Saturday, March 21, 2009

Financial Freedom - the why, the what and the how

Financial Freedom – basic questions

I stated in my previous blog post that financial freedom is something I have been working towards, for a long time now. The words mean different things to different people. So, here is my attempt at defining what the words mean to me.

The why

Pleasure in the job puts perfection in the work - Aristotle

The way I look at it, answering the ‘why’ is probably the most important step in achieving financial freedom. It is the answer to this question that provides the motivation to embark on what could be a longish journey.

Speaking for myself, I have always envied the entertainers – athletes in particular. Here is a set of people that do what they love to do and get paid handsomely at that. For the rest of us, achieving financial freedom and going on to do what one would love to do is the best shot nirvana.

Top notch quality output comes out of a sense of inspiration and love for what one does. And usually, ones makes a lot of money – if that’s the intention – doing what one loves to do, as the world is happy paying for inspired work. A win-win situation, no matter how one looks at it.

The what

So, what does financial freedom look like? My definition of financial freedom is that it’s a state where I have the option of deciding not to work for the monthly paycheck, without threatening my lifestyle. So, if one’s passive income is such that it covers expenses needed to cover one’s lifestyle, one can lay claim to having achieved financial freedom.

One needs to set aside a certain amount of money, the nest egg, to earn the passive income. Clearly, the nest egg that one needs depends on one’s lifestyle – the spend part of the equation – and the returns on one’s investment – the income part of things. Of course there are issues like the expected returns from investments and the rate if inflation one would have to contend with.

I have designed a spreadsheet that lets one calculate the amount of money one needs to support a given spend, subject to assumptions around the factors mentioned above. Drop me a mail at and I will be happy to send a copy of the same to you. You can change the assumptions mentioned in there and see what works best for you.

The interesting bit is that most of us don’t need anywhere near the kind of money that we think we would need, to maintain current life styles.

The how

This is the easy part. Draw up a personal balance sheet, listing out your assets – all assets excluding the primary residence - and liabilities – all loans. Also compare your current income with the expenditure pattern and see what kind of money you can out aside on a regular basis. Decide on a proper asset allocation – something that’s in keeping with your appetite for risk. Make assumptions about the returns you should expect. Do your math with the above and you will know how many years of toiling lie ahead of you. The spreadsheet that I spoke of above can help you do the math.

I would strongly suggest that you use the services of an honest and trustworthy financial planner to help layout a financial plan that you could use to achieve your goals. When you do that, make sure that you know what the financial planner expects to get paid and how. More often that not, the financial service providers – the mutual funds and the insurance companies – pay the financial planners for selling their products to you. Make sure that you know what the amount is and you think the same is fair.

And please make sure that you are adequately insured, as you go about doing the above. 

I intend to discuss the various aspects of drawing up and implementing a financial plan in my future blogs.


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