Why people are unable to plan their financial freedom

Most of us have a desire of being financially independent but very few of us succeed in this goal. Let us ponder why people are unable to reach their goal of financial freedom.

Undermining Importance of Savings: Savings are of the utmost importance when you are planning your financial freedom. No matter how much money you earn if you are not saving it won’t stay with you for long. Most of the people focus a lot on earning more money but focus far less on saving their hard-earned money. As a general trend, our expenses and standard of living adjust according to our income. People can target saving around 40-50% of their monthly income for their goal.

Also, COVID has shrunk major spending for most of us. This is resulting in an increase in our bottom line (net savings). So, we can use this opportunity to our advantage and reap benefits later.

Inadequately Investing: When you are planning your financial freedom, savings are not just enough. You need to grow your savings also. To grow your savings, you need to plan your investments wisely as they should yield decent returns for you.

Major blockers that people face here as follows: 

Lack of Financial Literacy: The most common factor that keeps people away from Investing is the lack of financial knowledge. It also makes them invest inadequately which leads to undesired outcomes.

A common example of this where Investors ignore their Risk Profile and take decisions which either too risky such as trading, speculating on market movements or they plan their investments too conservatively giving up return (adequate growth). Both situations keep individuals away from their goals.

This suggests before planning the Investments people must be aware of their Risk Tolerance (Risk-taking capability). We have a simple tool for you where you can check your Risk Tolerance for free (link at the end of this article). Most of the Investors tend to base their investments on two constraints Risk and Return, unintentionally ignoring other important constraints such as Time horizon, Liquidity Requirements, Legal, and Taxes. Along with Risk and Return these factors impact your investments and which in turn impact your goal of being financially independent.

The table below summarizes the common mistakes that investors belonging to different Risk profile tend to make:

This table can raise a question that how would you know whether your investment portfolio is under diversified or you are investing in the right sectors/industries/companies. To simply this for you we have built a diversification tester for you (link at the end).  

Status Quo Bias: As humans, some of us have a tendency to maintain the current state even if that is not the most favorable option for us. Some people think that they have enough time and can postpone the plan for some time (years) or few may be lazy enough to start. In both cases, investors end up losing the most valuable asset which is time. One must keep in mind if we want our investments to grow, we have to give them time.

Some millennials think that they can start it after a few years then also they will be able to plan their financial freedom easily. Yes, they will be able to plan it quite easily but may miss the magic of compounding or in other words opportunity to be extra – rich. Let us assume, they will be tripling their investments every 10 years, which is quite achievable with an 11.6% return per annum. So, in 20 years they will achieve a multiple of 9 (which is good). But they may miss the multiple of 27 (3*3*3 = 27), which can be achieved in their 50’s if they start in their 20’s. Early birds always have more time compound their and compounding does wonders with time. 

People also think they have a small amount of savings right now and investing them won’t make any difference and they will start investing once they will have a considerable amount to invest. Well no matter how small your investment is, now is the best time to invest as with time it will automatically compound to a considerable amount.

Perspective: Most of the people approach investing with a short term perspective in mind. They look for instant gratification (or gains) and fail to appreciate the wealth they can build in the long term. Some of them may sell a multi-bagger when its 50% up, but they fail to consider the fact it gives a return of 20% for the next 10 years then they stand a chance to multiply their investment 6.19 times.

When people don’t look at things from long term view, they also fail to consider how marginal improvements can make a big difference. For example, A Good ELSS will provide an average return of 12% per annum and PPF pays around 8% per annum. If one compares it for 1 year or 2 years difference won’t be considerable. But over 20 years, it will compound to 1.12^20 = 9.64 vs 1.08^20 = 4.66. Mind you this is just for a year, each year this difference will accumulate as you do tax declaration (For year 2 it will be 1.12^19 = 8.61 vs 1.08^19 = 4.31).

In 20 years the total difference will be 80 times (by adding each year multiple 9.64 + 8.61….and so till 1.2) vs 49 times, which can prove how even 4% the difference can be significant in the long term. Always try to make marginal improvements as they can lead to big differences in the future.

If you are wondering, what is ELSS? Is it suitable for you? Or how to select an ELSS according to your preferences. We have provided a link to an article and ELSS Selector Tool at the end.

Individual Characteristics/ Traits: Just like everything else, the qualities of an individual are vital here. Let us look at how individuals can impede their financial freedom journey if they lack certain traits.

Discipline: No matter what you do being disciplined reaps great results. If individuals are not disciplined it can be hard for them to control their expenditures and save appropriately. Lack of discipline may result in investors’ missing their planned investments (monthly SIPs, equity investments) or not following the investment plan in a prudent manner.

Perseverance or Patience: Patience and perseverance are also important as it’s a long term game. So one needs to have skin enough in it until you win. You have to wait for your portfolio or investments to perform (if you believe in them) because few things just take time.

Approach: If you are not following the right approach or doing it in an aimless manner than it will become harder than you think. As the right approach can help you to make a better investment decision and avoid biases such as loss aversion (when people tend to add a losing stock in order to losses or do average), status quo, availability bias (when people look easily available options ignoring what is best for them) or herding behavior. These biases can lead to sub-optimal decisions and following an investment plan (IPS) can help you avoid them.

It is always easier said than done but being aware helps!!

Risk Calculator: https://wealtheemonk.com/risk_calc/

Diversification Tester: https://wealtheemonk.com/diversify/

Article on ELSS: https://wealtheemonk.com/blog/6

ELSS Selector: https://wealtheemonk.com/elss_calculator/

LinkedIn: https://www.dhirubhai.net/company/infin-ite/

Let us know in case of any questions! Take care, Stay safe :)