The third and final pillar of financial independence is the investing pillar.
The earning pillar and the spending pillar give you the raw material for your financial independence.
This third investing pillar of financial independence is what turns that raw material into the finished product of financial freedom.
Your ability to master the investing pillar decides if you will achieve financial independence or remain stuck in the endless cycle of earning & spending money.
While the idea of earning and saving is easy to understand, it is at the stage of investing that a lot of stumbles take place.
The daily noise around how to go about investing your money is deafening.
The problem is not that there is too little information, instead there is too much of it.
In this article we look at some of the core tenets of the investing pillar of financial independence that are important for you to understand.
These tenets will help you cut through the noise and focus on the things that really matter.
The Investing Pillar of Financial Independence
Investing the money, you save each month is the holy grail on the path to financial independence.
There is no singular path to financial independence.
For someone like you in a regular 9-5 job it involves increasing your savings rate and investing those savings each month.
Investing is vast field, and you can go as deep as you want.
There are people who do this for a living so the knowledge on offer is vast.
Sensible investing does not lie in identifying the best mutual fund, a star fund manager or some secret tips.
Investing is about knowing its simple core principles and applying them to your situation.
Understanding Risk & Knowing Yourself
A good understanding of risk is critical to the process of investing.
Also, just as important is to understand and appreciate your personality when it comes to risk taking.
The process of investing is about taking on certain risks in the quest for getting an appropriate return.
An ideal investment would be one that offers high certainty and high returns.
Unfortunately, real life does not work like that. No one can predict what tomorrow holds as we live in an inherently uncertain world.
Higher returns typically come at the cost of sacrificing some certainty.
The higher the perceived safety of an investment, the lower is likely to be the potential return.
The key when investing for financial independence is to be willing to take on the volatility that comes on a path filled with uncertainty.
The very fact that the idea of financial freedom appeals to you means you are willing to let go the safety of a monthly paycheque at some stage in the future.
While you may understand the risks of investing, how you react to it could be quite different from someone else in the same position.
That comes from our personalities. We all react differently to the same stimulus.
Some people love roller coasters and cannot seem to get enough of the thrills it offers.
Then there are others for whom just the thought of getting on one sends chills down the spine.
The roller coaster is the same. Our reaction to it as unique individuals is vastly different.
It is the same with investments.
When you are dealing with something which has volatility built into it, you need to be prepared for what the ride will entail.
Investing is not about blindly taking risks.
Instead, it is about taking calculated risks which offer the opportunity for a worth-while pay off at some point in the future.
Asset allocation is the idea of investing your money in a manner that ties with the financial goals you have in your life.
That includes the goal of getting to financial independence or early retirement.
The goal of financial freedom is long term in nature and will take you a decade or more to achieve depending on your starting point.
This also means that the investments you make towards this goal should be the ones that are suited for a long-term horizon.
During the early part of your wealth accumulation journey, you are more suited to handle the volatility of assets that need a long-term horizon.
While some may prefer going down the real estate route, a simpler way is to hold equity (stocks/shares) based assets.
As you start getting closer to your goal, you change your asset allocation.
You need to now preserve the wealth that you may have already accumulated.
There is no perfect asset allocation formula.
Some people are unfazed by day-to-day market volatility. Others see their blood pressure spike with even a small drop in financial markets.
It is always a balance between what theory says you should be doing and what you can emotionally handle without turning into a nervous wreck.
Your ideal asset allocation will tell you that you should be allocating part of your investment in equities.
Diversification tells you how to put those asset allocation ideas into practice in the best conceivable way.
It helps you spread out the risks if something bad was to happen to a part of your portfolio.
Diversification is the financial world equivalent of not putting all your eggs in one basket.
Let us take the example of equities as the investment option for achieving financial independence.
At the start of your investing journey, you may be looking at holding 60% (or higher) portion of your total investment in equities.
Now you can meet your asset allocation target by holding 60% of your total investments in a single stock.
As far as asset allocation goes you are in 60% equity, but it is an extremely risky way of going about it.
If something were to go wrong with that stock your entire investment may be wiped out.
Diversification helps you spread out the amount over several different investment options.
This ensures you are not dependent on a single company.
You can spread the same amount of money across direct equities, mutual funds, ETFs, and index funds.
In addition, you can spread them across different countries instead of just focussing on India.
By doing so you significantly reduce the chance of getting hurt if something were to go terribly wrong in a specific company or country.
60% of your investments are still in equity but now they are spread over many equity assets.
Diversification thus helps you to reduce the risks of excessive concentration on a single company, industry, or country.
Power of Compounding
Your retirement corpus does not grow in a straight life.
The journey is slow in the initial years but keeps picking up speed with every passing year like a snowball.
That is the power of compounding.
Yes – Those compound interest questions you did in your school math class do have a real-life application.
And it is an amazing tool when implementing the investing pillar of financial independence.
Here is the best part – It requires you to do NOTHING to make compounding work.
If you keep investing year after year, compounding will keep doing it magic.
You harm the process of compounding by trying to DO something more.
Laziness is bliss.
Once you have automated the process of investing on a regular basis, just get out of your own way.
Most people are too lazy just to start the process of investing and that is when laziness works against you.
However, if you get lazy after you have set your investing machine on autopilot it will reward you.
But here is the thing.
The world around you will not let you be lazy about your investments.
The TV experts, social media, and people around you will keep pushing you to play around with your investments.
The need to act and do something will be extraordinarily strong.
Expect to be overcome with self-doubt from time to time.
Am I on the right path? What if there is a better investment option out there?
You will need to build your emotional strength to block all the noise and stick with your plans.
Even if there have been any errors you have made in the past, it is best to figure out a way to let go of financial regrets.
Conflict of Interest
We will live in a world that is replete with conflict of interest.
Our job is not to eliminate the conflicts that exist but instead to recognise them.
You may be expecting to get investing advice from your banker, but your banker too has a conflict of interest.
The same goes for many so-called investment advisors. What is good for you may not be good for them.
Once you recognise these conflicts exist, it will allow you to look through any investing wisdom coming at you.
Never ask a barber if you need a haircut.
Be meticulous about whom you are taking your investment advice from.
There are no secrets about investing that only one person possesses.
The basic tenets of sensible investing outlined here and at numerous other places are universal.
They are freely available for anyone to adopt if you are willing to put in the work to understand and implement them.
We all act in our self-interest first.
Therefore, it is only normal that a salesperson, company, or anyone else will first act in his or her best interest.
You in turn need to act in your self-interest too.
Once you recognise this, you will stop blindly trusting any investment product being sold to you.
Cost of Investing
John Bogle had once remarked – In investing you get what you don’t pay for.
What he meant was that the cost you incur when making investments is just as important as the investment itself.
What you do not pay in cost to some middleman goes into your pocket in the form of higher investment returns.
Always keep a hawk eye on the cost you incur when making investment.
Low-cost investment choices like broad market index funds, maximise the amount of money that gets invested for you.
A low-cost broad market index fund should form the core of your investment portfolio.
On the other hand, a high-cost investment product means the middleman takes a big bite out of every rupee of investment that you make.
This is a manifestation of the conflict-of-interest issue outlined above.
A salesperson will find it more profitable to sell you a high-cost product (fat commissions).
Your job is to make the cost of investing as a key part of your selection criteria when making investments.
Even though the costs may look small on a yearly basis (say 0.5%), but it can add up to an exceptionally hefty sum over the course of 20-25 years.
Yes, the magic of compounding works on costs too.
In this case it keeps increasing the costs you incur by going for a high-cost investment product.
Make compounding work for you – not against you.
Keep it Simple
Our daily lives and corporate jobs put a huge premium on complexity.
At a sub-conscious level, we start believing that the more complex something is, the more valuable it must be.
This feature of corporate life can hurt your financial wellbeing.
Financial salespeople are trained to prey on your taste for exotic stuff.
You will never be pitched to follow a simple life insurance rule or keep your investing choices simplified.
They will go to great length to tell you that if some investment product is too straight forward to understand then it is not good enough for you.
You need something exotic. The finance world is filled with exotic theme ideas.
Credit cards that are by invitation only, access to investment products that are reserved for high net-worth customers and loads of other nonsense.
Here is the thing with complex and exotic investment products. They are great for the person selling it but not for you.
This is due to the high fees and commissions the salesperson gets out of it.
And here is the painful fact. The fat commission comes out of the money you will pay to buy that product.
The more they make in commissions, the less you will have left as your investment.
In some insurance linked investment products, up to 50% of what you pay as premium may be going to the salesperson as commission.
The simpler the investment product, the lower the commission built into it.
The simpler something is to understand, the better it is for you.
Do your best to remove complexity from your investing process.
Your investments should be so simple to understand that even your spouse or teenager can handle it without much trouble.
The Investing Pillar is the third and final pillar of financial freedom.
Scores of people let their dreams of being financially secure and independent go unfulfilled because they fail to take this last step from saving to investing.
Spending years looking for the perfect investment or the best way to start investing means that they never even start.
Time is your biggest friend when it comes to investing.
How long you stay on the investment journey is much more important than waiting to find that perfect investment to get started.
Investing is like driving on a multi lane highway.
If you are driving on the correct highway, it does not matter which lane you are on.
If you keep looking straight and do not take your foot off the pedal, you will reach your destination.
Sure, someone else may choose to drive in a different lane but that should be of no concern to you.
There is enough space for everyone. Your focus should be to just get on the highway and start driving forward.
The tenets of investing outlined in this article are universally applicable.
Keep these in mind and you are all set to reach your destination of financial independence.
Dushyant Choudhary is the founder of dushyantnomics, an early retirement blog for professionals. Dushyant retired early from his 9-5 corporate life after a successful international career. He brings his knowledge and experience to his current role where he’s dedicated to helping professionals achieve a fulfilling retirement.