The Fundamentals of Financial Independence

Here are some important strategies that will help you achieve financial independence. It is important to get solid advice which can design a plan which incorporates Planning Values such as those noted.

Separate your savings from your investments Before you begin to invest for a long-term financial goal, you’ll need to save for an emergency fund – up to six months worth of your salary. Then you are prepared for an unexpected expense such as an engine job on the car, a leaky roof or loss of employment. Otherwise, you may need to tap into your investments that are intended for retirement or some other purpose.

Budget based on your income, not on your desire Plan to spend less than you earn and don’t take on debt that cannot be serviced by your future income. Budgeting is based on your income, not on your past spending habits. Total your monthly expenses such as housing, utilities, food, clothing, child-care, transportation and debt repayment. This sum should not exceed 75% of your after-tax income.

Invest by paying yourself first You will only beat the habit of procrastination if you focus on paying yourself first. A rule of thumb: save 10% to 20% of every paycheck. This can be achieved by purchasing units in a good investment fund on a systematic basis, using an automatic payment program.

Use beneficial debt to build equity Minimize and pay off consumer debts – monies borrowed to purchase cars, clothing, vacations, stereos and other gadgets that decrease in value. Debt to help you achieve an education or mortgage a home, and is acceptable debt. Only if the interest rate is very low, and repayment is affordable, debt for investments such as investment funds, your own business, or blue-chip stocks may make sense. The interest on such investments, if not held in an RRSP, is tax-deductible.

Differentiate your risks Inflation risk will compete with long-term investment risk. Equity investment funds and/or the stocks of many companies are not guaranteed, meaning there is a risk. Yet equities have a much better chance to outpace the negative risk of inflation – – or as some have humorously termed shrinkflation — when compared to a savings account over long periods of time. Inflation is the single greatest long-term risk. At 4% over 20 years, inflation will cut the value of today’s purchasing power by half.

Determine to diversify A properly diversified portfolio will hold several types of funds including a mix of equity funds. Equity funds should differ in terms of what sector of the economy they invest in, such as agriculture, technology, mining, or finance. Though each fund would hold many stocks, make sure they are diversified among the various sectors. One sector may gain while another may lose some value, balancing out over time. Equity funds can also diversify by country (such as holding domestic, US and global funds); investment style (such as growth funds, or value funds); or company size (such as small, mid, or large-cap). Consider adding bond funds to the mix to diversify even more.

Optimize Your Portfolio If you can optimize your portfolio, you may minimize the risks, to help your return on investment. To truly optimize, one needs in-depth knowledge only obtainable from a professional whose job it is to study funds as a speciality. To diversify in a balanced manner, one needs to weigh many factors in relation to economic sectors, managers’ styles, company size, and foreign economic conditions.

What are the 5 Laws of Wealth Creation?

Here are five wealth creation principles that will remain true forever.

1. You must get time on your side by investing early in your lifetime. Time adds value to money. Delayed investing shortens your time, which increasingly requires the compensation of higher and higher returns to meet your retirement goals. Examine the following graph to see how time affects your investment growth.

Source: Financium

2. Your investment growth must exceed inflation. If you earn 8% on a $10,000 investment per year, over 20 years with inflation at an average 4% your actual investment will grow to $457,620, but your actual buying power in the future will only be $208,852 (while your money is growing, inflation is increasing the cost of goods). The graph below indicates how inflation might affect your investment’s future buying power.

3. Algebraic factors apply to investing. You can indicate your multiple on capital invested by applying mathematical rules, factoring in both time and rate of return.

Graph

· Double Your Money: Rule of 72. To find out how many years it will take to double your money, divide 72 by your average annual rate of return.

· Triple Your Money: Rule of 113. Divide 113 by your average annual rate of return to see how many years it will take to triple your invested money.

4. Taxation can reduce your investment returns.

Every dollar of tax retained through tax-planning is a dollar earned.

· Deduct what you can against your income. Business owners have the advantage of deducting many operating expenses from their revenues.

· Contribute to registered investments. For both business owners and employees, registered investments may allow deductions against earned income and may offer tax-deferral.

· Defer as much taxation as possible. The beauty of registered investments is that they allow some tax planning benefits depending on your income, and capital available to invest.

5. Become an active investor. It is important to begin investing early in life when you get your first job or begin your career. By beginning early, you can have the above stated mathematical laws of doubling and tripling your money working for you. Many wait far too long before investing and lose the value that time can add to a good investment portfolio by increasing the future accumulation of investment money.

The following table will let you know just how much you will need to invest to accumulate one million dollars.

Source: Financium

How can I get serious about successful investing?

There are four basic types of people, each  with differing mindsets when they approach investing; the Sideliner, the Gambler, the Hobbyist, and the True Investor. If you want to be a serious and successful investor, you will need to mindfully recognize the erroneous attitudes of the Sideliner, the Gambler, and the Hobbyist.

The Sideliner Sideliners aren’t afraid to take action as long as they are in the audience where they won’t ever get bruised. They shout, stand, clap, loving the action of a bystander. Sideliners love the excitement of stock market news and the investor’s game. They often look at how the indices or a stock or a fund performed. Observation alone, never gets you in the game of investing. Sideliners may feel it is dangerous in the arena of the investor.

The downside Sideliners are analytical who love running numbers hoping to reduce most of the risk, comparing return percentages, yet out of a paralysis of information, fear sets in and they make minimal purchases just to play it safe. The sideliner is a silent observer possessing discernment for weighing facts, yet who witnesses other people’s investment success without taking any action to enjoy investing personally.

The Gambler These people are sanguine thrill seekers, who unlike the Sideliner, enjoys the casino, horse race, or scratch and win tickets. He or she confuses play gambling with risk tolerance, spends recklessly, considers that investment principles are for misers, and doesn’t seek the guidance of an advisor and consequently has a retirement portfolio that looks broke.

The downside The Gambler is comfortably numb and usually gets punished with frequent losses for taking above-average risks. They might buy an investment based on listening to the talking heads in the trading media, buy penny stocks, or low-priced failing company stocks — all based on uncredentialed hearsay. Because they think that they might make some fast money, they think they are investing, but they are not. Rarely does a Gambler stay invested for the long term.

The Hobbyist He or she buys things and investments on the basis of their emotional value, more than on investment value. As collectors they buy for popularity status, notions of status, aesthetic gratification, and pleasure.

The downside Hobbyists, when excited, may jump to buy anything that is referred to them by word of mouth or a talk show host. They may own all the British Royal plaques on a wall or the top “500 must see movies before you die”. Financial perspective gets lost because several investment funds may be bought by virtue of historic popularity instead of the potential for future gains. Because collections have been known to go up in value, they think they are investing. They do not understand the old latin proverb “Non Quantum Sed Quale”, meaning it is not the quantity, but the quality that counts.

The True Investor Utilizing an advisor’s wisdom, they buy good investments. Unlike Sideliners, they act. Unlike Gamblers, they minimize risk. Unlike Hobbyists, they buy on the basis of investment value. Investors are defined by their knowledgeable expectation for financial gain employing a principled process to minimize financial risk. Many also make it their practice to utilize professional managers and advisors when investing.

True investors act the part, with a vision to achieve excellent returns on their investments while exposing themselves to mitigated risk that suits their investor profile while enjoying the actions that lead to real financial success. It all comes down to how you think and if you’re thinking towards taking investment action.

What is the mind-set of financial independence?

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Establishing the right mindset towards money will eventually show up in your investment portfolio as wealth that can provide a lifetime of income and the eventual achieving of financial independence. This may be impossible, without understanding how attitude affects one’s financial destiny. First, let’s examine a few of the correct attitudes versus erroneous thinking that could block our way.

Agree about money Most people need to consider the input of another person regarding how money is spent, invested, and managed. The problem is, many people never agree to a strategy of investing and stick with it – they’re still broke while arguing or doubting how to invest at age 55. Find a compromise, and stick to an agreed-on plan to invest.

Know the state of your finances Many never reconcile their bank account or organize their financial receipts or statements. They continue to make purchases, but never really know if they can afford them. Financial independence depends on financial management – you will need to establish orderly control. Purchase a filing cabinet, trays for receipts, files for all categories of purchases – a place for everything. Consider using computer software such as Quicken, posting your income and expenses weekly. Reconcile bank accounts and know your balances on a weekly basis, and your financial position, on a quarterly basis.

Buy only essentials on sale Sale signs are everywhere – the consumer can get up to 70% off in some cases. Those who sell goods know that sale signs encourage people to buy. Consumers legitimize the purchase in their minds, on the basis of saving a few dollars on an item. The problem is that over time one may buy many items on sale, despite the fact that he or she is spending above the household’s discretionary income, and may max the credit cards. While overspending this way, unmanageable debt is created. Instead of using discretionary income to invest; it all goes to paying down escalating credit card bills and high interest. In order to break free of this habit, save money first, and buy based on true needs. Stay clear of malls until the habit is broken. Be careful not to go to the other extreme and become a scrooge, ruining life’s enjoyment for others. Save money first, and buy based on true needs.

Limit need-for-prestige spending Many people buy more expensive computers, stereos, cars and gadgetry in order to impress the neighbours – yet these items depreciate in value over time. Add to that, countless upgrades when we become discontented, comparing new arrivals on the market. Such buying behaviour may create a false sense of prestige, negating one’s future retirement security. Income may drop or disappear all too soon, leaving many unpaid liabilities. Invest in assets that appreciate in value, such as a home, equity investment funds, or segregated funds, while not spending more in relation to increased income.

Eliminate procrastination based on fear What occurs in the U.S. or the Euro zone affects us all collectively, only insofar as how the markets that you invest in respond. Over 50 years, we find that the U.S. markets initially declined in a crisis, yet each recovered in a remarkably short period of one week. After the Suez Canal crisis: markets down 1.5%, gained 4%. The arms blockage in Cuba: down 2%, climbing back 4%. President Kennedy’s assassination: a decline of 3%, rising again within one week, 6%. The financial crisis of 2008 ruined many people’s investment retirement portfolio if they sold their funds or stocks. Those who were patient saw most of their funds and stocks climb to much higher values than before the crisis began.

How do individuals or families accumulate wealth?

They save by moving money received as income into a separate account, before they spend it. It doesn’t matter if you have received an inheritance or won a lottery – the rule is the same. Save, and then invest before you spend.

Here are some good reasons for investing.

  • It gives us a sense of financial security, earned by continued discipline and adherence to the principle of saving, which adds to our sense of personal dignity.
  • We are eventually rewarded by seeing money make more money as it works for us, gaining and compounding.
  • Saving paves the way for the actualization of our goals and objectives in life, such as acquiring a home, making major purchases, travelling, putting children through college or university, or going back to school ourselves.
  • Accumulated assets will increase our net worth, and bring us to financial independence. Such control and flexibility is within our reach if we start now.

Stumbling blocks to saving. Don’t defer to only saving what’s left at the end of the month, or waiting until “things get better”. Usually there is nothing left at the end of the month and things rarely improve because the philosophy hasn’t changed – spending above income continues and debts increase. Except for a home mortgage or loans for motor vehicle transportation, and in some cases for investing; debt is a deterrent to financial independence. Commit to a strategy to pay down all household debt and start saving at least 10% of your income every month.

Inflation is a constant battle. Over the years, inflation reduces our buying power. Interest rates when increasing to reduce inflation also increase our debt repayment load as a percentage of income. The following table shows just what inflation can do to your investment income when needed when retired.


 

Planning for your dependants. Make sure you have sufficient life insurance to pay off your total debts such as: credit card balances, car loans, IOUs, and any business-related debt. Incorporate this with sufficient coverage to provide future income for your dependants. This is especially necessary if your debt exceeds your annual income as it does for the average household where debt runs at 150% or more, of income.

What is the difference between volatility and risk?

Volatility and risk are different concepts, but both have a role in determining your investment success.
 

Volatility is simply how much the market will increase or decrease, whereas risk is the amount of loss or gain you are willing to accept. How volatile your investments behave is often derived by the level of risk you are willing to accept. During periods of market volatility, it is important to stay focused on your asset allocation goals according to your predetermined risk profile.

Volatility is simply short-term instability that can affect all stocks, including good stocks or good equity funds, because of fear generated in the markets. The Euro-debt fears in 2012 are a good example of this. When markets are down, even a company that provides a useful, durable product may be affected. When the market calms, however, the company’s stock price may rise again.

What are the main benefits of investing in mutual funds?

What are the main benefits of investing in mutual funds?

The average investor, who buys stocks and bonds, does not have the necessary time to assess securities, nor the expertise to make qualified investment decisions. Mutual funds allow the investor to effectively hire a fund manager to make these decisions. Managers possess training in market analysis and have an understanding of economics. They work to assess the value of a company’s stock and develop an investment strategy that establishes buy and sell criteria, based on an educated, tactical discipline.

Some of the main benefits include:

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Instant Diversification. Many have heard the phrase, “don’t put all of your eggs in one basket.” In a mutual fund, investor monies are spread across a variety of different securities investments. By investing in mutual funds, as opposed to individual securities, the account growth or loss is based upon a group of different investments, rather than the performance of a single security.

Professional management. By investing in mutual funds, the investor is not involved in the evaluation and maintenance of the underlying portfolio investments. Instead, the day-to-day decisions of each fund are handled by experienced, professional money managers.

Lower fees and expenses. Mutual funds provide economies of scale. Because mutual funds pool the resources of many investors, the fees per share passed on to each individual investor from purchasing the underlying securities in a mutual fund are often less than if they would purchase the same individual securities on their own.

Convenience. Dividends and capital gains can be used to purchase additional shares, facilitating growth to an investor’s portfolio.

Automatic Investment Planning. Commonly, investors are able to set up a dollar cost averaging plan with their bank or brokerage account to invest a set amount each month into the mutual fund of their choice.

Thousands of mutual funds to choose from. Every type of investment fund—including equity funds, bond funds, diversified funds, balanced funds, and international funds—give you access to investments in the world’s strongest companies.

You can also invest among foreign securities. Although Canada has a strong economy and is a G5 nation, it represents approximately 3% of the capitalization trading in non-domestic markets. The U.S. offers access to the highest capitalization in the world, while tremendous investment opportunity lies outside of North America—accessible via mutual funds.

Financial Consultation. Your financial advisor can help you design your mutual fund portfolio and review it with you on a regular basis. Most advisors offer the majority of the better-performing funds—with both foreign and Canadian securities included, including a wide range of international and global funds.

What caused the Sovereign Debt Crisis (Euro Crisis)?

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In 1999, 11 countries met and decided to create a new common European currencythe Euro. This Euro currency replaced the currencies of the member countries of the European Monetary Union (EMU). The advantage of the Euro was substantial since businesses could now more easily assess the value of purchasing supplies and selling goods and services without having to deal with currency fluctuations across the different nations. Today the Euro is used daily by more than 50% of the EU’s over 300 million citizens.

The introduction of the Euro coincided with the creation of the European Central Bank (ECB), whose role was to monitor the newly created currency and maintain fiscal policy in the European Union. The ECB “levelled the playing field” by establishing common borrowing and lending requirements for all banking members of the European Monetary Union. Another stabilizing factor of the ECB was its ability to manage fiscal policy such as setting interest rates and managing foreign exchange reserves. All of these positive factors allowed the European Member Countries to stabilize their fiscal policies and provide guaranteed price stability. This framework for cooperation on economic policy solidified the banking ability of Europe’s economic and monetary union (EMU), of which all EU countries are part.

This single currency – the Euro – was first introduced in 1999 as ‘book money’, with the national currencies still circulating but having become sub-units of the Euro. Then, in 2002, the changeover to the new currency was completed with the introduction of Euro banknotes and coins. Today, the Euro is the only currency of all the countries in the Euro area.

The cost of changing money when travelling or doing business within the European union disappeared, and the cost of making cross-border payments has in most cases either disappeared or been reduced significantly. Consumers and businesses can now compare prices more readily, which stimulates competition and drives economic progress.

With the financial meltdown in the banking system of 2008, European Finance Ministers decided to support and protect the banking sector of the EMU. Individual countries decided to handle their own financial problems and supported their respective banking systems individually. Although the EMU centralized banking in Europe, it did not centralize the fiscal decision making of each member country. This proved to be a major weakness, as there was no common fiscal policy that dealt with the debt of each nation, hence the term “Sovereign Debt Crisis”.

The Sovereign Debt Crisis was a term designed to reflect countries with weak fiscal management and incredibly high debt levels. Individual European countries can no longer print money to inflate their way out of debt, and with no common European Treasury board to assist in regulation of individual countries debt problem, debt default is a serious possibility. Countries with weak fiscal management, such as Greece (where only 5% of the population pays tax), have borrowed from other countries to maintain its fiscal policies. Greece’s potential debt default would have rippling effects on other European states. Within a single market and major trading bloc like the EU, it makes good sense to coordinate national economic policies. A common treasury would enable the EU to act rapidly and coherently when faced with economic challenges such as the current economic and financial crises.

At the time of the peak of the crisis, the graph below reveals that Greece’s Gross Domestic Product (GDP) was less than the sovereign debt it carries and that Italy’s debt to GDP is very high as well. The implication for the banks in the EU states is that if people lose Euros deposited in Greece banks due to a fiscal meltdown there, the effectual “bank” value of the Euros held in Greece and the other debt-ridden states such as Italy diminish. This could cause a run on the weaker banks in these states, thus destabilizing the European banking system. Effectively the euros (such as Dutch or German Euros) held in countries with lower debt to GDP ratios (and with much higher GDP), will be viewed as safer.

The new European System of Financial Supervision (ESFS) is an important step forward. As well, three new authorities have been created for the European banking sector, insurance and occupational pensions. In addition, the European Systemic Risk Board (ESRB) is developing the tools necessary to warn and, if appropriate, make recommendations on measures to cope with potential sources of systemic risk.

Banks are necessary for the economy and businesses to function at very basic utilitarian levels. Since fear causes people to sell their stocks, the Euro Crisis calls for portfolio managers to be on alert, while considering incremental transits from equity to cash positions if necessary.

How professional managers minimize your investment anxiety

There are very few ongoing decisions that you need to make once you have purchased a mutual fund. Upon investing, you immediately get professionals with experience working for you. Each fund has a knowledgeable portfolio manager or a team of managers that work full-time on the investor’s behalf – to invest your money under strict guidelines. With professional expertise, they select suitable securities of many companies and/or governments.