Financial Independence and its importance

I had heard “financial independence” being used by people in different contexts many times, but I never realized what it really mean still I read the book, “Rich Dad, Poor Dad” by Robert Kiyosaki. A co-worker in New York, who was also my batch mate in IIM, recommended the book to me in 2007 when we were discussing what to do next in our respective careers. I Googled the book title and Amazon description said that it was “one of the best personal finance books of all times”. I was surprised why my friend would recommend this book, which apparently had nothing to do with my most important priority then, making a career decision. As I read the book, I realized why it was extremely relevant. I will discuss its relevance later in the post, but first let us understand what “financial independence” means for us.

What is Financial Independence

“Financial independence” in simplest terms means financial security. The broader interpretation of financial independence, however, differs from person to person depending on their personalities and circumstances. For many people, financial independence is job security and career progression. For some people, financial independence can be a secondary source of income, like a spouse who is working or a family business. For retired people, financial security is whether the money they have saved can last for the remaining 20 to 30 years of their lives. Again, there are those, for whom financial security is assured through inheritance. All the interpretations are right or wrong, depending on personal circumstances.

Asset Framework of Financial Independence

Let me now share with readers, Robert Kiyosaki’s perspective on financial independence, which he explains very lucidly in his book, “Rich Dad, Poor Dad”. Kiyosaki’s framework for achieving financial independence is investing in assets. Assets, from a financial perspective, are investments which generate future cash flows. Your gold or diamond jewellery, unless you plan to sell it in the future, is not an asset because it does not generate future cash flows. Neither is the house in which you live, nor is the car which you use because these will not create cash flows for you.

The cash flow from the assets should be sufficient to take care of your living expenses. As long as your assets are not sufficient to take care of your living expenses, you should invest more. Once the monthly / quarterly / whatever frequency cash flows are sufficient to take care of your monthly living expenses and leaves you with a bit more for unexpected financial requirements or re-investments, you are financially independent. This framework of financial independence is hinged on one critical factor; creating assets which generates good returns. So from now onwards, we will call this framework, the “Asset Framework”.

Essence of independence in the Asset framework

As discussed earlier, there can be multiple interpretations to financial independence depending on individual circumstance. The asset framework, however, applies to almost all circumstances and in a sense gives you real independence. Let me explain how. For example, if you think your job will provide you and your family financial security, you are really dependent on your organization for your employment continuity and in that sense, you are not independent.

Double income families can be lulled into a sense of complacency with regards to financial security because they think that, at least one of the spouses will be working and may not prepared for an unfortunate situation where both the spouses lose their jobs or are unable to work. Whether you are a single income family or a double income family, you should realize that, you are dependent on your employer for financial security.

The essence of independence in the Asset Framework is ownership. Ownership frees you from dependencies and gives you control over your destiny. As Kiyosaki wrote in his book “Rich Dad, Poor Dad”, if the cash-flows from your assets are greater than or equal to your monthly expenses, then you do not have to work for a living. I bolded the words work for a living because there is a difference between working and working for a living. When you have to work for a living you have considerably less degrees of freedom than if you were simply working, knowing that your asset returns can take care of your living expenses. More on this later, but financial independence is absolutely critical in retirement planning.

Financial Independence is a pre-requisite for stress free retirement

Many people pay lip service to retirement planning but the reality is that, most people in our country do not plan for retirement from a young age. The financial reality of retirement hit people once they are close to retirement or after they retire. I know many retirees, who had glittering careers when they were working, but now after retirement, are stressed about their financial futures; some blame inflation, others blame the Government for lower interest rates. The reality is that, during the course of their working careers, they did not give retirement planning the due importance, when they had the means to save and invest. Complaining now, will not improve their situations.

Financial independence in retirement is a recurrent theme in our blog. An important aspect of financial independence in retirement planning is the ability to maintain your pre-retirement lifestyle, even after retirement. People who think that, their retirement is secured by pension (if applicable), provident fund, life insurance policy or post office scheme returns are sadly mistaken. Pension or provident fund cannot assure lifestyle because they constitute only a small portion of your regular income in your working career. The only way to achieve financial independence after retirement, unless you receive a large inheritance, is to save and invest from a relatively early age. By saving and investing from an early age, you will be able to accumulate a sufficiently large retirement nest egg in assets which can in turn generate cash flows to take care of your post retirement expenses.

Financial independence is not just about retirement

Many people think that, financial independence is about retirement planning only. When people are doing well in their careers, they can be lulled into false sense of security and complacency. Based on my 15+ years of experience in the corporate sector, I can say that corporate fortunes are quite fickle; I have seen many a rising star fall by the wayside in the corporate rat race, due to circumstances beyond their control. There are others who are stuck in jobs that they do not enjoy, yet they have to, because they need the money. Financial independence through savings and investments, not only frees you up from stress related to job insecurity, it can,in fact, lead to better career choices and progression. With financial independence you can devote most of your energies to career decisions that are best for you, not the sub-optimal ones which look safe but may not be the best for you.

Financial independence and passions

Many of us may have dreams that are not necessarily career oriented. I know people who were passionate about interests, not related with their working careers. Some people I knew were interested in learning music, others who were interested in wildlife photography, others who were passionate about learning culinary skills and some others, who wanted to start something entrepreneurial. But many of them were not able to pursue interests because of financial pressures of having to earn a living. Yet there were others, who could pursue their dreams because they had financial independence of some degree. The best thing about financial assets is that, unlike a regular job, it does not take a huge amount of effort on an ongoing basis to manage them, in order to get the best results. Once you invest wisely and monitor your investments from time to time, the results will come almost automatically.

Financial Independence can help you give back to the society

Many of us want to do something for the less fortunate sections of the society, but we are not able to, for a variety of reasons. The most important reason being that, if we are not comfortable about our own financially security, how can we think of giving back to our society or community. On the other hand, if you are financially independent, you can devote your efforts and resources (financial or otherwise) towards charitable endeavours that can benefit less fortunate sections of our society. These endeavours help nations to lift themselves up and benefits wider sections of the populace.

How to be financially independent?

Money when invested intelligently grows in value over time, through the power of compounding. What is the power of compounding? It is simply the fact that, money is productive; it can be used to make more money. If you invest money intelligently, you will make more money; the money earned by investing, can be re-invested again to make even more money, e.g. interest on interest, profits earned on profits re-invested.

One of most important ingredients in the money making recipe is time. The more time you give for money to grow, the more it will grow. Over a long period of time, the power of compounding can be magical. That is why, it is so important to start investing from a young age. Obviously, in order to invest money, you need to save first. Saving capacity of each individual differs depending on their incomes and lifestyles. But even small amounts of savings made every month, when invested intelligently can create assets which can go a long way towards financial independence.

For example, even if you are to save just Rs 2,000 every month and invest it in diversified equity mutual funds, assuming 15% annualized returns; you can accumulate a corpus of Rs 1.4 Crores in 30 years.

Conclusion

Let me come back to the personal example with which I began this post. In 2007, I was looking for a career change and my friend recommended that I read, Robert Kiyosaki’s “Rich Dad, Poor Dad”. The most powerful, yet very simple concept in the book was, in my opinion, that of Financial Independence. I had been saving and investing for many years before I read the book. But after reading the book, I began saving and investing with focused, goal oriented approach; the most important goal, as you may guess, was of achieving Financial Independence. When I embarked on a journey of achieving financial independence, I knew that, I will not get results overnight; I had to be patient. But this journey, which is still ongoing, gave me the freedom to make career choices I wanted and not ones I needed. The satisfaction and freedom that I enjoy in my work today, is much more than what I had 10 years back. The journey towards financial independence, for me, is not all about savings and investment (they are very important, of course); it is a philosophy that I have embraced.