combination of insurance and mutual funds. It is important to remember that you have to research and study what insurance is suited for you. Always read the fine print. Buy it, don’t let it be sold to you.
5. Invest your money. Investing is simply making your money work for you. When we were young, we were always taught that the only way to earn income is by getting a job and working which most of us actually do. The problem with this is if you want more money, you’ll have to work more hours. However, there’s only a limit to the hours we can work, not to mention the fact that having lots of money is not that fun if you have no time to enjoy it.
You can’t create a duplicate of yourself to increase your working time so instead, you need to send an extension of you to work for you. That way, you can still earn money while sleeping, listening to the radio, watching TV or socializing with your friends. Investing helps you maximize your potential to earn even if you don’t receive a raise or work more hours than usual.
There are different investment vehicles available here in the Philippines. You can put your money in stock markets, mutual funds, bonds, securities, SDA’s or TD’s. You can also invest through real estate or by starting your own business. Be reminded though that you should study thoroughly whatever investment you choose to enter. Each of these investment vehicles has their own positive and negative side which will define which of these investments is more suited to you.
Financial independence does not directly relate to how small or big your income is. To be financially free, what we need is the discipline and the proper perspective with regards to money. It may be hard but everything will be worthwhile at the end.
“Poverty is not lack of time but mismanaged time. Not lack of money but mismanaged money.”