Just like how people who want to lose weight understand that they need to eat healthier and resist junk food to improve their future health, financially savvy people realise that cutting out unnecessary expenses and investing the surplus can lead to attaining financial freedom. With people living longer these days, it is really important to plan and manage your finances wisely. This can help reduce stress and improve your overall health, happiness and productivity. Remember, it all starts with you!
What is financial freedom?
Financial freedom is the state of having enough financial resources to support your desired lifestyle without the need to rely on traditional employment for income.
It means having the ability to make choices based on your personal values, having the ability to spend quality time with loved ones, pursuing personal interests and hobbies and achieving a level of financial security that provides peace of mind, knowing that you have enough resources to weather unexpected financial challenges.
While the definition and magnitude of financial freedom may vary from person to person, it generally involves being free from relying solely on work to sustain your livelihood. Financial freedom can lead to a higher quality of life, with less stress and more opportunities for personal growth and fulfilment and this makes financial freedom a highly sought-after state.
Earning, saving, spending and investing are the four primary components that require careful attention and must be managed effectively for achieving financial freedom. However, the order of importance will change depending on what stage of life you are in. While earning and working hard to improve your ability to earn more is important, it is equally important to save and invest wisely and control your spending.
We will discuss the importance of each of these four components in detail in this article in order to explore what it takes to attain financial freedom.
A. EARNING
Earning is incredibly important in our society. Money is the key to fulfilling many of our materialistic needs, desires and goals. It is what gives us the opportunities to do things we want to do, like buying a house, travelling or starting a business. Without earning, we might not have access to the things we need or want and we may not be able to achieve our goals. So, earning is really significant in our monetary system.
You can earn money in many ways, like running a business or working for a company that pays you a salary for your work. It really depends on what you do and how you want to earn your income. This is the primary way in which most people make their money.
Earning from a salary or business often takes up a significant amount of time, usually around 40 hours a week. By dedicating your time and effort to these activities, you generate the income needed to support your family.
In order to pay off your debts or increase your income, you can consider a side hustle in addition to your regular job. This way, you can earn extra money in your free time and work towards your financial goals more quickly.
A side hustle is a job or business that someone does in addition to their regular employment or main source of income. Side hustles can take many forms, such as freelance work, selling products online, tutoring, pet sitting or driving for a ride-sharing service.
You can also work on creating sources of passive income in addition to your regular job or business. This way, you can earn money without having to actively work for it all the time. Building passive income streams can require some upfront effort and investment, but it can provide a reliable source of income in the long run. It's a great way to diversify your income and achieve financial stability. For example, if you create an online course or write a book, you can earn royalties from sales of that work without putting in additional effort.
Earning provides you the necessary resources to save and the more you earn, the more you can potentially save. Therefore, earning and saving go hand in hand when it comes to building financial security and attaining financial freedom.
B. SAVING
Saving is the portion of your income that is deliberately withheld from your current expenditures and set aside for future use. The act of saving involves making a conscious decision to allocate a portion of your income towards achieving specific financial goals, such as building an emergency fund or saving up for a down payment of your house.
Saving money requires you to be purposeful and intentional. Creating a budget is a practical way to stay focused on your financial goals and make sure you are saving regularly.
Create a budget:
Creating a budget plan is essential to keep track of your monthly income and expenses. When you create a budget, you are essentially making a plan for your money. You decide how much you want to save, how much you want to spend on your regular expenses and how much you want to invest for your future.
A budget allows you to analyse your spending habits to see where your money is going and identify any unnecessary expenses that may be affecting your savings. For instance, you may have spent a considerable amount on dining out or entertainment, but failed to notice it because you paid using a credit card whose expenses you do not track.
Similarly, by drafting a budget, you may notice that at times you spend large amounts on buying the latest gadgets, which you may not necessarily require. While investing in technology can enhance efficiency of doing things and learning, constantly upgrading gadgets for the sake of showing off is not a wise expenditure.
A budget helps you to identify and address such gaps that hinder saving. By cutting down on such expenses, you can redirect the saved amount to other important areas. When you realise the extent of missed opportunities to save, you are more likely to be prudent in the future.
To make a budget that actually works, you should start by identifying your total monthly income from all sources such as your salary, any freelance work you do or any other sources of income you may have.
Once you know your monthly income, you can allocate a certain amount for your essential expenses like rent, utilities and groceries. It is important to be realistic and allocate adequate amounts for these expenses, because if you don't have enough money set aside for them, it can be really hard to stick to your budget.
You should also allocate enough money for your savings and investments which will help you achieve your financial goals. By taking the time to create a budget that is tailored to your income and expenses, you can make sure that you are able to stick to it over the long term.
Pay yourself first:
Paying yourself first is a habit that involves setting aside a portion of your income before allocating it towards your expenses. When you pay yourself first, you are essentially treating your savings as a bill that needs to be paid, just like your rent or mortgage. By doing this, you are making your financial well-being a top priority.
Paying yourself first also helps you to avoid the temptation of overspending and accumulating debt. If you wait until the end of the month to save, you may find that you have spent all your money and have nothing left to save.
Make saving a priority by allocating a portion of your salary towards investments at the beginning of each month. You can utilise options such as a recurring deposit to assist in the growth of your savings. After making these contributions, you can then allocate the remaining funds towards your daily expenses.
Create an emergency fund:
An emergency fund is a pool of money that you set aside specifically to cover unexpected expenses, such as a medical emergency, job loss or major car repair.
Having an emergency fund can prevent you from going into debt or having to use your long-term savings in case of a sudden financial emergency. Without an emergency fund, you might be forced to rely on high-interest loans or credit cards to cover unexpected expenses, which can quickly put you in a precarious financial situation.
By having an emergency fund in place, you can ensure that you have a financial cushion to fall back on in case of an unexpected expense, allowing you to avoid taking on debt and keeping your long-term savings intact.
Aim to save at least three to six months' worth of living expenses in an easily accessible account. This amount is considered a good benchmark because it provides enough time to address most emergency situations. However, the actual amount you need in your emergency fund may vary depending on your personal circumstances, such as your job security, health status and the number of dependants in your family.
Get adequate life and medical insurance:
Having adequate life and medical insurance is critical before you start investing, as unexpected events such as a medical emergency or unforeseen death could have a severe financial impact on you and your family. Without proper insurance coverage, your savings might not be enough to cover these expenses and you may end up dipping into your investments, which can disrupt the power of compounding.
Life Insurance:
Life insurance can provide financial security to your loved ones in the event of your unexpected death. Having adequate life insurance can give you peace of mind knowing that your loved ones will be taken care of even if you are no longer there to provide for them.
The beneficiaries of your life insurance policy can use the payout to cover expenses such as paying off outstanding debts, living expenses and other financial obligations.
Achieving freedom from worrying about life goals can be possible through the purchase of a pure term insurance plan. Such plans are highly beneficial because they offers extensive coverage at a lower premium than other types of insurance policies. This is because they focus solely on providing life coverage and do not include any investment or other options that would increase the cost of the policy.
When buying a term plan, it is essential to consider factors such as the required coverage amount, liabilities, life stages, income and future expenses. Moreover, choosing a reputable insurer with a high claim settlement ratio, additional riders and excellent service standards is crucial.
Medical Insurance:
Medical emergencies can occur at any time and without financial preparation, they can cause significant damage to your finances.
Private healthcare facilities are expensive and healthcare inflation is predicted to be higher than general inflation. Therefore, it is crucial to purchase health insurance for oneself and all family members to be financially prepared for medical emergencies.
Having adequate medical insurance can provide you timely, necessary and specialised medical treatments without having to worry about the financial burden it might cause.
In addition, having insurance can help you save money in the long run. The cost of medical treatment and life insurance premiums may seem expensive, but it is much more affordable than paying for the full cost of treatment or having to self-finance your medical expenses or life events.
Reduce debt:
It is important to prioritise paying off your high interest debt before investing, as the interest rates on debts such as credit card or personal loans are typically higher than the returns you may generate from investments. This means that paying off your debt first can save you more money in the long run, which can then be put towards investments.
Develop a plan to pay off your debt, starting with high-interest loans first. This involves making the minimum payment on all of your debts and then using any extra money you have to pay down the debt with the highest interest rate.
Once that debt is paid off, you move on to the debt with the next highest interest rate and so on, until all of your debts are paid off. This method can save you money in the long run by reducing the amount of interest you pay over time.
C. SPENDING
When you spend money, you exchange it for something of value, such as food, clothing, housing, transportation, entertainment or other items that meet your needs or desires.
When you have money coming in every month, it can be tempting to spend it on all kinds of things like buying a new phone, going on vacation or eating out at restaurants. However, if you want to make sure you are saving enough money and staying on track towards your financial goals, it is important to keep track of your expenses and stick to your budget.
Analyse your expenses:
It is important to be mindful of your lifestyle expenses like buying new clothes or frequent trips to the salon because such expenses can impact your ability to achieve other financial goals.
You can categorise your expenses into essential expenses, variable expenses and discretionary expenses to determine which expenses are necessary and which ones can be reduced.
Essential expenses are necessary for your survival, such as groceries, utilities, rent or mortgage payments. Trying to cut down on theses expenses can be difficult and if you try to do so can take a toll on your emotional well-being causing you to feel anxious, stressed or even depressed.
Variable expenses might include costs that can vary from month to month, such as transportation or medical expenses.
Discretionary expenses are not necessary for your survival but provide you joy or you feel are important for your lifestyle like going to concerts or other entertainment events, upgrading your phone, etc.
When you are trying to reduce your expenses, you can focus on your variable and discretionary expenses because theses expenses have the most flexibility to make changes. For example, with variable expenses like transportation costs, you can explore alternatives like taking public transit instead of a cab or car.
In case of discretionary expenses, you can allocate a portion of your budget for these expenses and stick to it. You could also cut back on some of these expenses or postpone them. For example, you could skip a night out with your friends or delay buying new clothes until you have more room in your budget.
By finding ways to reduce your variable and discretionary expenses, you can make progress toward your financial goals without compromising on your essential needs.
Remember that cutting back on your variable or discretionary expenses does not mean leading a frugal lifestyle. Rather, it involves reflecting on your income and lifestyle changes over time and making thoughtful adjustments to your spending habits.
Control lifestyle inflation:
As your income increases, your expenses tend to grow as well. This phenomenon is known as lifestyle inflation or lifestyle creep and it can make it difficult to save money.
Lifestyle inflation occurs when you start to conflate your needs with your wants. For instance, you might start eating out at fancy restaurants or buying designer clothing instead of sticking to your usual routine.
Over time, these expenses can add up, leaving you with less money for saving or investing towards your financial goals. To avoid lifestyle inflation, it is important to be mindful of your spending habits and avoid increasing your expenses as your income goes up.
It can be challenging to develop and maintain this habit due to peer pressure and societal norms. However, if you are able to effectively address this issue, it has the potential to provide financial freedom and therefore should not be overlooked.
Avoid impulse purchases:
Impulse purchases are purchases that you make on a whim, without giving them much thought or planning. These are usually items that you see and immediately feel the urge to buy, often because of a feeling of excitement or temptation.
Impulse purchases can add up quickly and take a toll on your budget. They may also lead to feelings of regret or guilt, especially if you later realise that you didn't really need the item or that it wasn't worth the price.
It is important to be mindful of your spending habits and to resist the temptation of impulse purchases. This means taking the time to think about your purchases, considering whether you really need the item and whether it fits within your budget.
D. INVESTING
Investing money is a way to use it to generate additional income or wealth over time. Money can be invested to purchase assets, such as stocks, bonds or real estate, that have the potential to grow in value or generate income. For example, if you invest money in a company's stock, the company may use the funds to expand its operations, which can lead to an increase in its stock price and generate a return on your investment. Similarly, if you invest in a rental property, you may be able to generate income from rent payments.
Investing money can be a way to make your money work for you, rather than you working for your money. You can earn passive income from your investments, i.e. earn money without actively working for it. This can be a helpful way to supplement your income and save for your long term financial goals, such as for retirement.
Here are a few examples of assets that can convert ordinary earned income to passive income or investment:
1. Rental properties: Owning a rental property can generate a steady stream of passive income in the form of rent payments from tenants. For example, let's say you own a rental property that generates ₹30,000 in monthly rent. If you have a mortgage on the property, your net income from the rental property would be the rent minus the mortgage payment and other expenses (such as property taxes, insurance and maintenance). Over time, the property you own may also appreciate in value, providing an additional benefit.
2. Dividend-paying stocks: Investing in dividend-paying stocks can generate passive income in the form of dividends, which are periodic payments that companies make to their shareholders. For example, let's say you own 10,000 shares of a stock that pays a dividend of ₹10 per share annually. This would generate ₹1,00,000 in annual passive income for you.
3. Businesses: Owning a business that generates profits without requiring you to be actively involved in its day-to-day operations can also generate passive income. For example, let's say you own a franchise business that is managed by a team of employees. As long as the business is profitable, you will receive a share of the profits as passive income.
4. Investing in mutual funds: You can create assets by investing in mutual funds that generate dividends and capital appreciation. For example, if you invest in a mutual fund holds a significant amount of stocks that pay dividends, those dividends will be passed on to you, which can provide a steady stream of passive income.
Invest the unexpected income:
Suppose you receive windfall gains such as an unexpectedly high annual bonus or an inheritance. Instead of spending this money on a luxury car or exotic vacation, you can set aside a significant portion of this income for the future, as you and your family is already accustomed to living without it.
You can also consider repaying or even prepaying outstanding loans with this money. However, it is not necessary to invest the windfall immediately, as suitable investment options may not be available at the time. It can be held in risk-free, liquid assets until a decision is made. For instance, a substantial annual bonus can be used to prepay loans and invest the remaining amount for future returns.
While unexpected income can provide a financial boost, it is important to remember that they are not guaranteed sources of income. Relying too heavily on windfall gains can lead to risky financial behaviour such as overspending or taking on too much debt.
Aim to start investing early:
Investing early can give you a head start in your journey towards financial security and help you build a strong foundation for your future.
When you invest, you earn returns on your initial investment, as well as on the returns generated by that investment over time. The longer your investment is held, the more it can grow through compounding. So, by starting to invest early, you have more time for your investments to grow, potentially resulting in a much larger sum of money in the future.
Achieving your long-term financial goals becomes easy when you start investing early because the longer you have to invest, the more time you have to accumulate wealth and reach your goals.
Investing requires discipline, patience and consistency. By starting early, you can develop these habits and be better prepared to navigate the ups and downs of the market throughout your investing journey.
Align your investments with your goals:
Aligning your investments with your goals means that you invest your money in assets that are in line with your financial objectives. This helps you avoid investing in inappropriate instruments such as investing funds for your short-term goals in equity mutual funds which could result in fluctuations in your capital or investing for your retirement fund in a fixed deposit which would not generate sufficient returns over the long term.
When selecting an investment instrument, it's important to consider your financial goal because each type of investment has unique features that make it better suited to specific goals. For example, if your financial goal is to save for your child's college education, which is a long-term goal that requires stable growth over a long period. In this case, you might consider investing in a diversified portfolio of mutual funds or exchange-traded funds (ETFs).
If your goal is to save for a short-term need like a down payment on a house, you might consider investing in a high-yield savings account or a money market fund that provides liquidity and stability, with minimal risk of loss of principal.
It is also important to choose your investments in accordance with your risk tolerance. If you have a lower risk tolerance, you may want to choose more conservative investments that have lower potential returns but are also less volatile such as debt mutual funds or hybrid mutual funds. If you have a higher risk tolerance and a longer investment horizon, you may want to consider investments that have higher potential returns but also have higher volatility such as equity mutual funds.
Conclusion
Financial freedom is the state where you no longer have to rely on a 9-5 job to sustain your lifestyle. Instead, your savings and investments generate enough returns to support your lifestyle, allowing you to spend your time on activities that you enjoy without worrying about generating income. This makes achieving financial freedom a goal worth pursuing and striving for.
Achieving financial freedom requires planning and discipline in managing your finances to ensure you can meet your long-term financial goals. You need to focus on earning and investing early, making smart investment decisions, sticking to a budget and avoiding unnecessary expenses.
It is important to remember that you cannot attain financial freedom overnight. Attaining it is a long-term journey that requires patience and perseverance. It requires a commitment to your financial goals and the willingness to make sacrifices in the present to reap the benefits in the future. I wish you the best in your pursuit of financial freedom.
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