The money questions that bother us can vary with our circumstances. When we begin to earn our first incomes, the newfound financial independence makes us heady. The freedom to spend seems so much more important than dealing with the question of whether there is enough money for the future. Building wealth is not so much on our minds as our financial decisions are focused on spending.
The middle years are somewhat divided between earnings and wealth. We worry whether we’re earning enough, our colleague is getting a higher raise than us, the neighbour living better than us, and others flaunting their wealth to show they have more than us. These are things that bother many of us. Our focus is on whether we are doing enough—earning or saving.
In the latter years, wealth matters more than income. Questions on financial independence take centrestage when we know we may no longer earn an income. We like to ensure we have enough and won’t depend financially on someone else after retirement. We are fine with more wealth, and the power to pass it on to our heirs. However, we dislike the idea of outliving our wealth and want to avoid it anyhow.
Definitions vary with age
These are generalisations. Financial freedom may not have the same meaning for everyone, or even for the same person at different points in time. Not having supervision and controls to spend as one wishes might represent freedom to a young earner; paying off the home loan and having no borrowings on the book may mean freedom to a middle-aged person; not having to ask anyone for money for any routine need might mean freedom to the retired.
The textbook definition of financial freedom is to have enough wealth so that one keeps earning the income one needs from the wealth one has accumulated. This is essentially a ‘save to build a large enough corpus’ view of financial freedom. We can stop working if we know we have enough—inherited or earned, saved and invested. This equation can be mathematically worked out, by plugging in assumed rates of accretion and growth for wealth and expenses over an assumed number of years. Technically, one can stop working for income if one’s wealth reaches the target amount.
Spending on what matters
Does this result in financial freedom? This is, perhaps, best answered by someone who is close to retirement age or has already retired, because they can see what they have and what they will use. Control over financial decisions provides a semblance of freedom. There is a sense of accomplishment of having built wealth over time. There is awareness about spending patterns and the ability to control expenses. The only unknowns are unexpected events that can impact the market value of wealth, or the nature of expenses. In reality, there is control and confidence more than there is financial freedom.
Now, consider the case of the 35-year-old Airbnb host. She inherited the property she lives in and chose to rent out one of its two floors. The property is her wealth and the rent is her income. She studied to be an engineer as her parents forced her into it. What she loves doing is painting, travelling, writing, and caring for animals. She dislikes her job and does not care much for the salary it brings her. Her question was how she can become financially free.
We tend to frame such questions in terms of income and wealth. This is only half the story. Financial freedom is lost if we’re unable to spend on what matters to us. Getting it right is tougher. Spending is a matter of preference and desire. A friend once told me that financial freedom meant buying clothes one likes without checking the price tag again and again. Sounds vain, but it is profound. It hurts to not have money to spend on things we care about. This freedom is what we desire—doing as we please with the money we have, with reasonable control and responsibility.
The masses in India who have been pulled out of poverty and middle class existence celebrate financial freedom by spending on what matters to them. Consumption of proteins, fruits and vegetables has moved up in the common man’s everyday plate. Each occasion to celebrate is marked by spending that would have been considered lavish, extravagant and ostentatious not many years ago. Financial freedom manifests as spending. That is why math must consider the future spending patterns rather than the future income patterns.
Freedom through adjustment
What my friend needs is an estimate of where her spending patterns will stabilise. If none of her interests are capable of generating an income and, instead, lead to significant spends, she must figure out whether what she already has will be enough. With her rental yields not matching the inflation rate, her renting model might not pass muster. There’s also the risk of low occupancy in her lone source of income. The property she owns is also the one she lives in. Hence, it won’t be available to use as a source of funds if a spending need arises.
Retired seniors already have enough knowledge about their spending patterns. The retiring young may still be in the process of figuring out what they care about. Or they may dislike the frugality and discipline their wealth may impose on them. That is also a loss of financial freedom.
So what did I tell my host? Find a component that provides income, to run with the interests you want to pursue. Offering travel guide services can feed into both the income and expense side; running an animal shelter can do the same; writing content for payment might generate income while doing what she likes. Diversify your sources of income. Experiment with these choices to see if the spending limits, lifestyle choices and income levels that they offer feel like the freedom you seek, I told her. Leading a simple life should be a choice, not compulsion. If they all result in lifestyle adjustments that are unsatisfactory, financial freedom is still far away.
The Author is CHAIRPERSON, CENTRE FOR INVESTMENT EDUCATION AND LEARNING
