Flickr image "Epiphany 3" by Felipe Venancio

The ultimate paradox of financial freedom has been revealed to me.

All this while, I’ve been reading, researching and writing about financial freedom. It took a recent episode of moving my net worth from one asset class to another that an epiphany struck me.

What is this ephiphany that Panzer encountered?

Financial freedom is in the mind

Financial freedom first and foremost has to begin in the mind. It’s where you conceive the very idea that you can take control of your finances by living within your means, saving and investing, growing your means and protecting your means.

As I started with this idea, and implemented it in the various posts I’ve outlined in this blog, I started to gain new insights about myself. For instance, tracking where every single dollar I earn and spend helped me modify some of my habits when it comes to spending. It has allowed me to evaluate where money (that represents life energy) goes and how that either adds value or subtracts value out of my life.

I also started some projects on growing my wealth. My blog monetisation efforts have given modest returns but they are positive returns. While I’ve managed to beat fixed deposits returns for the past 6 years since I started managing my own money, I’ve also under-performed for 2009 year-to-date and I hope I can end the year with a positive return.

Throughout all these experiences, I realised one thing.

I am already financially free.

Financially free

Huh? What is Panzer talking? Is he smoking a banned substance and high?!

No, what I’m saying is this.

I am not financially free using my traditional definition of being in a position where passive income from investments exceed my living expenses. I still need to get up and go to work in the mornings to make bread for my family.

But what I’ve realised is that in my current situation, my income exceeds my living expenses. My current career suits me as I look forward to go to work in the present environment. Because even if passive income exceeds living expenses, we can never predict if our life is taken away or our health is taken away. Thus, ultimately, happiness in life is wanting what you already have.

That means, in many respects, I already have a form of financial freedom.

Wanting what you have

For too long, I’ve waited to be happy only if I’ve achieved this or that and only if I’ve managed to hit financial freedom. It is still a goal I am striving for, but I realise that enjoying the process towards financial freedom. Being able to enjoy and appreciate what I have, does wonders towards my sense of well-being.

The target of financial freedom drives me. But the awareness and consciousness that being grateful for where I am now is also important liberates me from being dependent on achieving financial freedom to be happy.

A 42 year old successful CEO recently passed away at the OSIM International Triathlon. By all accounts, he had a good life. But it was taken away all so suddenly. Going forward, I’ll try to take each day at a time and to want what I already have.

I may or may not achieve my goal of being financially free with property investment (which I’m still considering and evaluating suitable properties) or perhaps go back to equities or even stay sidelined and wait for the big “correction”.

Whatever it is, health, family and happiness is important.

Financial freedom is a journey. If you enjoyed the journey, you won’t fret too while having your eye on the destination.

Be well and prosper.

[This article was first posted on 1 March 2008 on Five Cents Ten Cents on blogspot.]

Have you ever bought a bottle of wine from the supermarket, wine shop or duty-free at Changi Airport?

Do you read the labels on the wine to understand what have you bought?

For many years, I didn’t really read the labels because I didn’t understand what they described until I attended a couple of wine appreciation courses where the speaker shared with us how to read the labels. For example, the label above reads “Cabernet Sauvignon” which is a widely recognised and grown red wine grape variety. Wine labels go by grape variety or region or name of the winery and different types of wine have different types of labelling conventions based on country, custom and marketing.

Reading about savings and investments: Know what you are investing in!

This post is not about wine appreciation! It is about knowing what you are buying or investing. Many of us will rely on the recommendations of the sales lady at the Duty Free Shop in the airport or just pick the one that suits our budget and either red, white or rose wine based on the shape and look of the bottle. Few of us would actually take the time to learn more about it.

The same tends to apply to our investments. We tend to listen to the financial advisor or salesmen and women who have a vested interest to push the investment product or service to you for a commission.

Picking wine is one thing. Picking investments is another in that your investments typically involve large sums of your hard earned money which can grow or shrink depending whether you understand what you have bought. The risk of us NOT TAKING THE TIME TO READ AND UNDERSTAND what we invest is to take up more risks than necessary to earn the potential returns.

Structured Products: Risk-return in favour of the banks/issuers

Banks know that the average investor does not like to read. In the US, it is estimated that almost 1 in 2 adults never read a book afer they leave high school. I am not sure of the Singapore statistics but I dare say many adults don’t read fiction and non-fiction after the graduate. In this age of internet content, television programmes, movies, shopping, reading a good book at home doesn’t rank too high on many people’s list of leisure activities.

If you don’t read books generally and plough through details, chances are you won’t read the thick prospectus that banks and financial institutions are required by law to issue for investment products. Hence, banks and financial institutions go around splashing catchy advertisements on their “capital-guaranteed” structured deposits products only to have all the fine-print (at font 10 or less) saying the “capital guarantee” also comes with a catch, i.e. under certain conditions, say sub-prime or in the case of China Aviation Oil price collapse, the “guarantee” is not longer guaranteed.

Unfortunately, many unsuspecting investors didn’t read the fine print and their returns were far from what was suggested by the banks or financial institutions issuing the product.

I am not saying that structured deposits and products are all bad and all lose money. However, if you read the fine print and ask those who understand financial derivatives, many of these structured products are structured to weigh the risk-return trade-off IN FAVOUR of the issuing bank or financial institution. In simple terms, YOU TAKE MUCH MORE OF THE RISK, THE BANK / FINANCIAL INSTITUTION TAKES MORE OF THE RETURNS.

How the bank is able to do that is that they essentially make bets using a small portion of your monies invested with them for those few years on movements in currencies, share prices, interest rates and the remainder they put in relatively low risk assets. If the bets work out, the banks WIN BIG and give you a small portions of the gains as higher returns. In event that the bets turn out wrong, the bank can still give you back the “capital guaranteed” (less certain fees/charges) as the bulk of the investments were in relatively low risk assets.

Start reading today

There is no substitute for reading and understanding about investments. In this age of Google, internet and public libraries, the knowledge is out there. If you are someone who absolutely abhors reading but still wants to come out a winner in the journey of financial freedom, you need to then network with people. Ask questions, and find out more about the savings and investments where you intend to put your money.

Remember, in the land of the blind, the one-eyed man is king.

Be well and prosper.

Flickr! Photo by Panzergrenadier.

A commercial bank’s view of financial freedom
A good friend of mine who shares similar views on financial freedom flagged this advertisement by Citibank to me recently. The bank is asking its clients to update their income records as being the first step to enjoying greater financial freedom. Citibank sees financial freedom as,

Getting increased credit for all your needs and desires…

This is diametrically opposite what I share and advocate about financial freedom. If you truly wish to be financially free, getting yourself a higher credit limit doesn’t help you achieve it unless you are able to leverage on the credit to invest in something that generates higher returns than your interest. But with unsecured credit interest rates going from 12% to 24% per annum, it would be difficult for would-be Warren Buffet style investors to achieve that type of performance in any asset class consistently and without risking their entire capital!

Is all debt bad?

Debt is not good or bad. When you buy your home, you need to get a loan from HDB or the bank because not many of us have hundreds of thousands of dollars lying around to be used at one shot to the HDB or property developer. Hence, we need to pay 10-20% of the cost and use financing to help even out the cash flows. We borrow using our homes as collateral and pay over 10, 20 or even 30 years for our purchase. Some people call this “good debt”. To me, it is a form of debt that provides you with a roof over your head and to some extent helps you save on home rental expenses.

The issue comes with unsecured short-term credit. Credit has its uses. I believe when you use credit for consumption goods, you violate one of the fundamental principles of being financially free, i.e. to delay present wants for future needs.

One of the personal finance books I’ve read, “The Millionnaire Next Door” shares with us that the real millionnaires typically eschew or avoid consumer credit. In Singapore, the banks can only loan you 2 months of your income as unsecured credit. If you are unable to save up to have at least 2 months of your income on standby, then you are not yet close to living within your means.

Having the ability to obtain increased credit is just that. It has nothing to do with financial freedom. In fact, increased credit allows you to live beyond your means in the short-term with the risks of you getting way over your head if you do not pay off the bills charged to your credit cards promptly.

Developing your own ideas on financial freedom

The term financial freedom means many things to many people. To Citibank, it means giving you the credit to buy to your heart’s desire. To you and I, it should mean having sufficient passive income that covers our living expenses so that we can choose not to work for a living.

You have to decide which definition of financial freedom is right for you. Is the right to obtain credit to live beyond your means your path towards “financial freedom”? Or is it the ability to live within your means, to save and invest and to grow your means?

You decide the path to take in this journey towards financial freedom.

Be well and prosper.

The building you see above is not built without the contributions from various parties. Before the contractors can lay the foundation and start building the structure floor by floor, window by window, the architecture plans and designs have to be established. In it are details such as how tall would the new building be and how much gross floor area it would have. So how is the Bahrain Financial Centre related to financial freedom?

Setting targets for financial freedom

Before the first pile is driven into the ground, a target would have been set and a blueprint or design in how to achieve it would have to be established. This is where it relates to you who are reading this blog. How do you even start to decide what is your target towards financial freedom. Let Panzer walk you through how you can set a plan towards financial freedom. You can continue to refine, revise and retune your plan according to changes in your life and family situation but the major milestones and targets should be reasonably firm.

I have advocated based on the books I have read, the blogs I have visited and the conversations that I have had that TRUE financial freedom only comes when your passive income exceeds your living expenses.

Thus, as a simple formula, [a] financial freedom = [b] passive income > [c] living expenses.

In order for you to know how much passive income you need, you realise you need to ascertain what is your living expenses.

Establishing your living expenses

This is easier than it sounds. You could take the Excel approach to develop a monthly expenses worksheet that tracks your expenditure by various categories. That is one way. The easier way would be this. At the beginning of each month, capture what is the balances on ALL your bank accounts and CPF accounts, let’s call this opening balance. Total this up. At the end of the month, capture the same balances and total them up, let’s call this the ending balance. Take the ending balance less the opening balance. Then take this figure and subtract your income, dividends, interest, windfalls as well as CPF contributions. What is left is your monthly living expenses.

If the figure is positive your living expenses is less than your income, i.e. you are living within your means. If the figure is negative, you are living beyond your means!

The degree of precision is up to you. For me, I compute my living expenses based on totalling up individual expenses both known and estimated. I tend to estimate higher expenses to provide a buffer.

Establish the amount of passive income needed

Once you have established your living expenses, the amount of passive income needed has to be higher than what you have. Thus you can see a frugal lifestyle helps you establish a lower target for passive income. Let’s say you determined that you can live on say, $3,000 a month. Hence, for you to be financially free, you need to make $3,000 a month of $36,000 a year WITHOUT WORKING FOR IT. How do you do this? You can either grow your investment capital to $360,000 and look for an investment that pays you 10% per annum. Alternatively, if you can only find an investment that pays 5%, you would need an investment capital of $720,000 and so on.

If you look at the big picture, it is NOT complicated. The complicated part is firstly, establishing a lifestyle that is simple and yet meets your needs and allows you and your family to be happy. The other part that is complicated is searching for that investment that yields a high enough return so that your investment capital is not such a large amount that you are unable to accumulate it in your lifetime.

Financial freedom is not some esoteric concept that only a few wise men know. Everyone can find out about it. The challenge is to put into place a practical approach to achieve it in our lifetimes.

What is your own personal plan towards financial freedom?

What level of income are you able to survive on?

Post your comments and give it a go! I will post the most interesting and thought-provoking reply over the weekend!

Be well and prosper.