Happy Independence Day: How can you be financially independent?

Our Independence Day, 15^th August is a day of immense pride for all Indians. India’s independence set her on a path of progress. Today India is the 5^th largest economy of the world and one of the fastest growing major economies of the world. According to IMF forecasts India’s GDP growth rate in CY 2023 will be 6.3%, which will be the highest GDP growth rate among emerging economies. In this article we will discuss how savings and investments can help you get independence from the shackles of financial insecurity.

What is financial independence?

Independence means that you are free from the control of someone else. Freedom gives you the ability to do what you want, obviously within the boundaries of the law of the land. In the parlance of finance and investments, financial independence means that you have enough economic resources to meet your day to day needs. It is also important for you to understand that true financial independence means that you are not dependent on anyone e.g. children, relatives etc for meeting your daily needs.

What will happen if you are not financially independent?

If your income is not sufficient to meet your expenses, then you will have to use your savings to pay your bills. Over time, you may deplete your savings and lose financial independence. Then you will have to be dependent on others e.g., children, relatives etc. But you should consider whether the person supporting you is himself / herself financially in a position to support, for how long can he / she support you and what compromises is he / she having to make to support you? These are very difficult questions and can cause a huge amount of mental stress, as well as stress in your relationships. It is therefore very important to start planning for your financial independence and security.

How can you be financially independent?

The necessary condition for financial independence is to have sufficient returns from your assets to meet all your expenses for the rest of your life. Asset returns can be in the form of capital appreciation or income. Remember, your expenses will keep increasing over time due to inflation, so your asset value will also have to grow over time to generate to sufficient income to meet rising expenses.

What are assets in the context of financial independence?

It is important to understand what asset means in the context of financial independence. Assets are investments that generate cash-flows for you. Your self-occupied house is not an asset in this context because you do not get any cash-flows from it. Your car for personal use is also not an asset. Similarly, gold jewelleries are not asset unless you are willing to sell it for the value of the weight of gold. So what are assets? Bank deposits, investments in Government Small Savings Schemes, Mutual Funds, Sovereign Gold Bonds, Exchange Traded Funds, residential rental property, commercial real estate, commercial vehicles etc are examples of assets.

Financial independence may require small sacrifices

Most of us were born in independent India. We have enjoyed the fruits of freedom and progress made by our nation. Our future generations will partake in even more progress made by India in the coming decades. But we must never forget the sacrifices made by our forefathers for the independence of our country. India’s freedom struggle was long and hard; thousands died and many more suffered from imprisonment.

Likewise, our quest for financial independence may require some sacrifices to be made. Financial independence requires wealth creation. How can you create wealth? Savings is the most fundamental building block of wealth. You have to save a portion of your income on a regular basis to invest for wealth creation. The more you save, the greater will be your wealth creation. In order to save more, you may have to cut down on your expenses.

You should also try your best to avoid debt. Debt has a cost (income) and a part of your income goes into debt servicing which is detrimental to your savings and investments. The debts which can be avoided or reduced to a large extent are credit card or personal loans. It may require some small sacrifices, like planning your monthly budget and making cuts to your discretionary expenditures or luxury spending.

Wealth creation takes time – Start Early

Time is the most important factor in wealth creation. To understand this concept better, let us discuss the power of compounding. Compounding is interest on interest, or profit on profit. Time is the most important factor here.

For example, you invest Rs 1 lakh for three years at an interest rate of 8%* with annual compounding. At the end of the 1 year, you will accrue interest of Rs 8,000 (8% of Rs 1 lakh). The accrued interest will be added to principal amount and the total amount of Rs 108,000 will now earn interest.

At the rate of 8% per annum, in the second year you will accrue an interest of Rs 8,640. This accrued interest will now be added to the principal amount of Rs 1 lakh and interest accrued in first year (Rs 8,000). The total invested amount now is Rs 1 lakh + Rs 8,000 (first year interest) + Rs 8,640 (second year interest) = Rs 116,640, which will then earn interest at the rate of 8% in the third year.

The interest earned in the third year will be Rs 9,331. At the end of the third year you will get the principal amount of Rs 1 lakh and the total interest accrued over three years. The total accrued interest will be Rs 8,000 (first year interest) + Rs 8,640 (second year interest) + Rs 9,331 (third year interest) = Rs 25,971. You can see your capital appreciation is higher with each passing year.

*Assumption used for illustration purpose only

How you can create wealth with SIP?

Systematic Investment Plans (SIP) unleashes the power of compounding from your regular savings over long investment horizons. The table below shows a scenario analysis of the corpus built over various periods of time at different investment return rates, with a monthly SIP amount of Rs. 5000/-

Source: Advisorkhoj internal SIP Return calculations based on investment tenure and returns assumption. Disclaimer: Past performance may or may not be sustained in the future. Data provided is for illustration purposes only for investor education purposes. It does not depict or indicate any promise / guarantee / assurance for future returns.

Invest your savings in the right asset class

You need to invest your savings in assets which have a potential to generate returns. Different asset classes have different risk / return characteristics. You need to invest in the right asset class according to your age and risk appetite. For younger investors, equity is the most suitable asset class for wealth creation over long investment horizons (see the chart below). Mutual funds offer different investment options for investors with different risk appetites and investment needs.

Source: National Stock Exchange, Advisorkhoj Research. Period: 01.08.2003 to 31.07.2023. Disclaimer: Past performance may or may not be sustained in the future. Data provided is only for illustration purposes. It does not depict or indicate any promise / guarantee / assurance for future returns.

Financial independence can help you achieve greater potential

In 75 years post-independence, India’s per capita grew from just Rs 201 to Rs 172,000 (source: NSO, Government of India, FY 2022-23 estimates). As per leading management consultant, Bain and Company’s estimates India’s per capita income (in USD) will more than double by 2030 (source: Bain and Company, June 2023). Some global brokerage houses are calling this decade, “India’s decade”.

Similarly, financial independence will enable you to realise your potential. Unburdened of financial insecurity, you can pursue your dreams and aspirations e.g. setting up your own small business, travel around the world, devote more time to your hobbies etc. It can lead to a much more fulfilling life.

An Investor Education & Awareness Initiative

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Disclaimer: This document has been prepared by HSBC Asset Management (India) Private Limited for information purposes only and should not be construed as i) an offer or recommendation to buy or sell securities referred to herein or any of the funds of HSBC Mutual Fund: or ii) an investment research or investment advice. Investors should seek personal and independent advice regarding the appropriateness of investing in any of the funds, securities, other investment or investment strategies that may have been discussed or referred herein and should understand that the views regarding future prospects may or may not be realized. This document is intended only for those who access it from within India and approved for distribution in Indian jurisdiction only. Distribution of this document to anyone (including investors, prospective investors or distributors) who are located outside India or foreign nationals residing in India, is strictly prohibited.

Issued as an investor education initiative by HSBC Mutual Fund.