One of the primary goals of my life is to achieve financial independence. For me financial independence is not just any other goal, it is my ‘ultimate goal’. I’m living to see this become a reality one day. There is nothing in my life which drives me more than this goal. How I plan to achieve financial independence?
The only way to achieve it is by generating “enough passive income”. Like fuel is necessary to burn fire, ‘passive income’ is necessary to attain financial independence. So the target is to make ‘passive income’ equal my expense needs’.
I have already written a detailed blog post on the concept of passive income. It will be a good read as well. I will suggest you to jump to this post after finishing this article.
So this brings me to a very logical question. Generating enough passive income is enough to achieve financial independence? The answer is yes and no.
Yes because till there is passive income, there can be no financial independence.
No because till one has a correct mind-mapping, high passive income cannot be generated. Why? Because it is essential to know why passive income is essential for financial independence.
Read till the end and the relation between passive income and independence will become clear.
Mind Mapping of Financial Independence
What I mean by mind mapping? Mapping of the key ideas which clearly explains the process necessary to achieve financial independence.
A simple mind map which can lead us to financial independence from our present being is shown in the below flow chart:
Let me explain in short the flow of ideas shown in the above mind map.
First: It talks about an ideal income model. What is an ideal income model? A state of being where the person (family) is living a ‘frugal life’ in tandem with consistent ‘income growth’.
Second: Frugality and income growth assures increased ‘savings’ with passage of time.
Third: This increased savings, when invested in equity for longer periods of time builds a ‘corpus’.
Fourth: The build corpus shall take care of all type of financial goals of life, including retirement corpus building.
Fifth: Retirement corpus shall be used to build streams of passive income, which eventually will lead to financial independence.
Let’s see these ideas in more details to get a more surer perspective of attaining financial freedom in life.
#1. Ideal Income Model…
There are two components of an ideal income model:
- Frugal lifestyle.
- Continual income growth.
How they become components of “ideal income model”? Because working in tandem, they can transform even a pauper into a rich man. How?
What is Frugal living? Maintaining a lifestyle at a level which is way lower than what one can actually afford. What does it mean? Such a person saves more of their income than non-frugal living person.
Combine frugal living with income growth, and it can transform anyone to “richness”. How?
A person earns Rs.100,000 per month. He lives frugally (savings 50% of his income). His income increases at 10% per annum. Let’s see his savings pattern for next 5 years.
What is the significance of this example? The frugal person whose income is also growing, is able to set-aside huge savings every passing year. In 5 years the savings of the person rose from Rs.50,000 to Rs.73,205 per month.
This person is anyways saving very dearly (50% of income), but as the quantum of savings is increasing every year, its impact on financial independence is phenomenal. How?
More savings means more asset accumulation. How does it help? Please keep reading…
Try to plot such a “income model” for yourself. You will see how much you are saving and how much is getting spent. It will also answer if you are leading a frugal life or lavish life.
People who want to achieve financial independence, practising frugal lifestyle is a must.
#2. Invest in Equity…
Practising frugality is only the first step. It is also essential to utilise the ‘saved money’ wisely.
What it means by wise utilisation of savings? There are two parts to it:
- Investing the savings in equity.
- Staying invested long enough.
Why to invest in equity? Because equity can yield higher returns than other investment options.
How to invest in equity? In two ways:
- Buy stocks directly.
- Buy equity mutual funds.
But equity investing can also pose a high risk of loss in near term. What to do? Buy equity and stay invested for long term.
#2.2 Hold for long term
If the bigger purpose is to achieve financial independence, it cannot be achieved in only couple of years. It will take time to arrive at this goal.
Hence staying invested for long term is a must when dealing with the goal of financial independence.
Long term holding is a very effective way to manage the ‘risk of loss’ associated with equity investing.
#3. The Goal of Financial independence…
Achieving financial independence is not a common goal. Which are more common goals:
- Car purchase.
- Annual Vacations.
- Home purchase.
- Higher Education.
- Retirement etc.
In the above list of financial goals, financial independence is hidden in the term called “retirement”. But I personally feel that the “retirement” is too general a word. To give more purpose to it, better will be to rephrase it as “financial independence”. Why?
Because when we talk about “retirement corpus”, we are actually talking about an absolute amount that one will use post retirement.
But when we talk about “financial independence corpus”, we are talking about an amount which will generate enough passive income to support the lifestyle of the retiree.
Which you think is sounding more specific and purposeful? Retirement corpus, or financial independence corpus? I am sure the latter.
What about other goals?
It is equally important to manage other goals along with financial independence. Why? Because if not done, they will eventually eat-away your built ‘financial independence corpus’ anyways.
So the right strategy will be to put money proportionally in each goals separately. The idea is to keep the goal of financial independence isolated from other goals.
#4. How to achieve financial independence?
Financial independence can be achieved when income will continue to drip-in even when we are sleeping. We should not be required to work to generate income to manage our expense needs.
Income generated from job or business is not passive income. It is active income. The idea is to work and generate active income. Then divert at least 50% of the active income to built “retirement corpus”.
But building a big enough retirement corpus is not enough. It is important to convert the corpus into a “passive income generating machine“. How to do it?
Use the corpus to buy ‘income generating assets’. Which are the income generating assets? Few best examples of such assets are the following:
A sure way of becoming financially independent starts with living a frugal life. Frugality does not mean leading a life of misery. It means, diverting a bigger proportion of ones income towards net worth building.
A person who lives a frugal life, ensures that a big chunk of his/her income is available as savings. This is a huge advantage. Why?
Because this available liquid cash can be used to invest in equity. As equity earns higher returns, over long term such investments can built a sizeable corpus.
A part of this corpus shall be used to manage other financial goals of life. The balance should be used for “retirement” (financial independence}. But here it is essential to bifurcate between “other goals” and “retirement”. Why? Because it is essential to isolate retirement funds from other needs.
This is essential because, there are high chances that if there is short-fall in other goals, it will eat into the retirement corpus.
Building only “big enough” retirement corpus is not enough. One must use the corpus in a way that it enable streams of passive income
Have a happy investing.