An Update to My Seven Money Resolutions for 2011:
#4 — Work Towards True Financial Independence

by Vinaya HS on December 28, 2011

in Finance

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Towards the end of 2010, I made Seven Money Resolutions for 2011 that I hoped to execute upon through the year in order to strengthen my personal finances. A year has almost passed and I thought I’d provide an update on each of these resolutions.

Resolution #4:
I will work hard towards becoming truly financially independent. I want my money to work for me and not the other way around.

So, what exactly is financial independence?

  1. Freedom from financial reliance on loved ones.
  2. Freedom from financial reliance on creditors.
  3. Freedom from financial reliance on employment.

This still is the best definition of financial independence that I have come across. And financial independence is my foremost goal. Having cleared all of my liabilities earlier this year (which means that I can place a check against #1 and #2), I have been doing a fair bit of thinking on how I want to get to #3. My thoughts follow.

I’d like to split my target for financial independence into two stages:

  • Level 1 Financial Independence — where the sum of income from sources other than my regular job is equal to or exceeds my monthly living expenses.

  • Level 2 Financial Independence — where the sum of income from my investments is equal to or exceeds my monthly living expenses.

Update: Over the course of the year, I subsequently made an important distinction between financial independence and financial freedom (the comments on that post make for a very interesting read). I also discovered the concept of ERE and was hooked.

Right now, Level 1 is a medium-term (less than three years away) goal and Level 2 is a long-term (three or more years away) goal for me. Getting to Level 1 would mean that I achieve #3 — freedom from financial reliance on employment — but that would be inadequate over the long-term. Getting to Level 2, however, would mean true financial independence, but getting there is a tough task.

Let’s make some rough calculations. Suppose you estimate your monthly living expenses to be Rs 30,000. You’d need to have a corpus in the region of Rs 5,000,000 earning between 7% — 8%. Light years away from where I am today. :-) But as the saying goes, a journey of a thousand miles begins with a single step.

Accordingly, I am structuring two portfolios:

  1. A Passive Income Portfolio for Level 1 Financial Independence.
  2. An Investment Income Portfolio for Level 2 Financial Independence.

The names are slightly misleading. Let me explain.

My Passive Income Portfolio

Since I already have a couple of sources of income (the sum of which is less than my monthly living expenses) aside from my regular job and since I don’t need this income right away, I’m socking it away in a liquid mutual fund. At the same time, I’m also working on bringing-in other such sources of income (I need to do this given the irregular nature of such income and given that the sum of these should be equal to or exceed my monthly living expenses).

So long as I don’t need this income, I plan to build a corpus in the liquid mutual fund and gradually do an STP (Systematic Transfer Plan) into my Investment Income Portfolio (described below). But, were I to need this income each month (say due to prolonged unemployment or other such reasons), I’ll stop the STP and use the income.

Update: This strategy worked extremely well this year. I recently moved the accumulated funds into a couple of 370-Day Fixed Maturity Plans and shifted the book-keeping to be a part of my Investment Income Portfolio.

My Investment Income Portfolio

This portfolio would be my ticket to Level 2 Financial Independence — a portfolio that can generate investment income (in the form of interest, dividends, etc.) each month sufficient to cover my monthly living expenses. Ideally speaking, I’d never need to draw any of the principal ever. This is my dream.

I’ve just started putting this portfolio together. So it’s too early to talk about it. I promise to write in detail when I have everything in place.

Update: Right now this portfolio comprises of a mix of Fixed/Recurring Deposits, Public/Employee Provident Funds, Fixed Maturity Plans, and Direct Stock Market Investments (note the absence of mutual funds; I got out when I had to set right some negative cash flow).

Know what would be the icing on the cake? Still having Level 1 Financial Independence when you achieve Level 2 Financial Independence. That would take care of any inflationary concerns.

What do you think?




Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.

{ 6 comments… read them below or add one }

pattu December 28, 2011 at 6:59 PM

These statements seem contradictory:
“Level 1 Financial Independence — where the sum of income from sources other than my regular job is equal to or exceeds my monthly living expenses.”

“Level 1 is a medium-term (less than three years away)”

“Rs 5,000,000 earning between 7% — 8%. Light years away from where I am today”

For most people level 1 and level 2 fin indep. mean the same. Money from sources other than income meeting expenses.
Unless your light years are approximately = <3 ordinary years

pattu December 28, 2011 at 9:15 PM

oops.
“Unless your light years are approximately = <3 ordinary years"

should be before 'For most people …'

sorry

Vinaya H S December 30, 2011 at 7:37 AM

@pattu:

The distinction that I make between FI and FF seems to often cause much consternation. Perhaps an explanation can help here (all numbers are fictional).

Suppose my monthly expenses are on an average Rs 30,000.

Suppose, apart from my salary, I also earn Rs 5,000 per month from rent and Rs 5,000 per month from advertising on the blog. This is FI-income for me.

Suppose, I also earn Rs 7,500 per month from my investments. This is FF-income for me.

Now, while 30,000 > FI-income + FF-income I’m light-years away.

Once 30,000 = FI-income + FF-income I’ll be ordinary-years away. :-)

Once 30,000 < FI-income + FF-income I'll be less-ordinary-years away. :-)

And once 30,000 < FF-income …

pattu December 30, 2011 at 6:10 PM

Get it. My hunch is inflation in the 30,000 while the > changes to = and then not-so ER.

All your ERE posts are cryptic. If you are so convinced that conventional ret plans are inferior to your version of ERE you need to prove it with numbers. Still waiting for you to do something about this.

The point is until you do so I don’t see how others can relate in any way (+/-) to what you do reg. retirement.

pattu December 30, 2011 at 6:14 PM

oops again. It should read:

My hunch is inflation in the 30,000 while the ‘>’ changes to ‘=’ and then to ‘ not-so ER.

Vinaya HS December 31, 2011 at 10:09 AM

@pattu:

I’m still to work on that calculator that you so kindly provided. So many things…so little time…huge backlog.

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