Everybody wants to be financially independent, but it is not something that suddenly happens while sitting on the couch. Financial independence basically means that you have enough money to live on for the rest of your life without having to work for money or be dependent on others.
And you work hard to achieve that much-desired financial independence:
- you have committed to wanting it more than being afraid of it;
- you have created a plan that will get you where you want to go;
- you have always saved money – no matter what your earnings were.
That sounds awesome, but at the end of the day – are there risks that can jeopardize the financial independence that you want or have already achieved?
Unfortunately, the answer is “Yes, there are risks!”
The good news is that once you know about the risks, you can manage them. The first step to managing risk is identifying which risks you need to be concerned with.
Top 3 risks to your financial independence.
Risk number 1 – Earnings risk
The so-called earnings risk refers to the possibility that you might not be able to work as long as you have planned, or your business might fail, or you might experience some other negative disturbance to your earning potential.
How could you manage this risk?
There are different approaches to managing it:
- Increase your savings rate, either by spending less money while keeping your income constant, or making more money while keeping your spending constant.
- Buy enough disability insurance and life insurance to cover any outstanding debts and replace the lost earnings.
Of course, the dollar amount is unique for each person, family, and life situation.
Risk number 2 – Investment risk
Your investment returns are lower than expected – not a surprise. In fact, most investments do not have a guaranteed rate of return. As you know, the higher the return you are looking for, the greater the risk associated with it.
Portfolio management professionals
A good strategy for managing this type of risk is to use the help of portfolio management professionals or to acquire as much investment knowledge as possible to maintain a broadly diversified portfolio of low-cost funds that include different types of assets, which basically means a low investment risk.
When it comes to your future and your financial independence, it is best not to take risks and DIY but trust professionals who will carefully choose the right trade-off between investment risk and return.
Risk number 3 – Inflation risk
As you can guess, inflation is more than expected.
The impact inflation can have on your financial independence can be considerable. Inflation is essentially the increase in the overall prices of goods and services in an economy so tomorrow you will need more money to buy those goods and services than you have planned.
In other words, you have to plan carefully how to manage your finances so that one day your hard-earned money will not be eaten up by inflation.
However, you should not despair.
Experienced retirement investors
A simple way to increase your chances of successfully managing this type of risk is to use the help of experienced retirement investors. They usually have good investment strategies and can certainly help you to protect your earnings from inflation.
Sophisticated financial planning software
Another way to increase your chances of successfully managing the inflation risk is to use sophisticated financial planning software that will allow you to check whether you are saving enough so that even if inflation is higher than expected, you will still be fine.
How to mitigate those top 3 risks to your financial independence
Follow these steps:
- First of all, to mitigate the risks, you have to be aware of them, and acknowledge them.
- Take steps to deal with the risks and remember – knowing about the risks and thinking about them is not the same as doing something about them.
- Plan and develop your risk mitigation strategy.
- Act. Put in place your risk mitigation strategy.
Acknowledging the risk, planning your mitigation strategy, and executing it will significantly increase your chances of enjoying many carefree years of financial independence. An extreme, but very good, option to keep your financial independence is simply to accumulate so much money that you can live forever without having to work for money.
Definitely, this is an extreme example, but the basic idea behind it is that if the earnings you generate are sustainable and enough to cover your living expenses, you would never need to worry that you will outlive your money.
Anyway, this is not an option for most people as it requires a significant amount of earnings, so don’t be surprised that in order to enjoy being financially independent, you will probably have to take the other approach and hand over all or a significant portion of your income to retirement savings in exchange for a guaranteed monthly income.