Friday, February 26, 2010

On Financial Freedom

Just some thoughts on this term “financial freedom” that has become a much coveted goal in life popularized by Robert Kiyosaki in Rich Dad Poor Dad. Btw apparently Kiyosaki was never as rich as he proclaimed. He got rich after selling his book. Well, some of his ideas are refreshing though.

What is the definition of financial freedom?

I guess to most people, it would be having enough money in your bank to last a lifetime living the same quality of life and thus having the freedom to choose not to work for money.

In the first ever post on this blog, we worked out this amount is probably slightly more than half a million dollars for a conservative guy and $3mn for someone more aspiring. And this amount is highly unreachable with normal jobs since annual salary is about $30,000 to $40,000 on average in developed countries. (Well actually it’s doable given enough time: like 30 years, as we shall see but that defeats the purpose I guess :)

Hence there is a need for passive income (another term from Kiyosaki) to help fund monthly expenditures. However passive income can only come from a few sources:

1. Dividends from stocks
2. Interest from fixed income instruments (bonds, T-bills etc)
3. Rental income from property
4. Pension or annuity payout
5. Cash flow from businesses (which you don’t have to run it)
6. Royalties from books, songs etc
7. Others: sponsorships, fees etc

So, in order to fund an annual expenditure of say $25,000 (roughly 80% of Singapore’s average income), well say the income yield is 5-8% (an arbitrary average yield if you invest in some or all of the 1-7 above), you need a portfolio of $300,000-500,000. So theoretically, if you save enough and put your money to work wisely, you could become financially free in about 20-30 years. Hell, it’s still gonna take a long time!

(Obviously this amount comes up to be much smaller than what was stated in the first ever post bcos one no. simply calculates lifetime expenses (including mortgage and other liabilities) while the other no. is about how to sustain a certain expenditure with returns from a portfolio.)

Of course, if your monthly household expenditure is $3,000, this works out to be $36,000 per year, it should then then take you about 40 years to save up to a portfolio that could generate $36,000 per year assuming that you save 25% of your income and your savings are invested to achieve a return of 8%. Shiok huh? 40 years to financial freedom!

Well some capable souls might be able to shorten to 10 plus years which is not bad, bcos he or she would be 40+, still young!

Let’s delve into this a bit deeper. Why do people want so much to be financially free?

Well I guess according to the definition above, so that they don’t have to worry about money and bills, and can spend their time somewhere else instead of working like having time to engage full-time in a hobby, to play with kids, do volunteer work etc.

I guess this would be the goal for most who proclaims that their goal is to attain financial freedom.

To put it in another way: the crux of this financial freedom problem seemed to be represented in this matrix

    We want Time, Money and Happiness. Job gives Money but takes away Time and maybe Happiness: so how?

    Most people’s solution is to trade 10+ (if possible) or 20-30 years of time, do a Job that gives Money, and after getting enough money, quit job and get Time, Money and Happiness.

    At this point, we should also note that Time and Money does not generate Happiness. So even after you have achieved financial freedom. It does not guarantee Happiness - which I would think would be the ultimate goal in life. So something is missing here.

    Now the question is really then: is trading 10 plus years of life, or for others 20-30 years a good solution to achieve the coveted financial freedom or rather what most people actually want?
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