[sniplet SMR-2011-Update]

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?