9/2/10

Financial INTERdependence

"Financial Independence" seems to be an ever-increasing goal of the masses. I can only assume that this popularity is due to how it's perceived: 1) seen coupled with lavish lifestyles; and 2) seen as not having to work yet being able to make enough money to survive (i.e. living off of interest). There are a few flaws with this perception that are being overlooked:

- The expenses that come with (news-worthy) lavish lifestyles equate to the earnings on investments equal to the GDP of small countries. This is far from the norm; don't believe the hype.

- The only way you can truly not work yet earn money is to invest in something that does not require maintenance and that guarantees consistent, positive cash flows (otherwise, higher rate investments require quite a bit of work). This equates to a low-risk debt security, such as T-Bills and CDs (1.5% - 3.0%). Translation: one would have to invest between $1.7M and $3.3M to offset average annual expenses.

The only ways to increase interest income are to: 1) increase the volume of money invested and/or 2) earn a higher yield. For example:
  1. To double annual income ($50k to $100k) assuming the same T-Bill and CD return range, one would need to invest twice as much ($3.3M to $6.7M).
  2. To double annual income assuming the same principal investment (between $1.7M and $3.3M), one would need to earn twice the rate of return (6% - 12%). This level of return would require investment in more risky equity securities, like stocks. Thus, enters maintenance (aka work).
It is possible to passively earn enough money to support any lifestyle choice as long as you have enough principal.* It's also possible to earn the same amount with a smaller principal through higher yields. However, higher yields mean more risk which means the need to actively manage* your portfolio (analyze security trends; identify mis-pricings; etc). This also leads to inconsistent returns - years of high returns adjacent to years with negative returns.

*Unless you win the lottery, inherit a ton of money, find a coke dealer's backpack, put in 20 years as an iBanker or are nearing retirement, none of this is worth considering at this age.

*"Actively manage" = having to work



New definitions should be:

Financial Independence - free from the need of finances (ex: living off the land)

Financial Interdependence - financial gain from mutual reliance (ex: a job; investments; currently defined as "financial independence")