Happy Diwali/Deepavali! More and more people are thinking about financial freedom and early retirement. Here are a few simple illustrations to answer the titular question: How much do I need to retire early?
The first step is to recognise the difference between financial freedom financial independence.
Financial independence = Retirement (early or normal). There is no need for you to work again. You work to keep busy and healthy and active. Not for money.
Financial freedom = temporary break from corporate shackles. You do not have enough to never work again, but have enough to not work for say 5-6 years or more. In this time, you can work towards your passion with peace of mind and create an income from it (which is necessary).
Whether you are aiming for early retirement or financial freedom, the following illustrations are relevant because it seeks to answer,
How long will a corpus last? This is equivalent to asking,
How much do I need to retire early?
Do check out the free E-book: How to retire early in India to plan your strategies.
How much I need, how long will it last, what return do I require and how much can I draw are important questions that can be answered with tools found here: four simple retirement planning tools
Illustration 1
Suppose you have a corpus, C = Rs. 75 Lakh (75,000,00), you are going to assume that the post-tax return from the entire portfolio is equal to the rate at which your expenses increase (inflation). That is the real return on investment is zero.
The annual expenses in the first year of retirement = Rs. 3 Lakh (or C/25) (After that expenses will increase at the rate of inflation).
Then the money will last for 25 years. This means, that you invest 75 Lakh in a basket of instruments offering net post tax return of say, 8%. At the start of each year, you withdraw money for expenses and this withdrawal is also at the rate of 8% (real return =0), after 25 years, the money will get exhausted. For detailed illustrations see, Is it possible to retire early in India?
So the thumb rule is: For zero real return, the corpus will last for a time given by Corpus divided by withdrawal in the first year.
In the above example, 75L/3L = 25 so the corpus will last for 25 years.
If the initial withdrawal was 7.5L then 75L/7.5L = 10years (for zero real return).
Illustration 2
Thumb rules cannot always be used, and I prefer to use calculators. Faster and more accurate. Here is how the number of years a corpus will last varies with real return.
Achieving a real return (post-tax return above inflation) is very easy ... on Excel! In real life, it is better to err on the side of caution and use zero real return or even -1% real return. Thumb rules cannot be used for the kind of behaviour shown above. Please use this calculator.
Illustration 3
To further illustrate how erroneous thumb rules can be, have a look at the three lines below.
The vertical axis = no of years the corpus will last
The horizontal axis = Corpus divided by initial annual expense. For example, if the corpus is 50L and 4L is the initial annual expense, then 50/4 =12.5 would be value in the x-axis.
The thumb rule mentioned above is exact for the 0% real return line. This is a straight line (X=Y).
For +1% or -1% real return, notice how marked the departure from the thumb rule is!
This is the screenshot of the above-mentioned calculator. It would take less than a minute to calculate.
How to calculate the time a corpus will last?
Calculating this is simple in Excel. I usually prefer a formula to a function but functions are easier to implement.
How long will a corpus last =NPER((1+return)/(1+inflation)-1,-payment,corpus,,1)
Here NPER is the excel function,
corpus is the available sum to draw an income from, while rest grows in a basket of instruments.
return is post-tax return expected on the entire retirement corpus
payment is the monthly expenses in the first year of retirement
inflation is the rate at which the monthly payments increase each year in retirement.
(1+return)/(1+inflation)-1 = real return, representing the ability of a return (post-tax) to combat inflation.
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Please correct initial illustration of 50 / 3 is not 25.
Thank you. Done.
Very good one, Sir
With your calculator only, I have made your simple thumb rule more accurate.
First year annual expenses * number of years corpus should last*1.5 is the thumb rule that leads to corpus value which lasts for fixed years with 8% inflation & -3% real rate (or 5% nominal) rate of return required on corpus value.
Anyone seeking thumb rule for early retirement, in my opinion, will definitely be shrewd enough to derive -3% real rate or 5% nominal rate of return on his corpus.
Going for -3% real rate of return is fairly conservative approach.
For 300000 first year expenses, for 25 years, this modified value is 11250000. This value, when employed in right bottom RATE OF RETURN REQUIRED calculator yields 5%.
I have not stress tested this rule in various other permutations & computations, so maybe, I may be missing something.
Please verify.
Anyway, lots of thanks to enrich us with knowledge in personal finance.
HAPPY DEEPAWALI, SIR
ALL THE BEST, SIR
25000 yearly spending is merely an example.
Now a days, monthly spends are almost double or more of that, and if one plans to retire after a decade (i.e. around 2025), the corpus required per month would be around a lakh (or more). If we take life expectancy of around 80 years, the corpus required at the time of retirement will be: 13-14 Lakhs (post tax) * 25 years. I guess this comes out to be around 4 Crores. !!