financial independence

Wake up early; hurried breakfast, commute to work; hit the machine; read, reply, write, junk emails; attend meetings; hurried bites; emails again; meetings again; take responsibility for someone else's faults; take bullshit from the boss; office politics; little fun, loads of shit and frustration; commute back; work calls while commuting; back home; disgruntled greeting to family; not-so-fun dinner; machine and work again; deadlines; shit; frustration; hit the bed; wake up early...Everyday, five days a week, year after year...Heck, what a pitiful, distressing life, even when you are earning millions.  

If you are like most, your routine is supposed to look like that; and chances are that you are not a happy person. Both male and female, it is similar stuff, just a little bit of shuffling, but the chore is same. I know that you don't like it. Nevertheless, you are doing it because you want to make money, earn respect, take care of family needs, and provide for your retirement. You are kind of forced into this routine. Given a choice you would rather not do this grind; would you? That's the question. And if you are like most, you would rather have that freedom to choose work; where to work; how to work; and of course, whether to work at all. By work, I mean in general terms. In fact, not doing any work is also some work; learning Spanish may not earn money, but it is also work and fun for some. 

I call this person a masochist. In a way, most working men and women are like that. This includes self-employed too. People have made a mess out of their life. And they don't seem to do something about it. 

A few have realized that life is too short to be bound by someone else's demands, and therefore chose to do things differently. Here's what they do: Wake up when want to unless they are in the mood to see sunrise or do the morning jog; have a leisurely breakfast, lunch and dinner; do things that help them learn and have fun; take no instructions from anyone; choose their work hours and workplace; spend enough time with family and friends; sleep when they want to. 

You must wonder how it is that they are able to do this. Inheritance, may be? Not necessarily. In fact, they are the ones who have taken control of their life. And good news is that it is not that difficult; anyone can achieve that. I call it the ultimate liberation. 

You have to start with the premise that your life is too short even if you allot a hundred. Therefore you need to figure out what you want from your life; and you need to do it yourself, not piggyback. Remember, you are the hero of your life. Like someone said, you need to be yourself, for everyone else is already taken. You come out of school by the time you are 20 or 25. After that, you have to lay the path such that your life becomes fun. Remember it is not about cash, but fun. To see why let's flip it. What do you want: more cash and less fun until your last hours, or more fun and less cash? If you are a normal person, you will choose fun in life. Now, you cannot define fun in general terms. For Elon Musk, it is different from that of Warren Buffett; for you it is different from that of your friend. Nothing I have said so far is philosophical; it is both practical and real. 

So go figure out your definition of fun. Technology, business, cycling, marathons, photography, wilderness, there are plenty of choices to make. And make that your idea of spending rest of your life. But wait, unless there is lottery or inheritance, you are likely not able to tread that path. For most of us that means work to earn a living. 

Now I come to the real point of this post. There is also another word for my ultimate liberation. It is called financial independence. It does not depend upon how much you earn, rather it depends upon how much you have compared to how much you spend. In order to lead a life of your choice, you need to first make some arrangements. My guess is that it should not take more than 15 years of labor for anyone. Whether you are earning thousands or making millions, 15 is the maximum number of years that you should be willing to sort of compromise. I have noted this for a layman both in the US and in India. After 15 years of work, you will be transported to the world of fun and games. 

Some have got it wrong. You cannot have rules such as you need to save 30% when in 30s, 40% when in 40s, and 80% when in 50s for retirement. Although the thought is well-meaning, it is flawed. The best way is to increase your earnings and reduce your expenses as much as possible in your work years; and then throw those growing savings into the investment pot. Because increasing earnings is not everybody's cup of tea, it is far easier to control expenses. Like I have mentioned earlier, your financial independence does not depend upon how much your earn. If you earn a million and spend more than that, you are on a wrong footing. If your annual costs are 100 and your financial assets are many times over, you are financially independent. How many times over is a matter of judgment. Some say 25 times is enough. That means you are done with 2500 when annual expenses are 100. I see it slightly differently. All depends upon what is important in your life. If you have a passion so deep, you may be happy to live a life of absolute frugality to pursue your passion. After all, like I said, it is your life. If I want to make it more general, 25 to 50 times annual expenses should be enough. Don't tell me that your annual expenses are 100 and you are earning just about that; you will never be able to liberate yourself. 

Financial independence is achievable for anyone; from college dropouts to qualified professionals. It is achieved primarily through deferred gratification. That urge to spend is a behavioral pattern. When everybody should pick 15 years of bonded labor to lead rest of life more meaningfully, most don't do that. Heck, that instant gratification, that behavioral disorder called envy, come in their way. What a pity that they are so ruthless to themselves.

it's not current taxes, always aftertax cash flows

Every time I speak to someone about taxes, I am amused. Not sure whether it is their lack of common sense, or it is about the herd. I have seen this pattern even with qualified professionals. They seem to independently think less, and follow more.

To follow is normal for humans though. Look at the mutual fund industry. Most fund managers have this dilemma, to research and act, or to just be part of the herd. The reward is complicated. If they act independently, but lose money, it is a disaster both for their reputation and career, never mind the investors. If they follow what other fund managers do, but lose money, they get to retain their jobs. It is a no-brainer then to make the choice. 

For individuals, though, there is no such pressure; yet, that perverse behavior shows up from nowhere. Take taxes: there is no riddle in dealing with them. What is important is long term aftertax cash flows, not lower current taxes. Whether you are an employee or a business owner, the equation is the same. People forget about the long term impact as it is not as clear as short term is; and they look at their current year tax savings. So how do we plan our taxes? Let's slice it down in the Indian context, though the approach is the same in the US and elsewhere.

The essentials
First one is to take a term cover for life, not an endowment policy. In India, the premium paid is tax deductible. Therefore, people tend to take new endowments almost every year. It is as idiotic as it can be. Life cover is not dependent upon tax policies of the government. It is imperative for every one who has dependents whether or not there are tax savings. The same is true for medical cover. Just take one based on your requirement irrespective of taxes. You cannot be without having one; so there are no discussions here.

How much do you have to be covered for life and medical is a matter of judgment. You need not consult advisors for that. Use your common sense and choose. Think about what could happen if there is no cover at all, the likely financial consequences, and so forth. Then select the cover that suits your pocketbook.

In cash you trust
After that you have cash for investments. Put it where you feel you are most secure. However, know the consequences of investing in one instead of the other. It is always a trade-off: choose where the opportunity cost is the highest and stress levels are the lowest. Throw some cash in risk-free assets. These are the ones backed by the government, and are denominated in the local currency. In India, you can look at the public provident fund, RBI bonds, and even bank deposits. You have to have faith in the banking system, and assume that the depositors' cash is protected, which is mostly true even for private banks.

Again, how much to throw it in there is left to your judgment. What are your ideas about cash, bonds, and equity? Do you understand each game sufficiently enough? It is always good to have aftertax returns that supply stable, albeit low, almost risk-free cash flows. At the end of the day, you got to be able to sleep well. If you are going to be worried about your investments in equities each night, something is wrong. Move the allocation heavier to the other side if that's what you want.

Because you are trying to safeguard your emotions and stress levels, which is vital, there are no tax considerations in choosing these low-yielding investments. If you consider that after being in cash, there is either little or no money available for other investments, there is a solution.

But before that you need to know the real consequences of being in cash. Cash is a fixed currency investment, which is constantly under attack by that silent monster called inflation. Suppose you feel that say, Rs.10 m in cash is a stress-free bet, there is a double whammy in waiting. First, although interest income changes based upon the prevailing interest rates, its purchasing power diminishes year after year. Second, your cash investment remains fixed assuming you spend entire income each year. You will still have that Rs.10 m at the end of each year; the problem though is that its purchasing power comes down to Rs.5.60 m in present value terms at an annual inflation rate of 6% after 10 years; in 15 years, it reduces to Rs.4.20 m; and so forth. So if your allocation is mostly cash, you have to have lots of cash.

Now, back to the solution; in fact, it is more of a consolation. Remember it is about the trade-off: reduce your expenses. You can live well enough if you don't go out for food, don't buy expensive coffee, buy a smaller TV, use a cheaper smart phone, and so forth. There is fun in watching sunrise and sunset, cycling, beach, fooling around with friends and family. Much fun in life is often free or low cost. You know what I mean now.

Bonds
If you have more cash left, you can consider corporate debt. Buy them through debt funds, or traded bonds through stock exchanges. India does not have a thriving corporate bond market, unlike the US. So it is easier to use debt funds. Tax considerations do matter for debt investments; so read up on them. I wouldn't advise using an advisor here either. If you cannot understand even after reading about them, skip the investment, or at least defer it until you get it.

Here's the summary, but beware the laws change quickly; do your own research to stay abreast. Debt funds come in two forms: dividends option and growth option. The dividends option debt funds distribute dividends (they are called dividends although come from interest received by debt funds from their debt investments) at regular intervals. But the fund has to pay dividend distribution tax on the payouts; this is as high as close to 29% as of now. These dividends are not taxed at the hands of individuals again; some sanity. The growth option lets your share of potential dividends reinvested in the fund assets since there aren't any distributions.

So the math is simple: if your tax rate is much higher than the dividend distribution tax rate, go for the dividends option; if not, go for the growth option. But don't paste it in your mind; when laws change, you got to change your mind too.

I think short term capital gains (less than 3 years) are added to your income and taxed at the marginal rates. If your tax rate is 25%, and capital gains are 100, aftertax gains are 75. You have to check whether you are happy with aftertax gains. Long term capital gains are taxed at either 20% based on indexation, or 10% without indexation. Do some research on indexation, and find out if it is helpful to save taxes.

In summary, when you choose debt, you have to think about taxes. Debt funds tell you that they can give you returns higher than say, bank deposits. You can check whether it is true, and suits you. Liquid funds are far better in terms of meeting expected returns than other debt funds where returns are based on changes in interest rates and stability of corporate cash flows. Liquid funds are like cash though. I wish there was a more mature debt market in India where individual investors could buy and sell corporate bonds as they pleased.

Equities
After all, long term wealth is created only through equity investments. Either start a business of your own, or own part of an existing business. Buying equity index or individual stocks can lead you to that path. Not much time is required to think about taxes here. In India, short term capital gains are taxed at a flat rate of 15%, and long term capital gains are tax exempt. Dividends from stocks are also not taxed until they exceed Rs.1 m. Check again, laws change without noise and notice.

After your cash investments are made, your stress levels are taken care of, and your good night's sleep is assured, all cash, month after month, year after year, should go to equities. If you understand them and have time to do research, pick stocks directly; otherwise, throw the cash in the broader index.

Taxes
I am not sure why people get excited about taxes when it really does not require much time to plan at all. Sure, if you are an individual business owner, you may have to spend a little more time in tax planning; in that case, employ or consult tax advisors. If you have invested in properties and have capital gains, you may have to read a bit more about taxes on capital gains; just a little bit more time.

Don't go wild on taxes and complicate the matter; for it is not. And when the country is allowing you to earn your income, it is your obligation to pay up taxes due on that income. I know people who fret about paying even 10% on their income. Heck, when the tax laws are so friendly for the long term wealth creation, it is meaningless to try to evade or fight the system.

infosys: desperate or demoralized managers

The more I decide to let Infosys be, the more it gets attention. These are spooky times for the managers; and they are not making it any easier for the company either. Desperate times, desperate measures; humans will be humans, don't they?

I don't have to elaborate much, other than quoting them in their latest 20 F filing:

Any sensible manager would have kept that thought in mind, if there was any, rather than in print. This is anyway noted well in both these articles. We don't know whether the squabble was worth it; we don't even know whether it is a squabble or a hammer on the nail. Instead of dealing with real risks haunting the business, the managers proceeded to demonstrate their comical side, which wasn't required in the present situation.

There is a way to end this game, I guess. Something that is subtly suggested in one of the articles above. Both the founders and managers can exercise their choices; it's a free market anyway. The manager's actions will be reflected in the way the business is run, and the stock prices follow it eventually. 

If any shareholder has an issue with it, the first step is to connect with other shareholders who too are on the same page. Then this group can confront the board and management to replace the incumbents. There's really no point in expressing their views in the news media anymore. Enough has been said what looks like in vain. 

There are views that the founder shareholders have no right to comment on how the business is being run. This is in fact both ludicrous and egregious. They should be reminded that the founders have not ceased to be the shareholders; and shareholders are owners of the business. 

If war is not what shareholders want, they have an exit route available. Sell those shares, and look for a better business. It is a tough one for the founders, but probably should serve them well in the long run. 

Now it is for the managers to show that they are neither desperate, nor demoralized. And let the markets decide in due course as to who the winner is. 

infosys: founders' expected return

It's Infosys again. I had noted in February and April about how much an investor in Infosys can make. That was based on management's target, which later became an aspiration. I had concluded questioning the possibility of $10 b revenues and 30% operating margins. While I could not answer the question, management did. Well, it has effectively dropped those targets; and it appears to be not even a moonshot aspiration now. After all, 2020 is only three years away; and based on the current situation it was a tall order. When facts change, you change your mind, don't you?

But now what? In earlier posts I had discussed the expected returns of the new buyers of Infosys stock. Now, the founders selling their stake is in the news. Although the former founder chairman has denied the report and the current CEO has taken the damage control mode, an imperative question is whether the founder shareholders are happy with their investment in the company. 

Given the size of their investment, how much can they expect to make in future? There are two ways to look at it. One is the emotional aspect; Infosys was built by their sweat, grit and emotions. The company represents them, and they represent the company. It is obviously not easy to let go all of it once for all. It is not a business-only decision for them, which is understandable. Then there is the business rationale. There is a lot of cash that is involved; and the opportunity costs can be huge. If they sold their entire stock, will they buy it back again at current prices?

Infosys is now trading at Rs.948.60, and its equity is worth Rs.2179 b. The founders' stake is worth Rs.277 b at today's prices. Leaving the emotional aspect aside, if the founders are not selling their investment, it would imply that they are expecting a fair return on their investment; and I reckon, that should be upwards of 15% in the long run. They would rather put the cash in the index otherwise. 

Revenues increased by over 9% and earnings per share by over 6% in 2017. However, the management guidance for future is lower. I am not going to value the company on intrinsic terms. Let's use pricing mechanics for these discussions as it is more intuitive. In order to get 15% return for the next ten years, the EPS will have to grow at 15% annually when priced at a multiple of 15 at year 10. Even when priced 20 PE, the EPS growth will have to be close to 12%. If we make the managers' job easier and price the stock at a multiple of 25 at year 10, for 15% returns the earnings per share will have to grow over 9% annually. 

Historically, earnings per share grew less than 12% in the past five years and at 14% in the past ten years. So which is more probable, per share earnings growth of 15%, 12%, 9% or much less? And then which multiple is more appropriate? The fact is such that when earnings grow at 9%, the stock is more likely to get the multiple of 15 or lower rather than 20. If that is the case, the return over 10-year period would be close to 9%. A growth of 15% and multiple of 25 would take the return to close to 21%. I would rule out any repetition of historical performance. Unfortunately, Infosys has grown past such high growth rates. Hasn't it?

Is it more reasonable to expect earnings growth of 5-8% over the next decade? At the multiple of 15, the annual return will be close to 5% at EPS growth of 5%, and close to 8% at a growth of 8%. In fact at such growth rates, the multiple is likely to be less than 15, which will only lower the rate of return. Obviously that will not be adequate for the founders. May be their estimate is different, and a more optimistic one.

The stock performance during the past two years hasn't been satisfactory.

The opportunity costs for the founders due to returns lower than 15% will be massive. For instance, a return of 8% from Infosys will cost them Rs.523 b over the decade. There must be emotional, rather than business, side to the founders' investment objectives. 

The $2 b share buyback might help increase the earnings per share; but the core operations are moving towards the stable business model, and therefore the company may have to be valued as such. Unless of course the company reinvents itself. But how?