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by Adrian Mastracci
Business in Vancouver
Podium Column
August 14-20, 2001
The concept of attaining financial independence has been around
for some time, perhaps not totally understood by all investors.
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 expected lifetime.
Let's illustrate two scenarios. First, consider a male age 47 wishing
to achieve financial independence at age 60 with $75,000 of before-tax
income per year 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 female of the same age needs about $2,200,000
because she lives longer.
Second, consider a male age 30 aiming at financial independence
at age 50 with $75,000 of before-tax income per year 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 female of the same age
needs about $3,200,000 because of her longer life expectancy.
Investors must determine when they wish to achieve their unique
financial independence level and their desired income in today's
dollars.
A financial independence analysis captures the client's personal
wish list and estimates the value of investment assets required
to provide for the stated goals.
However, the most important part of this exercise is pinpointing
in the investment rate of return investors need to achieve their
unique financial independence targets.
Conventional wisdom considers the TSE 300, the Canada Saving Bond
rate, the Dow 30, the S&P 500 index, and the best performing mutual
funds as benchmarks of evaluating personal investment success.
None of these benchmarks is relevant. The only relevant one is
your personal rate of return required to reach your unique financial
independence goal.
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?
Once you calculate your personal rate of return, you don't have
to incur any more investment risk than necessary. Without that calculation,
you likely won't appreciate your level of portfolio risk.
Aspirations of financial independence have important implications
with every investor. The answers provide one of the essential elements
for the strategy and structure of the client's long-term asset allocation
plan.
Meanwhile, the size of the amounts that need to be saved begs the
question "What do I have to sacrifice to achieve such an investment
portfolio?" Surprisingly, the answer from many investors is "very
little if anything". Ask yourself what is important to you about
money, and then make the appropriate choices that will guide you
towards your objectives. Vacations can stay.
However, adopting a few principles will assist your journey. First,
time is your biggest ally so start as soon as you can. Second, discipline
yourself to a savings program that you can stay with over time.
Last, don't get in over your head with debt, especially consumer
debt.
Let's capture some of these implications. A 30 year-old that invests
$5,000 per year at 7% will accumulate just over $472,000 by age
60. A 40 year-old would have to invest just over $11,500 per year
to reach the same objective.
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