Financial independence isn’t an overnight-get-rich-scheme (…unless you are on this blog after winning a lottery … Congratulations!). Most likely, you are on that slow and steady journey to financial independence and in one of its stages, based on the age bracket that you are in.
The age brackets are rules of thumb. A stage can happen sooner or later. The sooner you can enter the next stage the better, as it accelerates your path to financial independence.
- Financial Security:
The journey to financial independence begins with the first step of achieving financial security. This is typically between the age of 20 and 30, right after completing your education and the first part of the career / professional life.
The primary goal in this stage is to get a stable job and become debt free. This means paying off student loans or any other debt that you may have, other than the mortgage for the house that you are living in.
The other goal is to sustain and manage all your living expenses from the primary source of income. Ideally there is also some money left for savings. The earlier one starts saving, the better. Nothing beats the power of money compounding!
- Financial Stability:
In this stage you are not just financially secure but also stable. Typically, during the age between 30 to 40 years old, when you’ve settled down in life – got married, started a family, have a career charted out ahead of you.
The financial goal is to not just have no debt other than the mortgage, but also the monthly / annual mortgage payments are less than 30% of your primary source of income. Anything higher than 50% of your salary / primary source of income could potentially mean either of the following:
o You bought a very expensive house,
o You are based in a HCOL (High Cost of Living) city,
o You have a lower primary source of income.
Any of these may require a rethink or some sort of remedial action, as this could potentially stretch your path to financial independence. Yes, I agree a house is an investment but …
o Mortgage comes with interest payments and >50% of mortgage to salary ratio means your interest payments are eating into that capital growth of your property.
o An expensive house also adds the risk of an expensive lifestyle. If most people in your neighbourhood are paying <30% of their income into their houses – either in form of rental or mortgage – means you are most likely earning less than your peers in that neighbourhood. This just increases the risk of ‘Keeping up with the Joneses’ (Do watch my YouTube video on ‘Being Rich versus Being Wealthy’ where I talk more on this topic).
o A high mortgage due to being based in an HCOL city is nothing but a ‘premium’ towards the city that could’ve gone into having your money make money instead. Post Covid lockdowns and with flexible working, more and more people are relocating to MCOL (Medium Cost of Living) or LCOL (Low Cost of Living) cities to maximise their savings, even if it means a comparatively lower salary (‘Gross salary is for show. Net savings is the real dough!!’).
The other goal in the Financial Security stage is not only are you investing your savings every month but also have cash available in your bank to take care of at least six months of living expenses. This helps with any emergency situation that may arise in family or any one-off expenses towards weddings, kids education etc.
III. Financial flexibility:
Financial flexibility is when you’re in the age of, I would say between 40 to 50 years old – typically at your career peak or heading towards that and earning well.
Ideally by the end of this stage, your mortgage paid off or is inconsequential. That means the monthly / annual payments aren’t 30% or 20% of your salary but even less than that.
In this stage you should also be diversifying your investments portfolio in a way that it’s started giving you a passive income. This could be in the form of real estate rentals, dividends, interest payments or money from side hustles. Key is to reduce the dependence on salary to sustain your living expenses.
In addition, your emergency funds should now be for 2 years of living expenses. This is important because most likely this is when major one-off expenses happen for parental care or towards the kids’ education. This is also when the career is mostly at its peak and typically most vulnerable towards corporate restructuring / reorganisations. A few times during my corporate career, I had to deliver the tough message of redundancies / recessionary layoffs to folks who were completely unprepared financially and didn’t have enough emergency funds. It then becomes a double whammy as they’ve not only lost their primary source of income but also have to encash their investments when the market is at its low.
- Financial Independence:
Welcome to the Financial Independence Club – the stage where you achieve financial independence! The main ‘eligibility criteria’ to become financially independent is that – you are saving 100% of your salary / primary source of income as your passive income is sufficient to meet all your living expenses.
This simply means you are no longer financially dependent on your salary or your primary job as your money is making enough money for you.
It could be that your investment strategy has not been about generating passive income but growing your capital instead. That can also make you financially independent if your total investments portfolio (or your ‘net worth’) is at least 25 times that of your annual expenses (to be even more safe and robust, it should be 35 times your annual expenses).
Important to note: Ideally the house that you are living shouldn’t be considered part of the net worth as it doesn’t give you any returns and you aren’t able to monthly / annually ‘withdraw’ from that investment (you will be find more details on this topic in another blog by me on this site).
In summary, the journey from Financial Security to Financial Independence is a long journey and depends on many factors – how you manage your expenses, how you control ‘lifestyle inflation’, how you plan your career, what is your investment strategy etc. Simply put, the more you plan properly, the sooner you achieve financial independence.
