The first step in achieving financial freedom is assessing your current position – net worth, debt, saving.
Deepak Jasani
As India celebrates its 74th Independence Day, it is time to think and act on your plan towards Financial Independence. Financial freedom is often referred to as financial independence is being in a state where you have control over your finances and have peace of mind from knowing that you have invested enough to manage your expenses and lifestyle for the rest of your life. Achieving Financial Freedom mean building a corpus such that it generates passive income greater than your expenses.
Becoming financially independent isn't a single goal, but a series of sub-goals which includes budgeting-increasing savings and controlling spending habits, determining investment goals and investment options, trimming personal debt, building emergency corpus, adequate insurance cover and implementing a legacy plan.
The first step in achieving financial freedom is assessing your current position – net worth, debt, saving. A bit of number crunching would be required to prepare personal balance sheet. Without knowing your current financial health, you cannot start setting up short-long term financial goals. A good financial plan is like a road map that shows us exactly how the choices we make today will affect our future. Not deciding on financial goal is a recipe for financial disaster. Investment goals - marriage, education, travel, lifestyle, health – would vary in terms of time horizon-, should be quantified. Current and expected income levels, annual spending rates, inflation (including lifestyle inflation) needs to be considered while quantifying these goals. In the pursuit to be financially independent, first, you must prioritize your long term financial goals.
In this journey of financial independence, savings is the fuel. Save before you spend. Financial freedom is wealth creation which is directly proportional to your savings level. Start saving early. The sooner you start, the better it is for you; this is because of the power of compounding—what Albert Einstein called the "eighth wonder of the world". Your savings will grow exponentially with time. An important step toward financial freedom is tracking your spending. One should be mindful of their spending and saving habits; these acts despite being small would have a cumulative larger impact in one's goal of financial freedom. Budgeting your expenses and incomes and its periodic review is important to get your finances on the right track. Nowadays there are many online tools/apps that can track your spending habits, flag overspent expense levels. One should not shy away to use these digital financial tools.
Once you start working towards financial planning, you have to clean up the mess before you can start building wealth. Debts (except Home loans) are toxic to wealth-building. Paying off your debt helps you lay a foundation to build wealth that will last. Once you’re debt-free, stay there. Having debt undermines your ability to build wealth and puts your financial plan at risk.
Insulate yourself in the short run by setting aside an emergency corpus. Emergency funds provide a sense of safety and flexibility with respect to investment options. Ideally at least six months' worth of expenses should be parked in very safe and liquid asset class. So, the next time a pandemic or recession hits and you miss a monthly pay check, you have got a safety net. Make sure you have enough insurance coverage. By availing insurance plans, you are buying safety and protection in advance for any unfortunate event or crisis, to be able provide your family and still secure your future goals.
One could have different investment strategies for different goals over different time horizon. One can either do the research themselves or can take help from financial advisor to make informed decisions. Don't follow a herd mentality approach. Don't be swayed by the exuberance or fear of the short-term aberrations if the investment horizon is long term. Asset allocation and diversification (within and among asset classes) are the fundamental financial planning tools that one needs to follow diligently.
Healthy dose of equity is required in one's financial portfolio to achieve the growth in corpus and attain financial freedom at quite an early age. Understand the risk-reward ratio before venturing in particular investment avenues. There are investment options for every risk level to build wealth, so make sure you choose what suits you best. The beauty of this journey of securing financial freedom is that every small step does its bit to grow wealth. SIP doesn't just allow starting to invest with small sums, but more importantly helps create a sense of discipline.
After making the right investment decisions, monitoring its performance is crucial to get the most out of the investments. Setting your investments on autopilot is not an investment strategy. You can take the help of a financial advisor to help navigate your investment options and brave the ups and downs of the stock market.
Investors should at regular intervals undertake due diligence and review their portfolio to weed out underperformers or those which does not suit their risk appetite anymore; ensuring that the portfolio reflects one's investment strategy.
Investing over the years may lead to divergence from the asset allocation set up initially. If due to run-up in markets, equity allocation has risen from initially established percent, the investor needs to shift the excess to debt or other asset class.
The same should be practiced post market crashes; allocating more to equity would be beneficial at that time. A basic asset allocation formula for equity exposure: 100 – (your age) can be employed diligently. Conservative investor can use 70 instead of 100.
As they grow older, investors can reduce equity exposure continuously and progressively so that they can get close to their desired corpus regardless of market ups and downs. Rebalancing and strict adherence to asset allocation should be practiced once every six months.
Remember, the journey to financial freedom is a marathon, not a sprint. One should be active through this journey. You probably won't make perfect linear progress towards achieving some of your goals, but the important thing is not to be perfect but to be consistent, which is required in achieving long-term goal of wealth creation. Like our freedom struggle, a whole-hearted commitment to financial planning will ensure attainment of Financial independence.
Happy Independence Day!!.... Happy Investing!!
The author is Head of Retail Research at HDFC Securities.
Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.