Thread by @sahil_vi

🧵🧵

How to make the right decisions so as to end up being financially independent

OR to be rich.

OR to retire early.

OR to improve the standard of your life.

Sharing my views & what works for me.

If you like it, please RT to benefit maximum investors. 🙏

Imagine a graph of your net worth versus time. Each point on the graph captures on the horizontal axis, what time it is in your life, and on vertical axis, what your net worth is.

This is how it would look like for most people. A wiggly line inching upwards & to the right. What do we want to maximize though?

If you carefully think about it. The answer will emerge. What we want to maximize is the area under the net worth - time curve. Maximizing this would enable one to fulfil all of the correlated objectives outlined in 1st tweet.

Which of these two graphs looks better to you?

Graph 1:

Graph 2:

Here are the two graphs next to each other:

I think most people will agree that Graph 2 is better. Now that we have established that, let us mathematically establish what our net worth looks like, then tie it to our life choices.

Now in the interest of keeping it simple, i will keep it part math & part intuition. I can derive the full math formula too, but that might make it difficult to understand for many people & thus be less inclusive.

The good old humble compound interest formula. But why? Because all investment compounds. In your savings bank account, at 3% per annum. In your FD at 5-6% per annum. In a nifty index fund, historically at 12-15% per annum.

But hold on, thats not it. We need to define these numbers & connect them to decisions we make in our life.

1. Let's start with simplest but not easiest but most important one. t. We want to compound our money for long durations of time uninterrupted. What interrupts compounding? Unplanned withdrawals. Why do those happen? Emergencies.

This is why its important to have an emergency fund, which you keep only for emergencies. Its ok to sell your house to invest in stock market if you find a mispriced bet IMO. But it is NOT OK to break your emergency fund for investing. Or spending. Or anything really.

But all emergencies cannot be covered by our emergency fund. There literally exist an infinite number of emergencies. These are also somewhat improbable. This is known as the concept of tail risk.

We ideally cover tail risk using something called insurance. The most common ones: Health insurance, life insurance, car insurance. All important. We want to guard against improbable events by having a company pay us if those events happen for us.

Really, its a beautiful model if you think about it. Insurance is the best of human ingenuity, our capitalist tendencies and compassion rolled into one. If X is unlucky and needs money, everyone else pays for it. If the company prices it correctly, it all works beautifully.

Now here is the part most people won't tell you because they might not have thought deeply about it. One of the best ways to increase 't' is to remain healthy.

When someone says 'health is wealth', this is sagely advice. Listen to it. Wealth or FI or FIRE is of no use if you cannot enjoy it.

Focus on eating healthy, exercising. Cannot stress this enough.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.
Please Remain healthy.

Summary until now: Emergency funds, insurance, health (most important). Dont interrupt compounding unnecessarily.

2. The next thing I want to tackle is P. The principal. This is what we invest in financial assets. But observe something quirky about 'P' in our context versus the compound interest formula.

(i) P grows over time as our savings increase.
(ii) Our habits dictate P. If we spend a lot and save little, 'P' is small. If we always save X and spend the rest, 'P' is large.

(iii) Job progress grows P exponentially. A promotion? You'd want that. A job change with large salary hike? Yes please.

The trick to increasing the area under the curve is to realize these things as early as possible & work towards it.

It makes sense to work hard when we're young, maximize our P (through promotions, upskilling, job changes) as much as possible. This is precisely what changes trajectory of net worth graph & maximizes area under the curve.

But it is possible to start much smaller. For most people:

Savings = Earnings - Expenses.

Invert it.

Expenses = Earnings - Savings.

Always aim to save a fixed % of salary no matter what. Plan expenses accordingly.

Most people that buy 100 clothes in a year, probably dont wear 20% of it. If you are buying 10 clothings from an ecommerce sale, ask yourself if you really need all of it, or whether it might make sense to delete the worst 2, which you dislike the most.

These sort of things automatically increase your P substantially since you are able to save & thus invest more.

Summary of 2nd point: Save, before you spend. Work hard in your youth. You are only young once (YOYO). Physically speaking its all downhill from 30. Upskill. Learn new things. Remain curious & a learning machine. Always entertain possibility that you are wrong.

3. Now we come to the factor which most people focus on. 'r'. The rate of compounding. The easiest way to influence this is to master your emotional response to notional losses, so that you are able to invest larger portion of net worth to equity.

If someone has 10% net worth in equity compounding at 30% for 10 years, and 90% net worth in FDs compounding at 5%. Net worth only compounds at 11%. Track net worth compounding, not equity PF compounding.

But how can one invest larger portion of net worth in equity while not interrupting compounding? By being secured on all other fronts. By controlling our behavioral aspects.

My personal trick here is: I came from nothing, and if i go back to nothing, i'd still be happy because i'd still have the love of my family. And the compounding of that does not depend on the vagaries of the market.

At same time, dont copy others % net worth in equity blindly. Everyone is different. Ask yourself what matters most to you. If you're still confused consult a financial advisor. They're trained for this.

Of course once we decide what % of net worth to invest in equity, THEN the fun starts. What stocks to pick, how to construct a PF. This is literally the last step in maximizing area under our net worth time graph.

And I have created enough threads on this topic. How to pick stocks.

https://twitter.com/sahil_vi/status/1433995153098768386?s=20

How to construct a portfolio:

https://twitter.com/sahil_vi/status/1413677567089856514?s=20

Summary of 3rd point: Conquer your behavioral aspects first. Try to maximize how much you can invest in equity while stomaching the 50-60% falls which happen once in 8 years. Dont overestimate your skills. THEN Work on maximizing equity returns.

Overall summary:
1. t: Prevent tail risks. Biggest obstacle to wealth
2. P: Save more than you can spend. Cut unnecessary expenditure. Grow professionally. Promotion, upskilling, job change.
3. Conquer behavioral aspects. Upskill investing OR hire competent money managers.

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PS: Dont treat any of this as financial advice. I am simply sharing my thought process so it motivates you to think, contemplate, then act. Please consult financial advisor or act based on own convition.

Dont follow anything I say blindly. I could be entirely wrong and daft and stupid and unskilled. I know my limitations & act accordingly. What works for me might not work for you, including a framework for how to think about FIRE.