When it comes to financial independence there are many different indicators we can try to focus on in order to measure our progress. But not all indicators are useful, even if we think they should be. The easiest example of this is income or salary; if we only focus on the amount of money we earn then we won't get anywhere because we might be spending it all, or more. A better indicator to focus on would therefore be our savings rate. There are many more examples of good and bad indicators for getting to financial independence and in this article I want to explore some that we may often look at, but in fact shouldn't.
Net worth, the number of different types of assets you hold, and your expected retirement date may sound like useful things to focus on when it comes to financial independence but, in reality, are not. Instead, by focusing on your budget, your reason for why you hold certain asset types, and your happiness in life, you will find that you're able to take more meaningful decisions and take better actions that can have a far more positive impact on your progress towards your goal.
Not that good: Your net worth
This may come as a bit of a surprise to some, but tracking your net worth isn't that useful when it comes to gauging your progress towards financial independence. At least, not in the way you might assume.
Let's say you calculated your net worth as £100,000. Now what?
Let's now say you could tell me "I have more than I did a year ago".
That's great. You're certainly closer to financial independence than you were before. But will you have more next year than you do now?
Based on the information you have, "yes" would be a reasonable prediction.
But here's the problem...
As the months were passing by you may see your net worth rise and fall based on various things. You make a big purchase, you go on holiday, there was a small emergency with your home, you unexpectedly win a cash prize in a competition.
Through it all you wouldn't know if your prediction would become true, because you don't know what other spends or unexpected earnings you might have in the remaining months.
You would need to wait for the year to be completely over before you could confirm your prediction. This means that by the time you know your year-end net worth, it will already be too late to make any adjustments in the case where your net worth ended up being less than it was a year ago. Because the year is already over.
Now here's the thing.
Let's say you ended up with less than a year ago and you're now planning to make adjustments in order to change that for the coming year.
How will you know it's working?
It's going to take another year for you to finally be able to make any confirmations...
Focus on instead: Your budgeted spending
Fortunately most people do more than simply track their net worth when it comes to measuring their progress towards financial independence. Net worth is good to show you your overall position and to confirm your past efforts, but it's not that helpful for making adjustments going forward.
This is why tracking your spending in accordance to your budget is better.
With your budget you don't need to wait for something to happen before you know the results. Instead you can use it to have more control over the outcome.
An easy example is the following:
Imagine you set aside £40 each month for new clothing, and you've already spent £30 buying a new shirt. When you see a nice pair of shoes for £25 you know, before you've bought them, that it's not a good idea.
You didn't need to wait for the year to be over before you could check your final net worth number. You didn't even need to wait until the end of the current month.
You know, based on the budget you've set, that the pair of shoes will ultimately lead to a worse financial position for you and therefore you should not buy them.
The information and therefore the decision is immediate.
Naturally this requires you to have a sensible budget that lines up with your income, and there's plenty of material out there to help you with that. But by making sure that you're not over-spending in certain areas you can be confident that you'll be moving towards your goal over time.
Without needing to wait for the end result to be confirmed.
Not that good: Holding many different types of assets
You'll often hear people recommend you include a mix of different assets in your investment portfolio so that you're not putting all of your eggs into one basket.
For example, stocks are one type of asset while government bonds are another. They typically have an inverse relationship where when one goes up in value, the other falls.
If you put all of your investments into stocks, and the stock markets fall, you may miss out on the rise of bonds. And if all of your investments are in bonds, you may miss out on the stock market's gains.
By including them both in your portfolio you're going to be covered from both sides, so the theory goes.
But stocks and bonds aren't the only types of assets available. Other types of assets may include cash, residential real estate, commercial real estate, corporate bonds, commodities, and even cryptocurrencies.
So in order to follow the advice of having a mix of everything, you'll want to include most if not all of these.
Now let's say you go and buy a bit of everything where reasonable.
You keep some cash in your bank account, you invest money into an index tracker, you invest money into a bond tracker, you're steadily paying off your mortgage, you've bought some gold, and even some bitcoin.
What's the problem here?
The problem is that while you may have a lot of different types of assets, 6 in total, you don't know if you've put too much money into one or another. Imagine some of those types of assets start to fall in value.
Should you be reducing your position?
Or should you actually still be adding more?
Or, is this actually all a part of the plan and you shouldn't change anything?
By only tracking how many different types of assets you have, you're going to have a difficult time knowing what decisions you should be making in order to keep your progress towards financial independence on track.
Focus on instead: Why you hold a certain asset type
While having a number of different types of assets in your portfolio is sensible, the balance (proportion of your money in each) between each type and why you have it that way is going to be of utmost importance.
Let's look at some common and familiar advice you might have already come across before.
"A younger person should have most of their wealth invested into higher risk assets such as stocks and shares."
Over a long time horizon stocks will broadly go up in value at a much quicker pace compared to less volatile assets such as cash and bonds. There may be some market crashes involved, but since the person is still young they have the time to wait for a full recovery. Furthermore the crash may even present great opportunities for wealth growth.
"As you get closer to retirement age you should transfer more of your wealth from stocks and shares into bonds."
By the time you approach retirement, much of your wealth should already be established. Extra money on top of an amount that already supports your desired lifestyle is rather meaningless, and maybe not worth the risk. Bonds, being less volatile that stocks, are therefore a good choice to preserve the wealth you have for your retirement years.
"You should keep a couple of months worth of expenses as cash in an emergency fund. And keep some cash in your normal day-to-day account for living costs."
Cash is cash, and while it may lose value over time due to inflation it will remain steady in the short to medium term. This will give you some breathing space should your other types of assets experience a temporary drop in value and need some time to recover.
For other types of assets you can come up with similar pieces of advice and reasons to hold them, or reasons not to.
With the purpose of each type of asset known you can better decide on what portion of your wealth to put in each, why that works for you in the long run, and remain confident in holding them through both the good times and the bad times.
This is much better than simply collecting different assets for the sake of it, or worse, chasing the next hot asset type with everything you have just because it happens to be performing really well right now.
Not that good: A retirement date
"Are we there yet? Are we there yet? Are we there yet?"
I'm sure everybody recognises the scene with an annoying kid in the back of their parents car, asking incessantly if they've arrived at their destination yet.
Not only is it annoying, but it's also meaningless. The answer is more than likely going to be a "no" which only brings about disappointment.
The same goes for looking at your target retirement date.
Much like looking at your net worth, it doesn't really do anything for your journey and progress towards financial independence.
At most you will only be able to tell if you are closer or further than you were previously, but that's about it. And the underlying realisation will be the same: "You're still not free".
The problem with this is that it makes the remainder of your journey feel like a burden. And that will only lead to demotivation.
Let's think of it in the context of some other things that can also feel quite long. A marathon for example, or a flight from one continent to another.
Marathon runners don't focus on the finish line, but rather focus on things in the present moment. They think about their pace, their splits, how their body feels, the other runners around them, the road that's right in front of them.
On a flight you (probably) don't constantly watch the television screen to see how much further your plane needs to travel, or how much time is left. Instead you may listen to music, watch a movie, or try to sleep.
In both of these examples, if the focus was only on the finish line the journey towards it would become almost unbearable.
And the same would apply to your own journey towards financial independence.
So stop focusing only on the retirement date.
Focus on instead: Being happy and fulfilled
A 2 hour session in the gym will feel like 20 minutes when you're motivated and feeling strong.
A day of lectures and lessons will be over before you know it, if you find the topic really engaging and interesting.
And Saturday and Sunday always seems to feel shorter than Monday and Tuesday, if you're someone who hates working but loves partying on the weekend.
The point is, time flies when you're enjoying what you're doing and have become really absorbed into it.
So you should take the same approach with your journey towards financial independence. Rather than focusing on how much further you need to go, or how much longer is left, find ways to enjoy your life in the present moment.
Don't rely on financial independence in order to be happy.
For many of us, most of the things we believe we'll be doing post-retirement will be possible pre-retirement.
I love to write, read, exercise, cook and explore new places. I don't need to wait for financial independence in order to do these things, I simply only need to make the time.
Find the things that make you happy and fulfilled in life, and make an effort to do them. Don't let yourself hide behind a financial wall, because you'll only end up regretting it.
Someone who's able to enjoy life before financial independence will almost certainly be able to enjoy life after it. But someone who couldn't find happiness before financial independence, may not necessarily find happiness after it.
And when you're focusing on your happiness instead of a retirement date, you may end up reaching it before you've realised.
At the core of this article I wanted to highlight how easy it can be to focus on the wrong information in order to make progress on the journey towards financial independence.
There are many things that sound sensible, like income, but are in fact not that useful when you really think about it.
Be it in our job, our life, or our money, we're often trying to predict the future to get a sense of where we're headed.
Predicting the future is always going to be hard.
But it's even harder when we're basing it all on the wrong type of information.