Financial independence is a goal that many aspire to, but only a few achieve.
Statistics show that globally, only 0.74% (59.4 million) of the world's population has a wealth of $1 million or more. It's important to note that having a million dollars may not guarantee financial independence, as this depends on factors such as lifestyle, cost of living in the country of residence, family responsibilities, and investment knowledge. Interestingly, out of the 59.4 million millionaires, 25 million are in the US, 6 million in China, and another 9 million in the UK, France, and Japan. The remaining 19.4 million (0.2%) millionaires are spread across the rest of the world. Statistically, people in countries with larger economies have a higher chance of reaching this goal due to more opportunities.
More people should be able to achieve this goal worldwide, provided they reprogram their mindset to break free from the old paradigm of scarcity and stories of limitations. Instead of working to pay bills and cutting expenses to save for retirement, medical needs, and children's education, the new mindset should be about becoming valuable by creating more value for others, investing in self, and focusing on innovation and entrepreneurship. The path is not easy, but then life is not easy; no one gets out of it alive.
I am impressed by the Gen Z who are breaking this mould and becoming entrepreneurs leveraging the digital revolution and their innovative mindset to achieve a better life. Now, many are in the position to do that behind the hard work and financial support of their parents. It's an evolution and will take time, provided we focus on tunning our education system towards building financial literacy, nurturing innovation and entrepreneurial skills from school level and providing practical experience and counselling for developing successful entrepreneurs of the future. There by increasing financially independent population that can reinvest to create more jobs and wealth for the economy.
In the US, for instance, financial literacy surveys suggest that a significant portion of the population lacks basic financial skills (Financial Educators Council). MBA programs, a common pathway for advanced business education, have a limited number of graduates annually. In 2021, the number of GMAT exams taken globally, a common requirement for MBA programs (not everywhere), was around 156,453, indicating the pool of potential MBA students (GBEN). Imagine how little of a population is educated formally in finance and business, and most of our lives revolve around money.
The purpose of the statistics is to tell you that it is challenging to achieve financial independence. If it had been easy, a large population would have reached it. However, financial independence is a continuum and not a destination. It can be on one extreme to have a lot of money well invested so as not to need to do anything now and for the next generation with the ability to employ people or support ventures to bring your dreams into a reality while travelling and doing what you like. On the lower end of the continuum, you have enough to take care of basic needs and need to do some value creation for extra spice in life. So, there is place for many who embark on this journey. The key is to have fun in the journey and continue climbing the ladder of financial independence.
The fact that you are reading and taking an interest in setting a goal of financial independence is a great start, and I believe that if you believe in the goal, you will eventually achieve it or at least inspire your children to get on the journey.
Let's start our journey by looking at what is the equation for Financial Independence:
Financial independence = Mindset + Financial Literacy.
Mindset includes our attitude, childhood influences, beliefs, values, ability to manage fear, playing positive stories in the mind, perseverance, curiosity to improve, questions to understand and passion to succeed. Financial literacy includes, along with technical mastery, elements like critical thinking, growth, problem-solving, portfolio management, risk management, resourcefulness, and a single-minded focus on value creation in everything that we do.
Each element of mindset and financial literacy, in turn, has a continuum. Let's take financial literacy, which can go from basic to mastery. Likewise, an individual may have a good mindset. Still, suppose they are in an environment that offers fewer opportunities. In that case, they must raise their level of thinking and perseverance to overcome the impediments that many in better environments don't have to face to reach similar goals. We cannot influence where we are born. Still, we can put in more to overcome the disadvantages, as with every disadvantage, nature also grants us some exceptional capability.
The journey towards financial freedom is not just about earning and saving money; it's deeply rooted in our psychological makeup. Understanding the psychological aspects that influence our financial decisions can significantly impact our ability to achieve and maintain financial independence. Let's delve into the psychology behind financial independence and offer insights into harnessing our mental faculties to build a secure financial future.
1. Avoid herd mentality. Fear is the biggest scourge of life and a threat to wealth creation. Following others unquestioningly like a herd shows a lack of confidence and fear. We all know that fear can make us do funny and, in the worst case, unbelievably ridiculous things. Fear suppresses rationality as we get into the fight and flight response (the amygdala winning over the frontal intelligent brain). All of us have followed herd mentality at some point in our life. I must admit that I have been a victim of it many times.
We have all seen exaggerated stock market increases and fall-behind the news that has some impact on the valuation of the companies but is significantly exaggerated. For example, a change in interest rates affects the cost of capital, which is used as a discount rate to bring future cash flows to present value. Suppose the interest rates increase while everything else remains the same. In that case, the value of the company will decrease, thus impacting its share price. However, the change in the share price is more than the financial impact due to the emotions of fear, which leads to factoring in the base more than the impact by assuming disproportionate negative perceived factors. Add on top people following others blindly selling off their assets without a rational view of the situation and assessment of the price, and you have a pronounced market decline.
The emotional sell-off helps the opportunists as they can buy the stocks at a discount. They know that the market is below the companies' intrinsic value (the company's real value) based on the discounted future cash flows, which is the perfect time to buy quality assets. It’s like buying luxury brands at a sale.
It's not uncommon to hear individuals say that I invested because my friend or family member suggested that the stock or real estate would boom. Many don't even take the time to ask for the logic for the increase; they follow like a herd.
My suggestion is that you build at least a basic understanding of your investment universe, know your reference currency and investment tenure, and learn some analytical tools that can help you do a basic assessment of the stocks, property, or any other asset in which you are investing. The better you get at analyzing with a calm and rational mind, the better decisions you can make.
2. In God, we trust others to show performance (real returns inclusive of fee, risks, commissions, etc.). I always say that “No one can take better care of your money than you,” as it is the most crucial point of wealth creation. Leaving our money in the hands of relationship managers or real estate agents is behind the mindset that I am trusting the experts. Logically, the thinking is good, as people who do not have good financial literacy should benefit from the knowledge of others. There is nothing wrong with this; rather, it is smart.
However, to find someone who is genuinely an expert, not a company’s salesperson, having your interest ahead of their interest at heart is rare. The relationship managers and real estate agents are employees working for their businesses and trying to maximize their value creation. They have targets to meet like any other company, pushing for products that can earn them a higher fee or commission. If you are not looking at all the costs involved in investing plus understanding all the risks, you might end up with the short end of the stick and shedding the value of your hard-earned money.
Another interesting point is to be wary of the baseline. Sometimes, you will hear companies sharing the performance of the real estate market or stocks from the time they were at their lowest price to show the highest gain to support their point. Let me explain by looking at the rise, fall, and rise of 2021 to 2023. The benchmark S&P 500 generated impressive returns of 28.7% in 2021 and 26.29% in 2023. Sandwiched in between was a bear market, as the S&P 500, at its low point, lost -25% of its value in 2022, according to S&P Dow Jones Indices. The market in 2021 benefited from the US economy growing at its fastest pace since 1984 post the pandemic. Now, if someone were invested in 2021, the person would be flat in 2023, losing 25% in 2022 and gaining 26.29% in 2023.
Be wary of being misled by super stories, only looking at a gain from a low. Always look at your performance all-in, from when you invested the money to how it gains or loses every year. If you get dividends, coupons, or interest, add them to the Net Asset Value (NAV) and subtract any interest on the loans, mortgages, fees, or commissions you have paid. All-in is the word.
3. Patience is a virtue, and a mindset of patience is imperative for investing. I read somewhere that nature wants to test us in places where we are not strong so we can build on those aspects to be overall better and stronger as individuals. Patience is something that I have struggled with when it comes to investing, and because of it, I lost money. Over time, I am getting better and taking a long-term perspective on investing. The problem comes in because of the harmful noises around us about politics, economics, or Domesday forecasts that take the focus from long-term to liquidating positions in the short-term to protect the money.
The better approach is to look at history and learn from it. Despite the many significant events like the Economic crisis in Asia (1997), the Russian financial crisis (1998), the dot.com bubble (2000), the economic effects of 9/11, the financial crisis of 2007-08, the Chinese stock market crash (2015) or Covid 19, etc, the overall stock market has grown over the years with bumps along the way. The point is that those who picked quality assets and remained patient during the crisis got good ROI from their investments.
Even nature takes incubation time to create its glory. Crops require seeding, fertile ground, sun and water, keeping the pests away, and time to produce a great harvest. Likewise, in investing, allow an incubation period and always purchase quality assets. Greed and get-rich-quick mindsets can destroy value and should be managed or better overcome with an attitude of patience and sustainable growth.
Remember, financial independence requires patience and discipline. Building wealth is a gradual process that involves consistent effort and time. Impatience can lead to hasty decisions, such as high-risk investments, jeopardizing our financial stability. Discipline in budgeting, saving, and investing ensures steady progress towards our financial goals. Developing a long-term perspective and focusing on our objectives can help us navigate financial ups and downs.
4. Play a positive, energizing and courageous story in your mind. We live in the mind, judging situations and people and reacting accordingly. Our perception can be faulty or contrary to the reality. So, we must continually work on ourselves to be pleasant, non-judging, positive and seekers of knowledge. Investing in us is the best investment ever. We have the foundation to build wealth if we have health, love, family, emotional well-being, positive spirituality, and creativity. These do not require money but can be a catalyst to make us achieve the most challenging goals.
Our mind continuously feeds us with thoughts, creates an image of ourselves, and subconsciously creates our attitudes and reactions to events and situations. It's hard, but the first step toward an enriching life is to work on the mind, calm it, and make it actively focused on value creation by replacing negative stories with positive ones. Reinforce the positives by thinking of all the good in life and the good coming instead of thinking about the troubled past or the risks in the future. Of course, you will have to look at risks and develop plans. Still, the point is to do it from a position of confidence, positivity, and pleasantness instead of stress and negativity. Take time to do breathing meditation, sports, introspection, laugh therapy or anything that gets your body or mind energized and refreshed.
Whenever possible, keep quiet and listen to the thoughts crossing your mind. What is the chatter? Is it positive or negative, stressful or energizing, ruminating or planning and ideating for a bright future? Work on focusing on positive things while objectively acknowledging the things you do not do well or mistakes made and how to learn from them and do well. Know yourself well before trying to understand the world and working on growth. Once you discover yourself, many material things will seem meaningless, and the focus will be on what matters to you, not what you have to achieve to be recognized by others.
5. Nurture a mindset of resourcefulness. A mentality of resourcefulness is a cornerstone of achieving financial independence. This mindset involves viewing challenges not as obstacles but as opportunities to find creative solutions and maximize the utility of available resources. Resourceful individuals tend to be proactive, seeking ways to stretch their financial capabilities through innovative strategies such as budgeting, investing wisely, and leveraging their skills and networks. They often adopt a frugal lifestyle, focusing on value rather than cost. They continuously seek knowledge to improve their financial literacy. By thinking outside the box and being adaptable, they can navigate financial uncertainties and turn potential setbacks into stepping stones towards their financial goals. This approach enhances their ability to save and invest effectively. It builds resilience, ensuring a more stable and secure financial future.
Conclusion
Achieving financial independence is deeply intertwined with our psychological makeup. By understanding and managing our beliefs, emotions, biases, literacy, goals, environment, and discipline, we can make better financial decisions and steadily progress towards financial freedom. Embracing resourcefulness, patience, a positive mindset, continuous learning, and strategic investing pave the way to a secure and fulfilling financial future.
It is not the destination but the journey that builds experiences, memories and engagement in life and the journey becomes more enjoyable when you can afford the experiences with your loved ones.
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