Rishi, a school friend of mine, left his job as a senior executive in one of the largest IT Enabled Services companies in India three years back to pursue his personal interests.Rishi was 41 when he retired from his professional career and is now focused on his two childhood passions, photography and music. Rishi is married with two school going kids and has ensured that his family enjoys a comfortable lifestyle. I have known Rishi for more than 20 years and have never seen him more contended and happy with life. Rishi’s is not the only example of early retirement. A number of people I know very well, have voluntarily retired from their professional careers to pursue personal interests and a few of them are not yet 45.
Rishi and others I know who have taken early retirement from their careers are, however, a very small minority. Many people simply cannot afford the luxury of early retirement. There are many acquaintances,just four or five years away from their retirement and they are quite nervous about retirement (in financial terms). Based on my observations of the changing corporate climate in India, early retirement is not always an indulgence for the more fortunate, because early retirement is not always purely voluntary. Corporate lives are getting increasingly shorter and many colleagues have told me that a forced career disruption in late forties or fifties is very difficult, both from opportunities and adjustment standpoints. I think it is prudent for people, especially those in high paying jobs, to financially plan for early retirement, whether they intend to actually retire early or not.
In this blog post, we will discuss how some people are able to take early retirements. Let us first discuss two half truths related to financial independence. Some people think that, only people who have substantial family wealth to fall back on are able to take early retirements. While inheriting family wealth certainly has advantages, it is not a pre-requisite for attaining financial independence early in life. Some of the people I know, who have taken early retirement, did not inherit family wealth. Some people think that, people in high paying jobs are able to retire early. Again it is only a half truth; I know many people with high paying jobs, yet only very few are able to accumulate sufficient retirement corpus early in life. The key to wealth creation is not how much you earn, but how much you save and how the money grows.
Let me share with our readers, my observations regarding the saving and investing behaviour of people who have been able to attain financial independence early in life. There are numerous examples of young entrepreneurs in Silicon Valley, California and also some, here in India, who became billionaires in their twenties and thirties by selling their start-up companies. I am not going to talk about such exceptional people. The observations which I will share are from regular people like you and me; the difference between these people who have financial independence early in life and the ones who are nervous about financial security can be attributed almost entirely to their saving and investment behaviour. Here are some common traits that I have observed.
People like my friend Rishi were able to save a much bigger portion of their income than most of us. It goes without saying that, the higher your income, more you will be able to save. All the young retirees that I know were in high paying jobs. But what separates Rishi and his ilk from the rest of the people in similar high paying jobs was the percentage of their monthly income that they were able to save from a very early stage of their careers. While many of us think that, saving 10 – 15% of our post tax salary is good enough; people like Rishi were saving 40 – 50% of their post tax income from a very young age. How were they able to save more? Obviously they had good monthly incomes to begin with, but more importantly they had a plan. The importance of having a plan cannot be understated. Whether your monthly income is Rs 30,000 or Rs 1 lakh or Rs 5 lakhs, you and your family is going to consume the same amount of food at home. If you are driving to work, the amount of fuel you will consume will depend on the distance from home to office and not on your salary.
The point is that, if some of the basic necessities of life cost the same irrespective of income levels, why are some people able to save much more than others? The answer is obvious. A significant part of incomes of people in the middle and upper middle income groups goes towards discretionaryor lifestyle spending. Unlike what many of us would like to belief, discretionary or lifestyle spending, is totally controllable, if you have a plan. There are opportunities in careers of some people, where situations enable you to save a large part of your salary, e.g. lucrative overseas assignments or assignments where the company pays for most of your living expenses. If you have a plan you will be able to take full advantage of such opportunities which come across your way; without a plan, it goes wasted from a savings perspective. It is therefore, important that you have financial goals and plan from an early stage of your career.
Savings is not the only important habit of people who are able to accumulate wealth early. Investing is another important habit. Spending less, by itself, will not result in wealth creation. You have to invest your savings wisely. I would urge all the regular visitors of Advisorkhoj.com to read the book, Rich Dad Poor Dad by Robert Kiyosaki. Kiyosaki articulates in very simple language, simple enough for all of us to understand, why the rich are able to grow their wealth; money creates more money. Idle money does not grow by itself; it needs to be invested in order to grow. Investing savvy is probably the single most quality, that I observed in people who were able to attain financial independence early in life.
Smart investors put their money to its most productive use by regularly investing their savings. Rishi, for example, had been investing through Systematic Investment Plans (SIP) in mutual funds for most of his corporate career and was able to create a substantial retirement nest egg simply through SIP. Instead of investing in an ad-hoc manner, they do their homework, in terms of research and planning before investing. They efficiently allocate capital between different asset types, e.g. equity and fixed income, large cap and small cap. They monitor the performance of investment on a regular basis and are always on the look-out for better investment opportunities.
Another common investment trait of people, who were able to attain early financial independence, is that, they invested mostly in assets which were able to generate cash-flows for them. Kiyosaki has also stressed the importance of cash flow generating assets. Many people spend a lot of money buying assets like jewellery, cars and expensive gadgets. You should understand that these assets though emotionally satisfying and aesthetically pleasing, do not generate any cash-flows for the investor.
On the other hand, stocks, bonds, mutual funds etc generate cash flow for their investors, either in the form of interest, dividends or capital gains. Cash flows create more cash and liquidity allows investors to tactically capitalize on investment opportunities.
Research has shown that thesingle most important factor in wealth creation is asset allocation. Smart investors like Rishi at the start of their careers invested most of their money in equity shares and equity mutual funds. Over a period of time, they altered their asset mix to have more exposure to debt. I have seen that, many parents advise their children who are beginning their careers, not to invest their money in equity and instead save it in risk free savings schemes. Since young people beginning their careers are inexperienced, they usually listen to their parent’s advice.
It is understandable that parents are concerned about the safety of their children’s money because equity is a risky asset class. But parents should understand that, equity as an asset class, gives the highest returns in the long term. Choice of appropriate asset class can make a huge difference to wealth creation in the long term. Let us assume, person A saves Rs 5,000 every month and invests in recurring deposits. Person B saves the same amount and invests in an equity mutual fund through SIP. Let us assume long term rate of return of equity is 15% and fixed income is 8%. After 20 years, person A will accumulate Rs 17 lakhs while person B will accumulate Rs 75 lakhs; the difference in wealth creation is huge.
Culturally, Indians are debt averse but in more recent times it has been observed that, indebtedness of our society is on increasing trend. Average urban household debt multiplied more than 7 times from in 2002 to in 2014. Household debt is one of the biggest impediments to wealth creation. Debt comes in many forms like credit card loans, personal loans, car loans, home loans etc. Cost of debt in our country is quite high and interest payment is one of the most unproductive uses of our income.
People, who were able to retire early, remained debt free for most of their working careers. Rishi, for example, took a home loan to purchase his apartment early in his career, but he made sure that his EMI was a relatively small portion of his income. Whenever he got a big increment or bonus, he increased his EMI or made a pre-payment; this reduced his interest pay-out and his loan tenure. After a few years, he was debt free and was able to invest more for wealth creation. I know that many people worry about their home loan EMIs; they should have worried about their EMI before taking the loan, not after. Proper financial planning can help you define specific goals like retirement, children’s education, home purchase etc and help you allocate your savings most efficiently for each of these goals.
A common attribute of people, who were able to achieve financial independence early in life, was their risk taking ability. By risk taking, I am not referring to trading in derivatives or investing in risky small cap stocks or high yield bonds or private equity investments; it is essentially about investment temperament. Greed and fear are the two dominant behavioural drivers in investments, but people who are able to conquer these emotions are successful investors. Rishi told me once that, the stock market crash of 2008 was the biggest boon in his personal finance journey. Even though his investments lost 40 – 50% in valueterms in that year, he tactically used major declines to increase his asset allocation in equity. At a time when most investors were shifting their asset allocation from equity to fixed income, Rishi shifted from fixed income to equity. It is not rocket science to invest in equity when prices are low, but it takes courage and discipline; obviously the gains are huge. Risk takers are able to taken contrarian calls with stocks and sectors. Contrarians say that, if a sector is beaten down too much, it makes sense to invest in the sector. Rishi, for example, invested in banking sector funds in 2009 - 2010 and got great returns. Similarly, investors who got into midcap at the end of 2013 were able to get terrific returns. However, I must add here that, taking contrarian calls requires a certain amount of investment expertise and not all investors are equipped with such abilities.
Finally, people who were able to take early retirements from their professional careers had a clearly defined plan of what to do after retirement. If you have a roadmap, you will be more committed. Commitment is the single most important factor in ensuring success in any endeavour.
Conclusion
In this post, we discussed some common traits of people, who were able to create wealth in a relatively short time-frame and attain financial independence. Not all of us want to retire early; many of us like what we are doing. The savings and investment traits described in this post, do not require any specialized skills. Interest in your personal finance, financial awareness, discipline and commitment go a long way in making your wealth creation endeavour a success.
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