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April 1, 2001--The
concept of attaining financial independence has
been around for some time, though perhaps not
totally understood by all investors.
I place a high importance on it and it is an
initial topic of conversation with every client.
In my definition, you achieve financial independence
when "you work because you want to, not because
you have to." Simply said, financial independence
is the accumulation of sufficient investment assets
to provide your desired level of income for your
lifetime.
Having reached financial independence you may,
at your option, begin to draw an income stream
from your accumulated portfolio to provide for
your lifestyle needs. These accumulated assets
typically consist of a portfolio of stocks, mutual
funds, bonds, savings accounts, income producing
real estate, royalties and family businesses.
The initial question that I pose to all clients
is "When do they wish to achieve their unique
financial independence level and what is the required
income in today's dollars?"
Many clients strive to achieve financial independence
between age 50 to 60, preferably before "formal
retirement" from their vocation. Once financial
independence is achieved, the clients typically
reduce their work time in favour of more leisure
activities or other pursuits, such as working
an average of two to three days per week.
Accordingly, the financial independence analysis
that I compile for every client captures the personal
financial wish list and estimates the value of
investment assets required to comfortably provide
for the stated goals.
More importantly, I also calculate the implied
rate of return to achieve this capital sum.
Consider a man age 47 wishing to achieve financial
independence at age 60 with $75,000 of before-tax
annual income in today's terms for the rest of
his life. He needs a portfolio approximating $2,000,000
by age 60 assuming inflation at 3% per year. A
woman of the same age needs about $2,200,000 simply
because she lives longer.
Next, consider a man age 30 wishing to achieve
financial independence at age 50 with $75,000
of before-tax annual income in today's terms for
the rest of his life. He needs nearly $3,000,000
by age 50 assuming inflation at 3%. Similarly,
a woman of the same age needs about $3,200,000
because of longer life expectancy.
However, the most important part of this exercise
is "What investment rate of return do you need
to achieve your unique financial independence
target?"
Some benchmarks of evaluating investment success
are touted to be the TSE 300, the Canada Saving
Bond rate, the Dow 30, or the best performing
mutual funds. However, in my view, none of these
are relevant.
The only relevant benchmark is your personal
rate of return required to reach your unique financial
independence goal. I calculate this rate primarily
by knowing the client's current assets particulars
and the estimated annual savings capacity available
for investment.
Your unique personal rate of return becomes your
"minimum investment benchmark" for your long-term
asset allocation game plan. Is yours 2%, 5%, 10%,
15% or have you reached your goal?
I relate all client portfolio review discussions
to the client's own personal rate of return. Nothing
else matters.
Once you know your personal rate of return,
you do not have to incur any more investment risk
than necessary. Without that calculation you are
likely not to know how much risk you are currently
sustaining. This is especially important to investors
who have reached their financial independence
goal.
My premise is that aspirations of financial independence
have extremely important implications with every
client. The answers provide one of the essential
elements for the strategy and structure of the
client's long-term asset allocation plan.
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