Based on our ability to foot the bills for standard of living we are often placed in socio-economic classes. The middle class is one long continuum before reaching affluent or HNI class. What I observed is, unforeseen events can push an individual and their families a notch or two below their current status more often than well planned savings and investments pushing individuals few notches above. Thereby it is easy to lose wealth than to gain and keep it safe, so extra care needs to be taken to preserve it. Someone who has an enviable lifestyle of a luxury apartment and a D segment car can lose it all within a month due to either a natural disaster or an accident which was never thought of.

These type of risks are tail risks, we are inherently optimistic and given the low probability of these high impact events we always think that such cases never happen. So we never have a mitigation plan in place. These risks when materialising will not just cause a setback, it ruins. Tail risks cumulatively increases, which means though as a single risk in single exposure looks negligible, multi risk, multi exposure over time will increase the likelihood of ruin very much.

Consider the following risks taken together – You don’t wear a helmet while riding a motorcycle, you frequently ride in the night in accident prone highways, you don’t sleep well often, you don’t eat a balanced diet, your motorcycle is not maintained routinely. The combined risk of having a serious injury has a very high likelihood thereby leading to a ruin.

Some tail risks like lifestyle diseases can be avoided altogether with a healthy lifestyle, many others like a geopolitical instability can’t be mitigated but can only be prepared to sail through with diversification of holdings. Insurance is a good option against many unforeseen circumstances, though many people view insurance as a expense, it is a way of paying it forward and praying such a scenario never happens. Someone not paying for insurance will have some money left in hand but at the grave risk of losing it all.

Identifying the tail risks in our life and planning for a mitigation is very much necessary. Being poor is expensive, once we are knocked off the socio-economic position, it is very difficult to claw back on to the same position. Mitigations are not just insurance, it is healthy lifestyle, adherence to safety standards, avoiding risky behaviours, hedging, diversification etc.

I like Nasim Taleb’s work on this topic and much more on probabilities. We don’t realise the skin in the game in the long term as we are too short sighted as a common human.

Early 2000s in India had a lot of Public Sector Undertakings (PSU) float a voluntary retirement scheme popularly known as VRS. If you choose to live in a Chennai suburb in your late 40s or early 50s with no loans and a house to your name, then the monthly recurring expense of 5,000 rupees with some set aside for additional expenses like repairs, medical etc annually amount to about a 1,00,000 rupees. The VRS plans gave a mouth watering deal of 15-20 years of annual expense. A lot of people who opted for this were in the middle management who were bored of waking up to go to office everyday. Most of them had a thought of becoming freelancers or do simple jobs to keep up the cash flow and not disturb the nest egg.

The reality was harsh, I have first hand information from near & dear ones and neighbours. The problems I observed were that

1. Skill was not up to date in their field as a lot of them were middle management.
2. Lacked the marketing and networking skills needed for a freelancer, unable to advertise and convince businesses to give them work.
3. Did not understand uneven cash flow, inflation, investment diversification etc as they always had ever increasing salaries paid monthly, their entire corpus was bank deposits.
4. Continued with their pre-retirement high income lifestyle.
5. Did not cover themselves with medical insurance, one critical illness away from bankruptcy.

A majority of them ran out of their retirement benefits within 6-7 years when they were hit by inflation – medical, food and education went faster than retail inflation where the interest rates were lagging behind. From being their own boss they had to take their kid’s help to live peacefully in just a short span of a few years. They were not able to find jobs as a free lancer; even if they did, they didn’t manage to break even. They also felt too shy to cut down their status symbol items in front of their near and dear ones.

Unless we have a passive source of income like a rental income or income from an established business/equity that can grow with inflation and cover monthly/annual expenses comfortably, it is very hard to achieve financial independence through a retirement corpus alone. A lot of FI/RE (Financially independent, retire early) blogs explain that we need to have a minimum of 300 times our monthly expense or 25 years of annual expenses in the corpus to achieve that. These have been inspired from low inflation economies not for India, I had observed that what looks good for 20 years in India usually runs out within 6-7 years.

Financial independence for a regular salaried citizen is extremely hard, especially for the people I observe who are on the consumption based economy, are encouraged to take loans for their purchases. What we need to plan for is financial resilience. More about it in subsequent posts.