How Do You Know You are Financially Independent
Let’s be honest here. How many of us, midway through the work day, having seen off a nasty email from another department, gets one from the boss, demanding a complex issue be resolved immediately while we still have a few things to deliver?
Do we take a cursory glance at the clock at the workplace, and count down to lunch time just so we can get a much needed temporal reprive from work? Do we look at the calendar and wonder why it is only Wednesday, when we have taken two weeks’ worth of battering while entrenched at the midpoint of the work week? Monday blues, anyone?
How many of us, on the way home after a dire and long work day, bogged down by years of disenchantment at work, wonder to ourselves if, and when, this will ever end?
So, what is stopping us from marching into the boss’s office and handing in our papers? What is hindering us from calling it a day at the workplace for good? The clear answer is that we need the money (we actually do not need the job; if it came with no pay I am sure we would not be working!). Financial independence, or rather the lack thereof, is what is holding us back.
An article published last year finds that most Singaporeans are not prepared for retirement. While Singaporeans have started to manage their financial wealth, most indicators suggest they are behind in terms of financial independence.
Financial Independence – How to know whether we have achieved it?
Make no mistake about it – Financial independence is the holy grail. Here, I define ‘financial independence’ as the status of having enough resources to pay one’s living expenses for the rest of one’s life without having to be employed. In short, we do not have to work for money anymore. We may choose to work, but that is not by circumstance. The attainment of financial independence needs to precede retirement.
So how do we know that we are there, that we are in the Promised Land of Financial Independence? The simplest way to do so is to construct a personal cashflow spreadsheet and furnish the elements into the sheet.
You may ask why we do this analysis based on cashflow as opposed to wealth (that is, the value of what we own). This is because cashflow is the major determinant of our day-to-day living.
Businesses go into financial issues not due to assets declining (although that is usually a symptom), but more because they run short of cash. A business selling millions of products but failing to collect cash from its customers, will come unstuck when its suppliers request payments. A business owing plants and factories but with a low cash balance, will face liquidity issues when it has to pay its employees.
Likewise, a person who has $2 million of personal assets which include $1.7mil in a property he lives in, may not have attained financial independence as things are, as his cash balance is likely to be low. He of course, has the option of downgrading his property and thereby monetising his biggest asset and improving his cash flow. We have to ensure we will not run out of cash before we run out of life. If we can fulfil this without a work income, we are financially independent.
Cashflow Analysis Components
There are many components needed in a cashflow analysis, and most of which require careful considerations.
While we may no longer have work income, we may still have other sources of income, which include dividends, capital gains from investments, CPF Life, annuity payouts, maturity of endowment policies, and possibly part-time income.
Do note that the certain sources of income are more secure than others. For example, capital gains may not materialise if the stocks or funds we have, underperform. On the other hand, the guaranteed portion of an annuity payout is certain. Hence, it is important also for us to understand the profile of the income. Those of you with kids out there may have a ‘fringe benefit’ in the form of an allowance, although this author is not sure if this is guaranteed!
The most often asked question is the amount of expenses we require when we retire. This is an easy question to pose but a difficult one to answer, as it can vary from $1,000 a month (for someone very frugal), to an astronomical figure (celebrities come to mind). While a recent survey finds that older Singaporean singles require $1,379 a month to live on, I believe most of the younger ones want significantly more on retirement, as they have been accustomed to a higher standard of living.
What is important here, is for us to have a handle on how much we spend per annum (I prefer annual figures rather than monthly, as the latter includes seasonality effect like year-end vacations etc), and assume we can attain roughly the same living standards in our post financial independence years. Other considerations include:
Singapore already has one of the highest life expectancies in the world, and we are forecasted to live even longer. Therefore, we should not assume, in our analysis, we will only live till 70. With long lives come the ill effect of higher medical bills, long-term care expenses, and inflation eating into our purchasing power more pronouncedly. Longevity risks can be mitigated through the use of lifetime annuities.
b. Parental support
For those of us supporting parents financially, we will have to consider their longevity too. As with us, their longevity will lead to higher medical expenses, and if they have inadequate health insurance, this is a potential landmine.
c. Asset restoration
While we get older, so do our assets, including the roof over our head. Have we factored that we will need to spend some money, every few years, so that our homes do not degrade from a palace to a squatter hut? If we are to be truly financially independent, the ideal should include being able to live at roughly the same standard at home, rather in an increasingly dilapidated environment. It is a moot point whether a car is an asset, but drivers may also need to budget for the purchase of a new car should they eschew public transportation, in their post financial independence years.
For those of us with the intention to leave some money behind, we may not be able to include these funds in our cashflow unless we own policies which help us fulfil that motive.
e. Large market dips
For simplicity, we tend to model investment gains on a straight-line basis, but the reality is that while long-term gains are the norm, the medium and short terms are punctuated by significant spikes and dips. Abnormally large increases are of course, welcomed with open arms. Sharp market downturns however, will negatively impact cashflow.
Do assess if your financial state and cashflow are healthy enough to withstand a large decline in the markets (try modelling a 50% drop in equity values) or a prolonged bear run. One way to buffer against unwelcomed market movements and add robustness to cashflow is through the use of annuities, as they provide guaranteed income.
It is possible to carry some liabilities and be financially independent at the same time. We just need to be cognisant that discharging our liabilities will impact cashflow; if the liability happens to be a significant property loan, there may also be adverse cashflow movement arising from interest rate increases.
In summary, a cashflow analysis helps us understand if we are in a capacity to troop into the boss’s office and announce our intention to walk away without repercussions on our daily living, and that of those who depend on us. It also enables us to assess how many more years we need to shoulder on in our professional role before we can be independent of a work income. Attainment of financial independence allows us to live, not just survive. Those who truly enjoy and thrive in their work can, and are encouraged, to continue. For the rest, the choices are limitless, and financial independence opens the door to options that never existed before.
Performing a cashflow analysis requires a trained hand, a clear mind, and an attitude to challenge the assumptions and face our financial health squarely in the face. Do reach out to your trusted financial advisor for help!
Article by Leon Loh, MBA