Gap year diary - 4 learnings in the financial freedom journey

I am on a gap year in 2021 to explore how I want to spend my 40s and craft my life 2.0.

In last article, I shared the story of my quest to craft a healthy and happy 100-year life. It involved multiple life experiments (teaching, writing, public policy related course), a 3-month sabbatical at 30 and the realization of 5 foundations for life 2.0 (freedom to run your race at your own pace) transition – money, relationships, health, career, and identity. I spent the last decade putting these five foundations in place before my gap year @40.

Today, let's talk about money & what did I learn in the last decade.?

1) High income is no substitute for personal finance literacy?– I did not grow up discussing money. It just felt an uncomfortable topic, as if talking about money signified its lack or greed. Even as I started working, nothing changed. My approach was simple – focus on doing well in my career, which will lead to higher income over time. Don't waste time tracking expenses or savings. Whatever is left post expenses, put that in FDs or real estate. As my income kept climbing up over time, I saw no reason to question how I handled money. I ignored any warning signs, like the time in my early 20s when I quickly took a credit card debt for a friend without realising it cost me a 36% interest rate!

As the 40s inched closer, I felt it would be good to check where I stood in my financial freedom journey. I was confident that my current portfolio (primarily India NRE FDs, homes in India and Singapore) must be earning me a minimum of 7-10% returns. Instead, I discovered that I was making a 0-1% real rate of return on my total portfolio (in Singapore dollar after all taxes and expenses).

What explained the difference? It turns out many assumptions, some laughably na?ve in retrospect (e.g. forgetting currency devaluation impact when calculating SGD actual returns from India NRE FDs). I assumed real estate to be an excellent investment without digging into the hidden costs of homeownership – property tax, society charges, recurring and one-time maintenance costs, agent fees, insurance cost, tenancy renewal gaps & opportunity cost of home equity capital. The property net returns were negative unless valuation had shot up (no such luck for my properties).

Aside from investment logic, I realised that our family housing needs keep changing with each life-stage situation (no kids to young kids to grown-up kids to outbound college kids). Instead of keeping the same house across different life stages (which will be either too big or too small at different life stages), why not rent a home best suited to each life stage for now? The money thus saved could grow as an investment over time, and we can always buy a house later whenever we are sure about the size and location of the home we need.

I also realised the limitations of focusing only on earning a higher salary. Why not also learn to invest & grow my portfolio at 4-6% per annum (versus 0-1% returns)? I would need to get my hands dirty, but I realised that if it matters in life, it is best to learn it oneself versus relying on others in the long term.

2) It is not about beating the market?– Now the real problem. How to generate 4-6% returns per annum in local currency post-tax with minimal capital risk? I started dabbling in the stock market. I would have chosen Index investing if I had 15+ years' time horizon. But by now, I was 35 and had only five years left before 40. Market recessions have lasted longer than that. I did not want to sell my stocks in distress to meet my living expenses after 40. How hard could it be to pick stocks on my own?

I became a stock picker. In the first two years, returns beat my targets (so did for almost everyone I knew in this rising market), but I was not sleeping well. What if the market crashes tomorrow? I had tied my returns to the fluctuating shares prices, something I had no way of predicting for the short to mid-term. I was plain lucky to be part of a rising market, but this was not the sleep-well-at-night financial freedom strategy I was looking for. Investing felt like gambling. I did not care about beating the market. All I wanted was minimum 4-6% annual post-tax returns in local currency with minimal capital risk.

After much experimenting and reading, I realised that instead of tying my returns to share price fluctuations, I should anchor them in dividends (earnings that companies return to shareholders). Over time, this evolved to the following five stock selection criteria for me - 1) 3-4%+ dividend yield post-market dividend withholding tax, 2) uninterrupted 15-20+ years of dividends & 3) 3-5%+ per annum dividend growth, 4) businesses likely to be deemed as too big or critical to fail, 5) undervalued by 20-30% versus fair value to provide a margin of safety and potential capital gains in mid to long term.

Simply put, buy dividend-paying blue chips on a dip, hold on for dividends, sell when past fair value. Repeat! It is a simple, even dull strategy with little regular action but it meets my risk appetite and goals. It has managed to even deliver significant capital gains upside in the last few years given my 5th criteria (only buying when under-valued and selling when past fair value). But the capital gains upside is just a cherry on top. The core is the dividend and the knowledge that I don't need to focus on beating the market to deliver my 4-6% returns and sleep well at night.?

3) Is it YOUR plan, or is it OUR plan??Initially, financial freedom was just a number - hit xx million. But what if my partner and I differed on the assumptions in that number - e.g. lifestyle choices or % returns? It took five years for us to figure out key questions we needed to answer for ourselves as a couple - 1) What is the lifestyle we want as a family, and its cost across life stages? 2) Can we afford the above lifestyle based solely on passive income from an investment portfolio, or does one person need to keep working? 3) How confident do we feel about this passive income plan? Is it based on hope or proven data? Does it reflect risks and black swan event protection?

A question on numbers quickly becomes a discussion about life. For example, when discussing the desired lifestyle, we discussed potential locations across different life-stages, homeownership versus renting, health & life insurance, schooling and college expenses for kids, discretionary costs, and what should we optimise. Does my wife need to work even if I quit? We agreed early on that it would be unfair to burden one person. Work should be a choice, not an obligation. I will only quit when returns from the portfolio are sufficient for our desired lifestyle. (And only when I have demonstrated those % returns for a few years to build confidence, my wife wisely added??)

We learnt that creating space for unhurried conversations over time is vital to building mutual confidence. Unhurried conversations uncover fears so that each person can express their concerns without feeling cornered to say yes or no to something prematurely. Our space for such conversations would be during weekend date nights or year-end financial reviews.

4) What is the true source of financial freedom in a 100-year life??– I worked at financial freedom. Yet, gap year makes me realise the inadequacy of the traditional financial freedom concept for a 100-year life – both financially and psychologically.

Financially, yes, it is good to have a neat plan, but can anyone genuinely anticipate life's curveballs over a 100-year life? Misfortune can visit in many forms – wars, financial market meltdown etc. It is not unimaginable to lose all assets in future for any of us. So, what is the solution?

The solution is in realising that financial freedom does not lie in numbers. It rather lies within - in the mindset we choose for life 2.0.?

Is life 2.0 about safety or growth? If safety, my focus is on preserving financial freedom while hoping for the future to unfold as I planned. It is how we have traditionally approached retirement (a one-time event in life signifying a withdrawal of active engagement from life from which there was no going back, hopefully!).?

Even if financially feasible, is this model of Life 2.0 psychologically desirable for a 100-year life? Clamouring for safety can breed fear and stagnation.?If life does not stand still, should we?

What if I imagine differently & focus on growth? What if I approach life 2.0 as a series of mini-retirements sprinkled through life as I periodically pause and permit myself to discover what is it that fascinates me NOW (and not 10 or 20 years back)? If talents & experiences gained in life 1.0 are married with passions closest to one's heart in life 2.0, I imagine sooner or later, it will end up creating value. Whether one chooses to monetise that value or not is beside the point. The point is to stay engaged with life. This mindset of curiosity and wonder might be the only source of financial freedom in a 100-year life. That security lies within and something no one can take away from us.

I love hearing from you. Do share your comments if anything resonates, your take on financial freedom or just to say hello as a friend:)

Cheers,

Sameer Srivastav

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