Financial freedom
The ultimate objective of financial freedom is to be able to choose how you want to live your life without worrying about finances.
Financial freedom allows you to retire permanently from active work.
If you have not achieved financial freedom, and you retire permanently from active work, you may one day run out of money during your retirement.
You may think financial freedom belongs to high earners. You would be very wrong because you fail to consider the other 2 critical components of your financial freedom journey – passive income and living expenses.
Say you are working on a job earning $250,000 annually but have a multimillion-dollar mortgage to pay off and your living expenses are $200,000 annually. You are far from reaching financial freedom. Why? Once you lose the ability to earn $250,000 annually, you lose the ability to maintain your living expenses and pay off your multimillion-dollar mortgage. You may even run into financial difficulties.
On the other hand, say you are working on a job earning $75,000 annually. You own your home outright without any mortgage, you have a stock portfolio that is earning an average passive incomes of $75,000 annually and you live on living expenses of $50,000 annually. Congratulations, you have reached financial freedom. Why? Because even if you leave your job now, your passive income of $75,000 will still be able to pay for all your living expenses.
The financial freedom journey is long. Financial freedom requires a long-term mindset to achieve.
Long-Term Mindset
Long-term investment for individuals is often thought to be holding an investment asset for a period of at least 7 to 10 years.
Why is a long-term mindset superior to a short-term one? Just look at Figure 1: S&P 500 1-Month Chart for Oct 2024 and Figure 2: S&P 500 6-Month Chart from Jun 2024 to Oct 2024. Without hindsight, it is so difficult to time the market to buy at low prices and sell at high prices.
You may be right some of the time, but you cannot get it right every time.
What if you get it seriously wrong? Just one error could set you back significantly on your financial freedom journey.
Have a look at Figure 3: S&P 500 1-Year Chart from Sep 2023 to Oct 2024, Figure 4: S&P 500 5-Year Chart From 2020 to Oct 2024, and Figure 5: S&P 500 29-Year Chart from 1996 to Oct 2024. Can you see the distinctive uptrends? Do you feel more confident that your investment would be worth more in 1 year, 5 years, and 10 years later if you hold them for the long term?
The fact of the matter is we should be holding an asset for decades to enjoy the fruit of long-term compounding.
The primary reason for Warren Buffet’s success is investment longevity, achieved by never interrupting the compounding of returns of his investment portfolio. He started young, stayed patient, and kept compounding consistently for more than 80 years.
Warren Buffett is admired by the investment world for his superior ability to spot and select successful companies for his investment portfolios to maximise his total investment returns.
Warren Buffett said in 2020: “In my view, for most people, the best thing to do is to own an S&P 500 index fund”.
JP Morgan reported S&P 500 index fund’s average annualised total return was 9.5% over 20 years.
Figure 6 tabulates the average returns of the S&P 500 over 5 Years, 10 years, 20 years, and 30 years to a timeframe of 150 Years. The average annual total returns were at least 9.35% with dividends reinvested.
What about the Australian and Singapore local stock markets for those living in Australia and Singapore who may want to invest in the local stock markets?
The Australian ASX 200 market behaved in somewhat similar patterns.
Figures 7 to 10 show ASX 200 index performance charts in 3 months, 1 year, 5 years, and 20 years respectively. The charts show that the longer the investment timeframe, the more distinct the uptrend. This again illustrates the importance of a long-term mindset.
Figure 11 is an interesting illustration showing the Australian share market returns over 122 years between 1990 and 2021. In those 122 years, the Australian share market returns were positive in 99 years and negative in 23 years. Despite the ups and downs, the average annual return was 13.2% over 122 years.
Most investors will be very happy with 13.2% of annual returns.
So, are you convinced a long-term mindset is needed in your financial freedom journey?
Figure 12 shows a $10,000 investment in 1992 in the Australian share market would have an investment value of $131,413 in 2022, 30 years later.
This again reinforces the importance of a long-term mindset to let compounding work, year after year.
Let’s turn to the Singapore share market.
Figures 13, 14, and 15 show the Singapore ST Index performance in 1 year, 5 years, and 10 years respectively. You may see there was no distinct uptrend in the long-term 10-year chart. However, ST Index companies generally pay higher dividends and if the dividends were reinvested, investors would have received an annualised total return of more than 6% over the long term.
According to sg.finance.yahoo.com, STI’s annualised total return (including dividends) over 19 years between 11 April 2002 and 31 August 2021 was 6.42%.
Figure 16: 5-year Annualised Return of Singapore’s Straits Times Index shows ST Index’s 5-year annualised total returns (including dividend yields) to be 7.4% as of September 2024.
The historical data of the US’s S&P 500, Australia’s ASX 200, and Singapore’s ST Index have consistently demonstrated the importance of a long-term mindset in the financial freedom journey.
As well, the historical data also point to the advantage of starting financial freedom journey early, as early as you earn your first active income.
Starting Early
Starting early makes an enormous difference.
If you maintain a long-term mindset and start early by regularly investing a fixed amount, you stand to enjoy the long-term average total returns provided by the market through the market up cycles and down cycles. You minimise the risk of market downturns and setbacks on your financial freedom journey.
Nothing comes easy. Amongst all your other financial commitments, you need to cultivate the discipline of investing regularly. You need to reinvest the dividends you receive. Reinvesting the dividends is to let compounding work for you.
Don’t believe that you can time the market right. Even professional investors do not get that right all the time.
What Will Your Investment Be in 10, 20, 30, 40 and 50 Years?
Considering the long-term average annual returns of the S&P 500, ASX 200, and ST Index, and let’s take your average long-term annual total returns to be 8%, you save $1000 every month without fail, and you reinvest all your dividends, what would be your investment values over time?
In 10 years, your investment value would be approximately $185,170.
In 20 years, your investment value would be approximately $593,977.
In 30 years, your investment value would be approximately $1,501,418.
In 40 years, your investment value would be approximately $3,515,689.
In 50 years, your investment value would be approximately $7,986,825.
Can you see how the time factor contributes to your financial freedom journey now?
Want to read more about financial freedom and passive income? Check out my “Financial Freedom blogs”.