‘Cornerstone’ is a bit of an unusual term these days, but it sums up really well how financial independence fits into the scheme of financial advice. The cornerstone was the first stone laid in a masonry construction job. It was the first brick put down from which every other brick would be laid. If you had the first brick right it ensured that every other brick would sit in its proper place.
A financial independence target works the same way. Once we know what your financial independence target is and when you want to achieve it we can start mapping out the rest of the advice.
What is it?
Financial independence refers to the creation of a passive income stream that meets your current expenditure. For example, if you currently spend $80,000pa then we need an asset base that will generate an income of $80,000pa to meet those expenses.
Once you’ve achieved it you can choose how you spend your time; continuing to work if you love your job or moving on to something else if you don’t.
When can I achieve it?
This is different for everyone. I have clients with over $1m in assets who have not reached financial independence and I have clients with $400,000 who are financially independent, it depends on your lifestyle and expenses. The reality is we will all achieve financial independence at some point. There will come a time when we won’t live on our salary anymore, we’ll live from our accumulated assets. The question is when you want this to happen and what you want it to look like.
Why is it so important?
I recently had a client come to me who thought it was a good idea to take less risk with their investments. So I asked them why they thought it was a good idea. They looked at me a little bit perplexed (surely less risk is always a good idea?) but I pressed on and asked why they thought they should take on less risk, or for that matter, any level of risk at all. They had simple been told to take less risk as it would give them less volatility and they liked the sound of that.
I explained to them that without a clear goal it was impossible to determine the level of risk needed to achieve it. I could take all investment risk off the table and invest in cash if they wanted stability, and I could invest everything into a high growth portfolio and chase the biggest returns, but without a goal I wouldn’t be able to tell them if they’d made the right decision or not.
So we set a financial independence goal. We worked out what they could contribute to it and how what level of long-term return we needed to get there. From there it was obvious for all of us to see exactly the level of investment risk we need to take on to achieve the goal.
What do I do if I can’t achieve it?
I’m no magician and there’s no rabbit out of the hat. If your target is unrealistic we’ll work through three scenarios; push the timeframe back, decrease the lifestyle you want (annual expenses), or increase the risk. There’s no way around it, a compromise will have to be made.
What if I’m already there?
I have a client who has roughly $3m in net assets and lives on less than $40,000pa. They’re easily financially dependent so the question I put to them is what’s really important about money to you? We now go through a process of creating ‘core wealth’ and ‘non-core wealth’. Core wealth we invest at low risk to keep safe, non-core wealth is for dreaming – how would you love to use the money you don’t need to bring joy and life into your world and the world around you?
As always, we’d love to hear from you by email firstname.lastname@example.org or phone 9382 8201