We all have been students once, right? Attaining a first rank in university was like the ultimate goal then. We all have dreamt of it, but only few achieved it. Similarly, attaining Financial Independence in working life is one of the most pursued goals. Unfortunately only few rare people can achieve it.
What is the hurdle in achievement of Financial independence? It is a 42 Km marathon. People try to sprint and complete it. As a result, they do not even complete a kilometre and looses the steam.
A marathoner can explain how they stage the whole 42 Km run in their mind. For these people completing a marathon will be impossible without following this golden rule of “stage“.
When the goal is difficult, it is better to break it down into stages. Likewise, attaining financial independence needs breaking-down into finite and achievable milestones.
How breaking down helps…
A person who leads a paycheck to paycheck life will find the concept of financial independence impossible.
Suppose this person makes a handsome Rs.300,000 per month as his net take home salary. As a result, he lives with a decent standard of living in India.
Though this person’s income is high, but because he lives paycheck to paycheck, for him achieving financial independence will be as difficult as any other low-income guys.
For such people, breaking down the ultimate goal into stages will make it more achievable.
Without breaking-down, the goal will look like a burden. But after breaking-down, the same thing will start to picture itself a ‘motivation‘.
How to create the stages of financial independence?
What I am suggesting here is a general idea. It will work for any one.
People of any income level can use this rule to create their own stages of financial independence.
The concept on which the staging is done is based on a small theory.
When it comes to financial security, people would first cover their basic necessities of life (like food, shelter, clothing, bills, education etc).
When their basic demands are getting taken care regularly, people then start spending on comfort.
After Basic Necessities and comfort comes luxury.
Now, everyone does not spend the same amount on basic goods, comforts and luxury. What is the pattern?
The pattern can be formed from looking deep inside ones basic necessities of life.
There are people who can spend as little as Rs.10,000 per month to cover their basic necessities of life. On the other hand there are people for whom the same basic necessities will need Rs.20,000.
In turn, these people will also spend differently on their comfort and luxury needs.
Why this difference? It’s because of the the way they have been brought by their parents. Example: A kid who has always lived in an air conditioned home, will treat AC’s as basic goods.
Based on this theory, I think that, the ultimate goal of financial independence can be broken down into three (3) stages.
- Stage 1: Basic Independence.
- Stage 2: Comfort Independence.
- Stage 3: Luxury Independence.
#Stage 1. Basic Financial Independence
This is the stage one (first milestone) of financial independence. What does it stand-up for?
It tells people to first build enough asset to cover the basic necessities of life.
What does it mean? Building a large enough asset base, which ultimately yields so much income that it covers the basic necessities of life.
Which are the basic necessities of life?
- Food.
- Rent/EMI.
- Utility Bills.
- Communication.
- Education.
- Public Transport.
- Basic Clothing.
- Basic Health.
- Basic Emergency Cash.
- Basic Maintenance.
Note: I have assumed that the Rs.50K is net of income tax and retirement savings contribution.
Suppose there is person who basic necessities cost him Rs.”N” per month. This person intends to attain stage one of financial independence. How he will do it? By building an asset base of Rs.200N.
Example: Suppose there is a person whose basic requirements of life costs him Rs.50,000 per month.
This person will need an asset base of Rs.1.0 Crore (200 x 50,000) to achieve stage one. How? Here is the calculation.
How to understand the calculation? By investing Rs.1.0 Crore in an investment option which yields an annual return of 6% p.a., will yield an annual income of Rs.6.0 lakhs (or Rs.50,000 per month).
Why 6% p.a. return and not more or less? A suitable risk-free debt based investment portfolio can easily yield an average return of 6% p.a.
Quick Tip: The trick lies is identifying the basic necessities of life. Categorise all your expenses. How to do it? Read more about it here…building expense tracking software in MS Excel.
#Stage 2. Comfortable Financial Independence
This is the stage two (second milestone) of financial independence. What does it stand-up for?
It tells people to build more asset to also cover those requirements of life which makes them comfortable.
Here one will have to build and bigger asset bases than what has been done in stage one. This asset base will so big that it will cover both basic necessities and comforts of life.
Which are the comforting requirement of life? These are such spendings which cannot be tagged and luxuries, as they tend to become “basic necessities” in times to come. Few examples are shown below:
- Household help.
- Internet.
- Basic Shopping.
- Entertainment.
- Person Vehicle Costs.
- Child Plan.
- Basic Investments.
Suppose there is person who basic necessities cost him Rs.”N” per month. This person intends to attain stage two of financial independence. How he will do it? By building an asset base of Rs.400N.
Example: Suppose there is a person whose basic requirements of life costs him Rs.50,000 per month.
This person will need an asset base of Rs.2.0 Crore (400 x 50,000) to achieve stage two. How? Here is the calculation.
What does this calculation say? By investing Rs.2.0 Crore in an investment option which yields an annual return of 6% p.a., will yield an annual income of Rs.12.0 lakhs (or Rs.100,000 per month).
Quick Tip: People who spend on their comfort needs often overspend. Hence it is advisable to build an expense budget and spend accordingly. Read more about 50 30 20 rules of budgeting.
#Stage 3. Luxurious Financial Independence
This is the stage three (final milestone) of financial independence. What does it stand-up for?
Here the asset base built by the investor is so high that all type of expense requirements of life is met.
Here one will have to build and biggest asset bases, more than what has already been done in stage one and two.
Generally people tend to spend much more on luxury than they do on basic goods and comfort needs. Why? Because of two reasons:
- Luxury is costly.
- Luxury is also tempting.
Hence the size of asset bases required to cover luxury needs of the person is quite high. The proportion can be like shown in the pie chart.
Which are the LUXURY requirement of life? These are those spendings which people generally incur when they have excess cash in hand. People generally spend money here to uplift their standard of living.
- Purchase of bigger home.
- Buying a bigger car.
- Vacation.
- Celebrations.
- Donations.
- Investing for net worth building.
- Shopping.
Suppose there is person who basic necessities cost him Rs.”N” per month. This person intends to attain stage three of financial independence. How he will do it? By building an asset base of Rs.1200N.
Example: Suppose there is a person whose basic requirements of life costs him Rs.50,000 per month.
This person will need an asset base of Rs.6.0 Crore (1200 x 50,000) to achieve stage three. How? Here is the calculation.
What does this calculation say? By investing Rs.6.0 Crore in an investment option which yields an annual return of 6% p.a., will yield an annual income of Rs.36.0 lakhs (or Rs.300,000 per month).
Quick Tip: People who can afford to spend on luxury shall take extra care in making their asset size grow faster. Why? Because it will further increase their monthly income. Read more about asset building here.
Conclusion
For sure, achieving financial independence is no small feat. To make this tough task a reality, it is better to break down the overall goal into small stages.
Breaking down the goal into smaller milestones, will give a sense of achievement, when they are met. This in turn will motivate the person to try harder.
Financial independence is goal which is challenging. Before one attempts to make financial independence as their goal of life, it is better know more about passive income. Why? Because without passive income dripping in, there will be no financial independence.
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