The Financial Counselor is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give personal advice, either
in these columns or by letter
by ARTHUR W. JOYCE
IT is easier to ascribe to others that enviable condition of affairs known as ‘financial independence’ than it is to define it for one’s self. Any thought on this subject more serious than the happy little ceremony involving a wishbone proves conclusively that it is decidedly a relative situation. Great wealth is not its prerequisite, no more than great, genius is essential to an independent mind, for independence exists upon many financial levels, ranging from modest to ambitious. This characterization of its scale gives a valuable clue to a practical approach to the subject, because it suggests that financial independence exists, not alone in fact, but also in an attitude of mind.
There is no limit, of course, to wishing, but there is a fairly definite limit to what one has any reasonable expectation of getting, and fortunately there is a decided limit to what one really needs to enable him to live comfortably. It seems sensible, then, to define financial independence as a condition denoting freedom from the pressure of necessary financial obligations, which is a practical matter about which something can be done, rather than to construe It as freedom for unlimited spending, which is a visionary matter for idle dreaming. In order to recognize this freedom, it is clearly essential to know the type and limit of the obligations from which freedom is sought.
The basic financial obligations devolving upon the head of a family are threefold: first, he must provide for the current maintenance of the family while he lives; second, he must provide for its maintenance if he should die prematurely; and third, he must provide for his own and bis wife’s old age. His job is the vital factor in the first instance, while his savings control the others. The first obligation presents the greatest difficulty, partly because it is the heaviest, measured in terms of money, and partly because this matter of the job presents, by its very nature, a challenge which he must face and solve largely as an individual operating alone. The obligations for premature death and old age not only involve less money to discharge, but can be undertaken upon a coöperative basis which greatly facilitates their solution.
It is not without significance that the first step begins at home. The minute the family budget becomes balanced with a surplus, however small, independence from current obligations becomes a fact. Now family budgets are often described as plans adopted seriously, enforced painfully, and abandoned gleefully as perhaps, after all, more appropriate for the government and one’s poorer relations than for ones self. Nevertheless, they help to differentiate between the unavoidable cost for such essentials as food, clothing, shelter, and health, anil the voluntary outlay for miscellaneous expenditures from which the elusive surplus is wrested. The mere fact that budgets help people to save who cannot otherwise do so is sufficient evidence of their value, even though they fail to perform the miracle of holding within its income a family which is indifferent to exceeding it.
Once the surplus above current unavoidable living costs is obtained, then that portion of it which is saved serves to provide for future obligations. These should include the establishment of a savings account, representing primarily an emergency fund from which cash may be obtained without delay for those sudden and unexpected demands which cash alone can satisfy. The amount of savings allotted for this purpose need not represent a large percentage of the total, especially when provision for the two remaining obligations creates as a by-product a cash reserve fund steadily’ increasing in size, and readily available for most purposes. This matter of the instant availability of a pure savings account has its advantages for real emergency use, but unfortunately the ease and promptness with which it functions are not limited to serving emergencies, but arc available for any purpose whatsoever, with the result that the very characteristic which makes a savings account ideal for emergencies often operates to destroy its existence before the emergency occurs. Naturally the bulk of the savings should he allocated to the two major future obligations — premature death and old age.
Here the task is not as formidable as it appears, for three ameliorating factors arise. In the first place, the effort involved may be undertaken upon a cooperative basis, with many people joining bands in a process vastly simpler and easier than that involved in the compet it ive and single-handed effort of gel ting and keeping a job. In the second place, the amount of income necessary to discharge these obligations is definitely less than that required for present maintenance. And finally, only one of these two obligations can ever become a fact, since it is obvious that premature death and old age cannot both occur. Let us examine these three helpful factors briefly.
The mechanism for coöperative action exists as an established fact in the institution of life insurance, the efficiency and reliability of w hich none can dispute. Thanks to its scientific principles and its ready availability to most people, it permits a given individual, in coöperation with millions of others, to protect his family and himself against hazards common to most people, to a degree utterly beyond his power if he acted alone. This principle applies equally to life insurance ami to annuities, despite the fact that they serve different purposes. Life insurance replaces income halted by premature death, thus having the advantage over any other savings plan whose completion is bused upon survival for a given period. Annuities replace income halted by old age, with the unique advantage over any other savings or investment method of producing a fixed return which can be guaranteed for the remainder of a lifetime, and which is so arranged that it gives the annuitant the complete use of his entire capital wit hout jeopardizing either I he amount of the return or its duration.
A minute’s reflection suffices to prove that the amount of income necessary for the maintenance of the family after the premature death of its head is less than that required while he lives. He, himself, absorbs a considerable portion of the family’s overhead— probably about one third. The cost of his food, clothes, business expenses, life insurance premiums, and a host of lesser items, ceases upon his death. Moreover, many of the family’s luxuries, justifiable while he lives, must necessarily be lost when he is lost, for his death is a tragedy compelling readjustment in the scale of living for those who survive. No fixed rule can be laid down indicating the extent to which this downward readjustment is reasonable, for the health of the surviving family, and both the number and ages of its; children, affect it profoundly, but. it may lie accepted as a general rule that a reduction of income by one half is not too drastic to be workable. No man, out of the earnings with which he supports his family, can reproduce for them, through his life insurance proceeds, an income equal to that which he earned while living, and no time should be wasted upon such a false premise. He. can, however, with his life insurance, provide a reasonable income, either permanent or for the duration of the family’s most critical period, measured against (heir minimum needs; and the fact that such provision may fall short of an ideal goal is no excuse for failure to assure it. It is likewise clear that the demands of old age are materially less than those of any other period of human life, for the children are presumably self-sustaining, and the natural demands of a man and his wife in their sunset years are essentially moderate.
Despite the fact that premature death and old age cannot both occur, the impossibility of knowing which one will happen makes it prudent so to arrange the provision for each that it will, in considerable degree, facilitate provision for the other. Life insurance is obviously the only vehicle capable of bearing this double responsibility. It will not only complete an estate which otherwise, by premature death, might be incomplete, but it will also provide, by the same outlay, a retirement fund as the result of systematic savings, accumulating at compound interest. It is entirely proper for the budget to include under savings the amount expended for life insurance, since in most cases, involving contracts started under middle age and kept in force for about twenty years, all or substantially all of the premiums paid are recoverable by the insured himself if he lives, (An exception to these statements must be noted for term insurance, which indemnifies for death w ithin a limited period, but which has no investment value for the insured while he lives.)
At retirement age, the savings created through life insurance may be used to buy an annuity. When the budget’s surplus, after payment of life insurance premiums, still has a balance for investment, part of this may be invested annually in an annuity to guarantee an extra monthly income for life, available when retirement age is reached. Taken together, life insurance and annuities constitute a perfect hedge against the risks of dying too soon or of outliving one’s earning power. They are the logical backlogs upon which to depend in safeguarding the future.
It seems reasonable to consider that a safe and sane approach to financial independence of a practical variety is one which takes cognizance of the three fundamental obligations enumerated above. The first, step—current maintenance while the breadwinner lives—cannot exactly be taken for granted in these troublesome times, but normally most people qualify for it. Even this step alone has its obvious advantages, though it leaves untouched any provision for the uncertain future. The second and third steps — premature death and old age — present no insuperable task. One of the greatest barriers to their solution lies in a tendency to overrate their demands, with the attendant danger that a modest start seems of little avail. When provision for all three steps, each in proper proportion to the others, and all within the reasonable limitations of the amount of savings which provides them, has been completed, then the result may he interpreted as financial independence of a thoroughly satisfying type, which is not invalidated by the modesty of its scale.
A man who is now blind, and whose previously perfect vision faded slowly before complete darkness set in, has said of his experience that it was far better to be able to see a little than not to be able to see at all. Who will deny that a similar interpretation of financial independence is equally irrefutable?