What is Financial Freedom and How to Achieve it (3 Simple Steps)

What is Financial Freedom?

The concept of “financial freedom” is a dynamic one. People have different perspectives and definitions of financial freedom. However, ideally it is a financial position where you become worry-free about your finances and all your financial goals are easily met as and when they become due.

So, financial freedom does not mean becoming rich and having a lot of money, but to have enough money to fulfil all your needs and wants without worrying about uncertainties of life. Again, financial freedom is a situation when you can do whatever you enjoy and like to do rather than doing things just to earn money. In other words, it is when you are in complete control of your finances and life choices.

Steps to Achieve Financial Freedom

Now that we have got the concept of financial freedom, let’s dive deep into how we can achieve this. Here are the three simple yet most effective steps you should take to reach financial freedom easily.

1. Pay Yourself First

Saving! Saving! Saving! This is the single most important step to achieve your financial goals. No matter whether you are a salaried employee or a self-employed professional, the first thing to do after getting a payment is paying yourself first – save first, spend later. You should try and save at least 20% of your monthly income. How much you save is more important than how much you earn.

Let’s take an example. Rohit and Mohit work in the same office. Rohit gets a salary of Rs. 80,000/- per month and saves 15,000 from that money. But, Mohit gets a Salary of 60,000/- and saves 20,000. Who will achieve financial freedom earlier? Of course, Mohit. I hope you got the point.

2. Convert Savings into Investments

Now that you understand the importance of saving, the next big thing is investment. Don’t just save, but convert your savings into investments. Without investment your money will lose value with time due to inflation (price hike).

For example, with 100 rupees you can now buy 10 pens of Rs. 10 each. But, after 15-20 years you will probably get only one or two such pens for the same 100 rupees. So, the buying power of your money decreases with time. That is why you need to invest in growth assets to beat inflation.

Now, invest in what? That depends on your current financial position, risk appetite, financial goals and investment horizon.

• If you are a conservative (low-risk taking) investor or your financial goal is just 3-5 years away, you should invest in debt funds, hybrid mutual funds and other fixed return assets.
• If you are an aggressive (high-risk taking) investor, and/or your investment horizon is long term (7+ years), you should park your money in equity mutual funds and stocks.
• If you already have a good amount of money and just want to protect that money, you should invest in low-risk debt funds, fixed deposits, real estates, equity index funds etc.
• Again, if your financial goal is to generate wealth in the long run, you should go with smallcap and midcap mutual funds and high growth stocks.

Long story short, link your financial goals to your investments, plan asset allocation according to your investment horizon and design a diversified portfolio. Ideally, your investment portfolio should be a mix of both debt and equity. As a thumb rule, your debt allocation should be an equal percentage to your age. Rest should go to equity.

For example, if you are currently 30, invest 30% of your savings in debt instruments (fixed deposits, debt mutual funds, provident fund, insurance policies etc.) and 70% should go towards equity instruments (equity mutual funds, stocks and ETFs).

And preferably, you should invest on a regular basis through SIPs (systematic investment plans) and staggered way of investing in stocks. Automating your investments is the best way to manage behaviour throughout your investment journey. Starting early is an unimaginably great advantage when it comes to investing and the magic of compounding.

3. Prepare for Financial Emergencies

Think what happens when you invest your money in stocks thinking about long term, but a few months later a medical emergency occurs and you have to exit from that investment. Maybe you’ll have to take a loss on that investment. Even worse, you may end up having a huge debt burden (loans) on yourself. It’s a warning sign that more than 5 crore Indians are pushed into poverty every year due to medical debt.

So, another super important step towards financial freedom is to prepare yourself beforehand for a sudden and unexpected financial crisis. Here are two things to do for that –

• Build an emergency fund of 3-6 months expense depending on your job security. If you are salaried and your job is permanent and secure, a 3 month expense would do. But a 6-month expense worth of contingency fund is suggested for self-employed professionals. Put this amount in a fixed deposit or liquid fund so that you can withdraw immediately in case you need this any moment.
• Take insurance covers to protect yourself from unforeseen financial burdens. You must have a medical insurance to cover medical emergencies. A policy with 5-10 lakh rupees sum insured should be fine for most people in India. And if you have dependents (your parents, spouse, children etc.), you should also have a term insurance plan of 10-20 times your annual income. If your annual income is 5,00,000/-, you should take a term life insurance of at least Rs. 50 lakh.

So, to summarise the above points, save regularly, invest regularly through SIPs, prepare for emergencies with an emergency fund and insurance plans. These are the three simple yet giant steps towards achieving your financial goals in the long run and living a life free from worries. Best wishes for your journey towards financial freedom!

Here’s a super useful videos on financial freedom (in Hindi) from Parimal Ade. And here I link to another great video (in English) from Akshat Srivastava.