Road to financial freedom: Reality of being financially free

Fri, Feb 21, 2020 7:24 AM on Exclusive, Recommended,
Road to fi...

The idea of Financial freedom in itself is very vague and abstract. Let's use a thought experiment, and ask ourselves a simple question. What does it mean to be financially free? You might say that's an easy question, "a lot of money". But what exactly constitutes a lot of money? That is exactly what I want to clarify in this article. This article will help you realize what that number looks like. To turn this abstract idea into something concrete and attainable. After reading this article you will able to specify the amount you will need to be financially free. For simplification's sake, I will be calling this the financial freedom number. My financial freedom number is 3 Crores and if you want to know how you can come up with that number for yourself then this article will help you.

Although, there is a caveat for this to work. You have to be either young or have a lot of money already saved off. I know that My financial freedom number is not very easy to attain but I am young and have time as an advantage.

Three ideas that will aid you in this process are Frugality, Investing, and the 4% Rule. Let's start from the beginning and understand each of them individually:

Frugality

Frugality at its core means to save as much as you can while spending the bare minimum. It is true that the more you save the better your chances of attaining financial freedom. Frugality is a very subjective idea. Some find it very easy and most don't. It's the idea of cutting back on anything that barely resembles novelty. The idea of extreme frugality is to live a life well below your income while saving about 50-70% of that income. People who want to retire early feel like this is a valid trade-off. And many think it's too extreme a way of living. Why save so much when you don't know when you will die. You might be dead tomorrow so, why not enjoy life as much as you can? And I think both arguments have a valid point. We can, however, choose a middle ground between these two extreme views i.e. save as much as we can while at the same time giving ourselves a little freedom to explore life. Things such as travel, spending time with your friends & family are important things that you may want to do in the present and a lot of those things will end up costing money. One way I like to circumnavigate this dilemma is by budgeting. You fix the money you want to save and spend within a given time frame based on your income.

Investing

Let's make another thing very clear. Putting all your money in your bank account and waiting to be financially free is a very inefficient idea. There is a thing called inflation which eats away at your money like a termite (more on this later). One of the things our country lacks that other more developed countries have is an index fund. In an index fund, you can buy a basket of stocks of some of the best companies, throw your money at it and expect to make a 7-10% annual return with no worries. Then what options do we have as Nepalese to make a similar return on our investments? If you are young and have throwaway cash at your disposal, then it's better to invest in the stock market. My avg return for the past 7 years has been about 15% (Not adjusted for inflation) which is not bad. Or you can choose a safer route and invest in debentures which give about 10%-10.5% return annually. Also, there are mutual funds where you don't have to worry about looking at individual stocks. The market is changing and evolving and a lot of people are getting access to the securities market. I hope this will only get better from here on else. So look for opportunities to invest. You do not have to follow the things I say, maybe you can invest in a lucrative business and make more money there than in the securities market.

So, the moral of the story is to invest your money instead of keeping all of it in a vault somewhere. If you are very conservative with your money, it's better to invest in bonds or put your money in fixed deposits. Or a smart idea would be to invest 20% of your investment in stocks and use the remaining 80% on safer investments such as mutual funds or debentures.

The 4% rule

The 4% rule is the core concept behind this idea of financial freedom. This rule has changed my entire outlook on money and how I save and invest. This is a brilliant idea proposed in a 1998 study done by Trinity University, that showed that if you only withdraw 4% of your annual return on average, then you will be able to never outlive your money. What does this mean? I will explain this in the end but first, let's find your financial freedom number.

Here's how I got the 3 Crores as my financial freedom number. All I did Was (over)estimated the amount of money I would need every month to sustain my life (1 Lakh). Now all I had to do was to multiply my monthly estimated expense by 12 (to get my yearly estimated expense). Now that I have the amount of money, I would need every year to sustain myself, I can then multiply that with 25. And that is how I Got 3 crores as my financial freedom number.

The reality of financial freedom

That number I Came up with is my current financial freedom number. That is to say that if I have 3 crores right now, I will be financially free for the rest of my life. But due to inflation that number is mostly going to increase in the future. 1 lakh a month estimation that I Came up with, will probably stay the same for the next 3 to 5 Years. And that will entirely depend on how much that 1 lakh can buy in the next 3 to 5 years.

Let's take a bitter pill. This idea is not easy by any means. To earn that money, I have to be able to do something very substantial. Or else the only other way is to have a high paying job, which is not a luxury for many. So, what can we do? well not much. You can save a lot and hope that your investments (it could be your job or you can choose to be an entrepreneur) produce good results.

The entire world economy runs on debt. That simply means the government gets to print money whenever they need it to sustain the economy. Which means our economy in itself is inflationary? This implies that every year you will lose your purchasing power. Or to put it simply your money loses its value. The number that you come up with right now will change in the future.

The idea behind the 4% rule is that, say you make a 10% return on your investments annually. The idea is to withdraw 4% of that return letting the rest get eaten away by inflation. On average inflation fluctuates around 5-6% annually. Given that, by using only the 4% of your return, you will be able to live the rest of your life never having to worry about money.

Now, if you do manage this feat. You can make time for things that matters to you. Maybe you could choose a career that you have always wanted but couldn't do it because there were no financial incentives. Personally, my main reason behind my pursuit to financially freedom is to be able to live a life on my terms or else what's the point of earning money. So, if you already have a good life, a family, a job that you love then you can choose not to use this idea. You are already free to do whatever you want.

So, in the end, I will like to end this article by saying that the way to attain financial freedom is good income, frugal living, and compound interest.

And if you want to learn to invest in the stock market or understand investing, in general, do check out my website where I post weekly on personal finance and economics.

Ravi Timsina

https://rtistic.info/blog/

and If you want to study more about the 4% rule, here are some links that might help,

https://en.wikipedia.org/wiki/Trinity_study

https://fourpillarfreedom.com/the-trinity-study-updated-for-2018/

https://www.investopedia.com/terms/f/four-percent-rule.asp