15th August is a day of pride for all Indians. On this day in 1947 we gained our much cherished independence from colonial rule. Fruits of freedom are sweet but it requires hard work and sacrifices. India’s independence came after a very long period of struggle and sacrifice by several generations of Indians. In this blog post, will discuss about a different kind of independence, but equally important in our lives, financial independence.
What is financial independence?
Financial independence may mean different things to different people, but if you look up the definition of financial independence on the internet, then most common interpretation is, “not having to work for a living”. There may be different motivations for being in a job e.g. interest in your area of work (industry, functional area etc), company’s culture, your colleagues, job satisfaction etc, but the primary purpose of working is to earn income to pay our living expenses, e.g. food, rent, EMIs, utility bills, children’s school fees etc. Financial independence means taking care of your expenses without having to work.
Is financial independence relevant for all?
Financial independence is relevant to everyone, whether you are in a job or owning a business. If you are in a job, a day will come when you will retire. Once you retire, you will have no income in form of salary, in other words, you will have to be financially independent. Circumstances, beyond your control can force you to leave your job and be without income. You will still have to pay the bills. If you are a business owner, there may be periods where your income from your business is less than your expenses. These periods may be short or long. You will have to dip into your savings unless you are financially independent.
What will happen if you are not financially independent?
If your income is not sufficient to meet your expenses, then you will have to be dependent on others e.g. children, relatives etc. But you should consider whether the person you are depending on is himself / herself financially in a position to support you and for how long? You can pay for your living expenses from your savings, but over a period of time, you may deplete your savings and lose financial independence. Remember, your expenses will keep increasing over time due to inflation, while your savings will deplete over time if you are living off your savings.
How to achieve financial independence?
You will achieve financial independence if returns from your assets are sufficient to meet all your expenses for the rest of your life. It is important to understand that assets are investments that can generate future cash-flows either in the form of regular income or capital appreciation. Electronic gadgets, watches, jewellery, cars for personal use etc cannot be considered assets in the strictest sense because they do not generate cash-flows and usually depreciate in value over time. Bank fixed deposits, stocks, bonds and mutual fundsare assets because they generatereturns in form of interest, dividends and potential capital appreciation. If the returns from your investments are sufficient to meet your expenses, factoring in inflation, then you will be financially independent.
Suggested reading: Asset class diversification and why it is necessary when you invest
Financial independence is not just about retirement
Many investors associate financial independence with their lives after retirement. It is extremely important to be financially independent by the time you retire, but financial independence is not just about retirement. Many younger investors are striving for financial independence so that they can pursue their passions e.g. travelling, art, music, starting their own business, doing charitable work etc. By saving and investing from an early age, it is possible to achieve financial independence much before your official retirement age.
Did you know what is goal based financial planning?
Planning for financial independence
- Start saving: You need to save to invest in assets which can generate returns for you. The famous investor, Warren Buffet said, “Do not save what is left after spending, but spend what is left after saving.” You have to prioritize savings if you want to achieve financial independence.
- Start early: It is very important to start saving from an early age. One of most important factors in wealth creation is time. Investments generate returns over time and returns invested generate more returns. This is known as the power of compounding.
- Investing your savings wisely: You need to invest your savings in assets which can 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.
- Remain disciplined: Investment discipline means that you invest according to a plan (financial plan) designed to meet your financial goals and balance risk and returns (asset allocation). You should stick to your plan and not make emotional decisions.
You may like to read: how asset allocation helps diversify your investments
How can mutual funds help?
- Mutual funds are ideally suited for long term wealth creation for retail investors because it offers risk diversification and professional investment management.
- You can start investing in mutual funds from your regular savings through Systematic Investment Plans (SIP). You can start investing in mutual funds from a young age through SIPto get compounding benefits over long investment tenures. Did you know how you can maximise your SIP returns in volatile markets
- Mutual funds offer a variety of products for different risk appetites and investment needs. You should invest in the product that is suitable for you.
- Mutual funds are one of the most tax efficient investments for long investment tenures. Long term capital gains in equity funds of up to Rs 1 lakh is tax exempt and taxed at 10% thereafter. Long term capital gains in debt funds are taxed at 20% after indexation.
- After you have accumulated the desired corpus for your goal, you can use Systematic Withdrawal Plan facility to meet your regular cash-flow needs in a tax efficient way.
Investors should consult with their financial advisors on how mutual funds can help them achieve financial independence. You must read do you need a financial advisor
Issued as an investor education initiative by HSBC Mutual Fund.
You may like to read an infographic on Happy Financial Independence Day
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.