5 Steps towards becoming financially independent

Definition wise, being financially independent means that you don’t have to work for earning money anymore. You have enough in your bank account (Or somewhere else you prefer to stash cash) and you can just use that money to live your life. This may sound like a distant dream to many who are reading this article, however, there are people who have successfully retired from their job at an age of 40 or even 35. If they can do it, why cannot you?

Setting a goal

The first thing that you need to create is a goal. You know how much money you need to be termed as financially independent and when you want that to happen. This will help to create a proper financial plan. So, let’s say you want to be financially independent at an age of 50 with a total of AED 1,000,000 and your current age is 30. Assuming you don’t have anything in savings right now, that’s AED 50,000 per year or AED 4,167 per month.

Next is Planning

So that means every month from your income, you need to set aside AED 4,167. Luckily, the actual amount can be less than that as remember, your savings should also grow with time. That means that even if you put your savings just into a savings account which gives an interest rate of 2% every year compounded yearly; this will accumulate quite a lot much in a period of 20 years. I will do the calculations here for you, assuming that the interest you get on your savings account is just 2%, for the same scenario above, you need to save AED 41,160 every year or AED 3,430 every month.

Let’s dig deeper. All of this assumes that you will get a return of 2% per year on your savings. What if you invest that money and earn a higher return? Below table shows you the amount you need to save every month and year for higher rate of returns:

Yearly Return (%)2%4%6%8%
Yearly Savings41,16033,60027,20021,900
Monthly Savings3,4302,8002,2671,825
Total Saved (In 20 years)1,000,0001,000,0001,000,0001,000,000

So, to reach your goal, you need to save just 1,825 per month if you are able to receive a return of 8% per year. Sounds impossible? Not really!

Where to Invest?

Now comes the biggest question! How do I ensure this 8% rate of return (Or potentially higher)? Banks are unlikely to provide that kind of return and the simplest answer is you need to invest on financial instruments such as stock and bonds. Now, just reading the word stocks, you may start to freak out, but you should not. Stock markets go up and down all the time and you don’t have to be lucky and find the right time to invest. Actually, there is no such concept of right time. You just invest when you can and keep investing, irrespective of whether the market goes up or down. You don’t have to believe me but believe the data!

Historically, S&P 500 Index (An Index which tracks 500 of the most prominent US company stocks) has given a return of 2.86x in last 21 years (Way more than an 8% return every year). So, yes, if you had put in AED 100,000 at the start of year 2000, you would have AED 286,000 for yourself just by investing on S&P 500 Index. Please note that in the last 21 years, the world has seen 2 recessions and another one currently looming because of the Covid-19 situation, which will not be the case in every 21-year cycle.

Diversification

Now, comes the most important part. You cannot expect this level of return by investing into a single stock and you must diversify the risk by putting your money into an index like S&P 500 so that even if a company falls down, the rest of the companies in the index will keep your risks lower. It will work even better if you diversify the risk further with investing in bonds, apart from stocks, or even better, invest in risk-free financial instruments such as savings scheme.

Sticking to the Plan

You must have realized by now that investing is a long-term thing and you shouldn’t panic when the market goes down and stop investing completely. Just keep your calm and put money into investment account every month just as you would otherwise. Bad times will pass, the market will eventually go up. But if you stop investing now, you will lose on the potential long-term gains . Therefore, your path to becoming financially independent will become steeper as ever.

If you don’t want to get into all the hassle of financial markets, but still earn good returns, Financial advisors like FinFlx can certainly come to your rescue. FinFlx will identify the best stocks, bonds or other financial instruments to invest your money based on several factors such as your age, your salary, your risk appetite etc. to ensure the best possible return of your money over time. FinFlx doesn’t have any hidden fees and the advisory fees are lowest in the market. If you are too nervous to invest in market, FinFlx has a risk-free savings scheme as well where you will receive a fixed return without any risk of losing your capital.

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