The nine levels of financial freedom you should aim for

The nine levels of financial freedom you should aim for

 
Most of us associate financial freedom with not needing a job. But while a complete retirement may be a few years away, here are nine levels of progress that you can measure yourself against.

In your 20s and 30s

Level 1. You get to decide how to spend your salary.

This happens as soon as you get a job in some cases. In most cases an education loan or family may have a prior claim on your salary. But you can quickly get to a stage when you can cover all that and be able to spend on more than just necessities.

Level 2. You can quit a toxic job and tide over till you get a new one in 3-4 months.

When your savings get to a point where you can ‘walk away’ from a job that’s more stress than it’s worth. We are not saying that you quit on an impulse, but you don’t have to suffer in silence either. Having invested in achieving skills that are in high demand will make this happen quicker.

Level 3. You can take a year, or two, off without it pinching you

This is ‘explore my options’ money as against the ‘walk away’ money we talked about earlier. Take some time off to explore an alternate career, without neglecting your financial commitments over that period. You will need to take a call on whether you are going to live frugally in this period, or maintain the same lifestyle as when you had a salary coming in.

Level 4. You can take a year, or two, off and finance a passion

When you are able to take an extended period off and not only manage your financial commitments during that period, but also have enough money to spend feeding your wanderlust, pursuing a passion, or creating a startup.

In your 40s and 50s

Level 5. Becoming debt free

Paying off your loans is a liberating feeling - especially the loan against the home you live in. Besides releasing cash flow, this is a key financial freedom. Being debt free means that no one, but you, has a claim on your income.

Level 6. On track for quitting your job, forever, by a target date

The date may be defined by law, convention, or your own aspiration. You start by figuring out the amount required to help you maintain your lifestyle without an income stream coming in after the target quit date. At this level of financial freedom, you know that the investments you currently have, plus your investing rate will get you to your target amount by your target date.

Level 7. Your current investments are enough to quit your job on your target date.

You don’t need to save and invest any more. All you need to do is to earn enough to pay for your lifestyle till then. This allows you to switch to a possible lower paying job, switch to gigs and improve work life balance.

It often comes as a surprise to many people that they are, in fact, already capable of doing this.

Level 8. You can quit your job today

You can give up on the regular salary credits and the investments you have will take care of your lifestyle for the rest of your life. You may already be at this level and not know it.

Level 9. You have more money than you need to live on

You can quit your job and your investments will not only take care of your lifestyle for the rest of your life but also be able to fund a passion - travel, charitable work, or create an inheritance.

Please take a moment to think about where you are in this journey. Every time you achieve a level, celebrate your achievement and set a plan for the next level.

Happy Investing

Source : Scripbox.com
 

Over time compounding can make you very rich

Over time compounding can make you very rich

Compounding has the potential to grow your savings at a phenomenal pace, making you wealthy over time

There are two kinds of investors in this world, those who understand compounding and those who don't. Almost everyone who invests claims to understand compounding, but very few grasp its potential to grow your money in a big way.

This is because compounding produces such unintuitive results that perhaps only a few mathematically-inclined individuals can be expected to have a real feel for it. The rest of us must rely on calculations. For instance, consider in which scenario your money will grow more - at 10 per cent a year for 15 years, or at 33 per cent a year for 5 years? The answer is that the two will earn the same amount, about 4.18 times.

Overtime compounding can make you very rich

But first, let's define what compounding is exactly. Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also earns interest. This addition of interest to the principal is called compounding. For instance, suppose you put Rs 100 in the bank at a 10% interest rate compounded annually, at the end of the first year, the interest will be Rs 10. Now, in the second year, the 10% interest applies to both your initial amount and the interest earned the previous year, that is to the total amount of Rs 110. The next year, the second year's interest gets added, and so on and so on. Although we use the word 'interest', the idea of compounding applies equally to all forms of returns, not just those that are called interest.

The biggest thing to appreciate about compounding is the value of time. As your returns start earning, and then the returns on those returns start earning, the profits start piling up.

The graph below shows this clearly. The blue line starts rising slowly, but as compounding takes over, the extra time means a lot more income. Translated into a human lifetime, it means that starting to save at the age of 30 instead of 50 can mean retiring with four times the wealth. The graph shows this clearly. If one has time to learn just one thing about investing, then this should be it.

Let's all learn to play and make best use of compounding our investsments.

Happy Investing

Source : Valueresearchonline.com

 

The Plan : Investing on a salary of 35k

The Plan : Investing on a salary of 35k

Sumit is a 24 year-old with a salary of Rs 35,000 and no major responsibilities. He needs to optimise his portfolio

Sumit is 24 years old. He works with a multinational company. His monthly take-home salary is Rs 35,000. Since he lives with his parents, he doesn't have to worry about basic living expenses. Sumit plans to get married in two years and his parents will take care of his wedding expenses. He is a diligent saver and keeps his monthly spending below Rs 10,000. He wants us to build a financial road map for him and analyse his investments in stocks and mutual funds.

 

Emergency fund
Since Sumit is single and stays with his parents, he doesn't have to worry about emergencies. But once he gets married he should maintain an emergency corpus equivalent to at least six months' expenses. An emergency fund acts like a cushion during tough times. It should be kept in a combination of sweep-in fixed deposits and short-duration debt funds. This helps earn higher returns without compromising on liquidity.
Action: In the future, maintain an emergency corpus equivalent to six months of expenses.

 

Life insurance
Sumit has a term cover of Rs 50 lakh. Term plans are the best form of life insurance as they provide a large cover at low cost. Endowment insurance plans and unit-linked plans (ULIPs), which are a combination of investment and insurance, should be avoided as they provide neither sufficient insurance nor good returns.
However, Sumit doesn't need such a large life cover at this stage. One needs a life cover only if one has financial dependents. Since he has already purchased one and plans to get married in two years, he may retain the cover and reassess his needs once he gets married.
Action: Continue to stay away from endowment and unit-linked insurance plans.

 

Health insurance
Sumit has a health cover of Rs 4 lakh from his employer. He had a personal health cover too, but he discontinued it a few months ago. It is recommended that one buy a personal health cover apart from the one provided by an employer. Health cover provided by employers ceases with employment and one is not covered during the job-transition phase. Hence Sumit should buy a health cover of Rs 2-3 lakh, which would cost him around Rs 5,000-7,000 per annum.
While purchasing health insurance, Sumit should ideally go for a policy without a co-pay and sub-limit clause. In a co-pay clause, you have to necessarily bear a certain proportion of the treatment cost from your pocket, irrespective of whether the total bill amount is within the health-cover limit. A sub-limit clause restricts the coverage to certain expenses, like doctor fees, room rent, ICU charges, etc. For example, if a Rs 2 lakh policy cover has a sub-limit for daily ICU charges at 2 per cent of the sum insured, the insurance company will only pay up to Rs 4,000 for the same. The balance cost has to be borne by the insured.
Sumit should try not to miss any premium payment and should continue with the same health plan year after year. Health plans cover treatment of certain medical conditions only when the policy has been renewed continuously for a specified number of years, which is known as the waiting period. This may vary from two-four years depending on the policy. Sumit should also ensure that his parents have the necessary health cover as unforeseen medical expenses can dent one's financial plan in a big way.
Action: Buy a personal health-insurance plan.

 

Children's education and marriage
Sumit wants to start investing for his future children's higher education and weddings. He estimates the combined cost to be Rs 40 lakh in today's terms. At 8 per cent inflation, this would swell to more than Rs 3 crore in 20-30 years when he would need this money. Assuming a return of 12 per cent, an SIP of Rs 7,500 in one or two good equity funds should suffice, provided the SIP amount is increased by 10 per cent every year.
Action: Start an SIP of Rs 7,500 and increase the contribution every year.

 

Retirement
It is too early to estimate the required retirement corpus for Sumit as his lifestyle and expenditure are likely to change in the coming years, especially after he gets married. But he should continue to invest the available surplus regularly in equity to reap the benefits of compounding over the long term.
Action: Continue to invest in equity mutual funds through SIPs.

 

Portfolio
Sumit has accumulated around Rs 2.40 lakh in eight decently rated equity funds through SIPs. These are a mix of tax-saving, large-cap and small-cap funds. He should invest in no more than four to five mutual funds as too many schemes make it difficult to monitor the portfolio and may result in him losing out on returns in the long run.

Investments in a tax-saving fund should be limited to the amount required for tax saving as it has a mandatory lock-in period of three years.

With Sumit's goals more than 20 years away, the major portion of his portfolio should be invested in two multi-cap funds and a small portion in a good small-cap fund. Multi-cap funds have the flexibility to invest in companies of all sizes. This helps the fund manager derive the best possible return. Since Sumit has enough time, he can continue to invest in his small-cap funds. But he should remember that small-cap funds are extremely volatile and may move up or down sharply, even with the slightest movement in the market.

Sumit has also invested Rs 1.40 lakh in stocks. He should continue with them only if he has the required skills and time to invest directly in stocks. Otherwise, he should shift to equity mutual funds.

Action: Reduce the number of funds. Invest in multi-cap funds.

Keep in mind

• It's always desirable that you start investing early in life as you will be able to reach your financial goals faster and more comfortably.
• Marriage increases your financial responsibilities. Make changes to your financial plan accordingly.
• Don't rely only on the employer-provided health cover. Buy your own health insurance as well. Take into account the co-payment and sub-limit clauses.
• Four or five funds are enough for optimum diversification.
• Multi-cap funds are the best category of equity funds to hold as they can invest across companies of all sizes.
• Direct equity investing is fine if you know how to research stocks. Otherwise, go for equity funds.

 

Happy Investing

Source: Valueresearchonline.com

The case for a fixed choice

The case for a fixed choice

Even the most die-hard equity fan must ensure that at least some of their investments are in a fixed income option

As regular readers must have noticed, I have often lamented the excessive reliance on fixed income that Indian savers are prone to. India has traditionally been a 'fixed income country'. Generations of savers turn automatically to savings instruments like PPF, bank deposits, post office deposits, etc for all their savings needs. This is something that I've often written about and pointed out that long-term savings and investments must be invested in equity or equity-backed mutual funds.

Interestingly, it increasingly looks like a certain proportion of younger savers have taken to the equity mantra a little too much. Savers who get start investing in equity mutual funds and have a good experience tend to go almost 100 percent into it. This is a mistake, and the reasons are the twin concepts of Asset Allocation and Asset Rebalancing.



These sound complex but are easy to understand in just three steps. One: Broadly, there are two types of financial investments, equity (shares) and fixed income (deposits, bonds etc). Two: Equity has higher potential gains and more risk, while fixed income has lower but steady gains. Depending on your needs, you should be investing in the two in a particular proportion. This proportion, and the process of arriving upon it, is called asset allocation. Three: As time goes by, equity and fixed income gain at different rates, thus disturbing the desired asset allocation. Shifting money between the two to restore that allocation is called asset rebalancing. That's it.



The question is why does it work? The basis for asset allocation is that the two types of financial assets - equity and debt - are fundamentally different. Not only are they different, they are complementary. In terms of the conflicting need of investments to give high returns and high safety, each plays a role that fills in the other's deficiencies.


Let's see how that happens.



There are just three ways that an investment can make money. One, by lending money to someone who pays interest on it, be it a business or a government. Two, by becoming a part owner of a business, as in having a share in it. And three, by buying something that becomes more valuable, like gold or real estate or indeed any possession.



Equity grows faster than debt (which means all kinds of deposits), but is much more volatile. There are times when it will rise much faster than debt, and there are times when it will grow slower, and will fall. It turns out that the best way to protect as well as take advantage of the fact is to decide upon a percentage balance between equity and debt and stick to it by periodically shifting money away from the one which becomes high and to the one that becomes low. When equity is growing faster than fixed income - which is what you would expect most of the time - you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored. When equity starts lagging, you periodically sell some of your fixed income and move it into equity. Inevitably, things revert to a mean, and that means that when equity starts lagging, you have taken out some of your profits into a safe asset.



There is practically no case for any individual having no fixed income investments at all. The only question is what kind. For individuals who like to keep it simple, the entire thing can be done within hybrid mutual funds. The asset balancing and allocation all happens transparently and effortlessly within the fund. Even the traditional favourite, Public Provident Fund (PPF), is not a bad choice because it does provide tax savings as well as tax free returns, although the very long lock-in period is problematic.



No matter how completely you have bought into the equity story and what route you take, some fixed income investments are a must for everyone.

Happy Investing

Source: Valueresearchonline.com