Financial Independence is one such form of freedom, which allows us to live our lives as per our own lifestyle patterns backed up with the robust financial arrangement.
What is Financial Independence?
Financial Independence is an amalgamation of two words “financial” and “independence.” Financially pertains to the art of managing money and independence signifies freedom from assistance from others and doing it by your own.
So financial independence is the capability to have a financial arrangement in such a way that you have adequate funds to lead a life as per your chosen lifestyle without being dependent on others. It simply means that if you were to quit working today, you would not lose any significant part of your way of life due to a lack of a working income. Financial independence is attained when you have adequate funds to take care of your current and future expenses including necessities and lifestyle based expenditures.
Now, financial independence means different things to different people. For some, financial independence is the stage when they are paying off their debts, for some, it may mean when they have enough funds to start their own business, for some it may mean having enough funds to go for their dream vacation or own assets which they always desired. So, it’s up to an individual how they define financial independence for their own self.
Different stages of Financial Independence:
To reach or attain the financial independence involves a journey in the lifetime of an individual based on these five stages:
Stage 1: Financial Dependence is the stage which may include when you are young adults and are dependant on your parents for the financial support to take care of your expenditures or may be as an adult depending on the financial support from others due to some reasons.
Stage 2: Financial Solvency is the stage when you can support yourself and your dependants without being dependent on others for your own working income. It is a stage when you get income which is equal to or greater than your expenses.
Stage 3: Financial Stability is the stage where you want to get rid of all of your debts or some of them which are high-interest rate debts, this stage requires you to make a strategy which will help you get closer to financial independence. At this stage, you attain a financial stability with your regular flow of working income and freedom from the debts.
Stage 4: Financial Security is the stage when your current lifestyle and basic expenses can be taken care of with your investment income, savings, and the cash reserves. You have a sense of accomplishment that all your major goals in life are achieved or nearer to be achieved.
Stage 5: Financial Independence is the stage where you can just sit back and relax as you know that you have managed to attain adequate resources to fund your current standard of living for the rest of your life. At this stage, you don’t require your working income to manage your life expenses.
Steps to achieve Financial Independence:
The First step is to set a goal or goals which would help you to lay out the path to achieving those goals. It could be buying a house, planning for retirement, owning your dream car, going for a dream holiday, etc. It could be a short term goal or a long term goal based on the deal tenure required to achieve it.
The Second step is to get control over your finances. One needs to know about his/her spending pattern before getting started on the path of attaining financial independence. Regulating control of your money can be easily done by spending in permissible limits of your total income or earnings. You need to make calculations about what is coming in as income and what is going out in terms of expenses to have control over your money and to assess your financial standing.It is important to set a realistic budget for your expenses and don’t go overboard to spend more than you earn.
The Third step is to secure yourself from potential risks which could be the risk of an early death, the risk of an accident, disability, illness. It is important to have a financial arrangement for yourself and your dependants in the form of insurance policies to cover such risks which if occurred could devastate your life and the life of your dependants.
The Fourth step is to become debt free from the loans and borrowings which you have taken to accelerate and fund your needs and goals of life, be it a housing loan, education loan, car loan, personal loan, borrowing from a friend or relative, etc. This will ensure that you have more disposable income in your hands for wealth creation.
The Fifth step is to start investing in wealth creation. The sooner you start, the higher you will accumulate. The ideal investment portfolio is a balanced mix of equity, debt and money market instruments, depending on your risk taking appetite.Also, it is important to keep reviewing your investments and manage them as per your life stage.
The Sixth step is to enhance your sources of income where you need to have more than one source of income, be it a rental income, pension income, income from investments, etc. It will give you a sense of financial stability and independence by diversifying streams of income.
The bottom line is to turn that idea of financial independence that you have in your mind into a long term goal. It is important to ascertain what can you do today to move forward in your life defines your path of achieving financial independence.
The author, Harjot Singh Narula is Founder & CEO, ComparePolicy.