There is an old saying ” Spend the interest, Never the principal ” . For a salaried employee, it translates into “Don’t spend the salary, only spend the interest income”. For people employed in private sector jobs in a dynamic and uncertain world, there is never a job surety and security. Additionally, there is no financial instrument currently available in the marketplace that provides livelihood insurances, unlike the health and life insurance instruments which are prevalent around the globe.
This puts the onus directly on us to insure our livelihood incomes. The aim must not be to quit everything and prepare for a life without work. Just as taking a health and life insurance doesn’t mean to take life and health matters loosely, similarly financial freedom must be a goal to insure against uncertain times in life , provide necessary cushion to absorb pandemic situations , and maintain ethics and independence in one’s thoughts and actions .
In today’s materialistic world with high living expenses, this could seem to be a mammoth goal requiring huge corpus building. Additionally, it is not advisable to delay your gratification for so long that you compromise your current life while building this . It is a process which takes time. Success in such a long process may seem elusive. Hence, I will describe a simple , and practical 3 pillared-approach which I have personally utilised . This will break your goal into 3 major milestones , help you track your progress and gain increasing confidence towards your goal . You will enjoy this journey and will also be guilt-free in your daily living.
Let’s first define the three Categories of expenses, used in this model –
- Necessary Running Expenses : This category caters for the basic minimum requirements for a regular household living. This would include your house rental, Groceries, electricity etc, other running and maintaining expenses , schooling etc . These expenses are almost constant month-by-month and are essential expenses .
- Discretionary Expenses : They are regular expenses that we incur to complement our necessary expenses. Some people don’t shy in even quantifying these as essentials, nonetheless, we have pulled them in separate category as they are not the basic necessities. These include eat-outs in restaurants, Movies , Shows, Subscriptions etc. They fall in second-major category of expenditure for a regular working professional .
- Luxury Expenses : The third category of expenses is aimed towards enjoying luxuries. They are high cost transactions, aimed for luxurious living including Leisure Travels , club memberships as well as Luxury Shopping etc.
Corpus is defined as any income generating asset including rental property, stocks, bonds, Fixed deposits etc. The earnings flowing out of the corpus would be additional source of income , beyond the salary.
We will apply the principles of “Don’t spend the income, spend only the interest” on these three types of expenses.
i) Pillar 1 – Building Corpus to Meet Discretionary Expenses
The first pool of corpus* is intended to fund the discretionary expenses (as defined above). The reason I prefer to tick this box first is that these expenses are notorious for being unaccounted for and leaking our paycheques . If we can first take care of them and fund them through our interest income rather than the principal , it would provide a major psychological advantage in this journey.
The aim is to build enough corpus, so that the earnings generated out of corpus, is sufficient to meet discretionary expenditures. e.g. If monthly discretionary spend is Rs. 20,000 , this would target a corpus amount of Rs. 30 Lakhs (Assuming 8% annual interest income of the corpus).
As a corollary, limit your expenses in this category to the earnings you generate out of your corpus. Don’t fall into the trap of assuming Level 1 spendings should be x% of the income. The spendings should be proportionate to your corpus , not your monthly income.
You must aim to build this corpus as soon as possible, to reassure First pillar of independence. This will ensure that all these discretionary expenses will be funded by your corpus and your salary won’t need to be spent on it . Aha ! this is a great moment and achievement. You would be free from the guilt of spending a major portion of your monthly salary on discretionary expenses. Congratulations!
ii) Pillar 2 – Building Corpus for Discretionary + Luxuries
Once you have build the Pillar 1 successfully , the next target is to increase the size of corpus so that in addition to discretionary expenses, it is also able to fund our Luxury expenses.
Eg. If average annual spend is Rs 3 lakh a year (Rs 2 lakh on family vacation + other luxury shoppings), one must aim to build 37.5 lakhs additional corpus (assuming 8% avg earnings on corpus).
Once you reach this level , you don’t need to have a guilt about spending a majority of your salary on your discretionary and luxury expenses. What a beautiful achievement! You are spending on all your luxuries and discretionary items out of your corpus earnings (which are earned passively while you are sleeping) and none from your salary, which you earn by trading off 8 hours of your day. At this stage, our salary is needed only to meet necessary Level 3 Living expenses and the rest is invested (see below infographic)
iii) Pillar 3 – Building Corpus to Meet all Expenses
Third level of financial independence is the final level which will take you to the independence club. Achieving this will ensure that you wont have to spend your salary on any expenses , and all of the salary you earn from your job will go straight to add to your corpus (See infographic below). Its beautiful result, isn’t it!.
Everyone has his own lifestyle and expenditure requirements . Build your own corpus pillars based on the above fundamentals. The more quickly you build your corpus, the more it will benefit from years of compounding and will minimise your time to achieve the objective.
You can start applying the financial freedom principles right away (from day 1), by keeping your expenditures in line with the overall corpus. eg. If your current corpus is short of first pillar requirements, this means you need to quickly save and build it up, or alternatively, you can reduce your discretionary expenditures in line with the current situation. This ensures you never go over-board on these expenses and incentivises to quickly build it up to live a guilt-free and insured lifestyle.
As you build and achieve these three pillars of financial freedom, make sure you pat yourself on the back and celebrate these three major milestones achieved by your discipline and hard work. It is not an impossible task and a lot of people have been able to reach there in 5-10 years, while celebrating intermediate successes and living an enriching life.
*Note : As your expenses increase with inflation or lifestyle changes, the buckets of corpus will need to be adjusted accordingly.