15th August is a day of pride for all Indians. On this day in 1947 we gained our much cherished independence from colonial rule. Fruits of freedom are sweet but it requires hard work and sacrifices. India’s independence came after a very long period of struggle and sacrifice by several generations of Indians. In this blog post, will discuss about a different kind of independence, but equally important in our lives, financial independence.
Financial independence may mean different things to different people, but if you look up the definition of financial independence on the internet, then most common interpretation is, “not having to work for a living”. There may be different motivations for being in a job e.g. interest in your area of work (industry, functional area etc), company’s culture, your colleagues, job satisfaction etc, but the primary purpose of working is to earn income to pay our living expenses, e.g. food, rent, EMIs, utility bills, children’s school fees etc. Financial independence means taking care of your expenses without having to work.
Financial independence is relevant to everyone, whether you are in a job or owning a business. If you are in a job, a day will come when you will retire. Once you retire, you will have no income in form of salary, in other words, you will have to be financially independent. Circumstances, beyond your control can force you to leave your job and be without income. You will still have to pay the bills. If you are a business owner, there may be periods where your income from your business is less than your expenses. These periods may be short or long. You will have to dip into your savings unless you are financially independent.
If your income is not sufficient to meet your expenses, then you will have to be dependent on others e.g. children, relatives etc. But you should consider whether the person you are depending on is himself / herself financially in a position to support you and for how long? You can pay for your living expenses from your savings, but over a period of time, you may deplete your savings and lose financial independence. Remember, your expenses will keep increasing over time due to inflation, while your savings will deplete over time if you are living off your savings.
You will achieve financial independence if returns from your assets are sufficient to meet all your expenses for the rest of your life. It is important to understand that assets are investments that can generate future cash-flows either in the form of regular income or capital appreciation. Electronic gadgets, watches, jewellery, cars for personal use etc cannot be considered assets in the strictest sense because they do not generate cash-flows and usually depreciate in value over time. Bank fixed deposits, stocks, bonds and mutual fundsare assets because they generatereturns in form of interest, dividends and potential capital appreciation. If the returns from your investments are sufficient to meet your expenses, factoring in inflation, then you will be financially independent.
Suggested reading: Asset class diversification and why it is necessary when you invest
Many investors associate financial independence with their lives after retirement. It is extremely important to be financially independent by the time you retire, but financial independence is not just about retirement. Many younger investors are striving for financial independence so that they can pursue their passions e.g. travelling, art, music, starting their own business, doing charitable work etc. By saving and investing from an early age, it is possible to achieve financial independence much before your official retirement age.
Did you know what is goal based financial planning?
Issued as an investor education initiative by HSBC Mutual Fund.
You may like to read an infographic on Happy Financial Independence Day
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