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‘What is your definition of financial freedom?’, is a question I get asked by readers from time to time. Opinions and definitions in this regard vary widely and often a matter of convenience. Some call it financial freedom, some, financial independence, some early retirement!
Here is my take on this subject. The following should have been in a flow chart form, but I am too lazy to draw one.
Can you quit your present job to do nothing or whatever you want?
If ‘NO’ go to part II below.
If ‘YES’, proceed to Part I
Part I
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Can your corpus handle day-to-day expenses for the rest of your life (including the typical expenses of your partner, or spouse)?
If ‘YES’,
It implies, You are
- retired if you do not work for money anymore.
or
- financially independent if you work for money when and how you feel like it. The income can be spent or invested without constraints, unless something out of the ordinary occurs. You are neither dependent on your spouse or on anyone else for income.
Assuming the corpus is large enough and nothing abnormal happens, you can be retired or financially independent for life. You can switch between the two states at will or remain in one state for as long as you want/can.
If ‘NO’
This means
- You are dependent on your parents, partner or spouse to support you while you explore your options. Obviously a less than ideal situation which we shall not discuss further.
or
- Your corpus can handle day-to-day expenses for some years to come, but not for the rest of your life. You are free to take a break, pursue a passion that would give you a steady income down the line (before your corpus runs out!). You can handle your typical family expenses for a few years without depending on your partner (who may or may not be working). It seems fit to say that you free to do what you like but not whatever you like (like not working again).
You need to work, but you are free to choose your line of work. You are financially free as long as your income steadily increases and the dependence on your corpus to provide monthly income decreases.
Financial freedom is not permanent. If something goes wrong -you are out of work, your income does not increase enough – you might be forced to take up a job that you are not too thrilled about …again.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Part II
You cannot quit your job, but would like to asap to be either independent or free.
Here is a checklist
1) Are you investing like your ass is on fire?
2) Are you investing productively?
3) Have you factored in at least 8% inflation after you quit your job?
4) Are you confident that you can lead a frugal life? Good but dont depend on it too much!
5) Are you hoping to beat inflation? You might, but it is best to plan with zero real-return after taxes.
6) Are you influenced by blogs like Money Mustache, Early Retirement Extreme? Don’t be. They are clueless about Indian inflation levels. So understand retirement mathematics first. That is universal. Underestimate the longetivity of your corpus.
7) Do you like the idea of a safe withdrawal rate? Don’t. Will not work for our inflation levels. You will keep withdrawing more and more as time goes by. Are you ready?
8) Have you assumed a real return for your entire portfolio or only your equity component? Common mistake. You need a good amount of debt. So don’t expect too much returns from your folio.
9) Understand volatility. Don’t assume a SWP from an equity fund will work. It might, it might not. You can’t take that chance.
10) Keep your CV up to date. You never know, you know!
About the Author
M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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Hi Pattu,
Happy Republic day!
Thank you for this brilliant post. I Fall under the Part 2 category of people and yes investing like my backside is on Fire.
Do you think it is better to err on the side on rate of return for Longevity of our portfolio? Example Say i reach or am close to my desired Corpus due to favorable gains in Equity Markets, would you recommend re-balancing rather than stay put to a rigid percentage of Equity vs Debt. your thoughts ?
Regards,
Rohan
Happy Republic day! Thanks Rohan. Actually it is when you rebalance you stick to a rigid asset allocation. I think a young person can afford to have 60% equity min until they are ready to retire. However, if you want to retire in the next couple of years, it is better to start adoping the bucket strategy. Spread your risk among assets of differing volatility but safe guard income for at least next 10Y with fixed income.
Hi Pattu,
Happy Republic day!
Thank you for this brilliant post. I Fall under the Part 2 category of people and yes investing like my backside is on Fire.
Do you think it is better to err on the side on rate of return for Longevity of our portfolio? Example Say i reach or am close to my desired Corpus due to favorable gains in Equity Markets, would you recommend re-balancing rather than stay put to a rigid percentage of Equity vs Debt. your thoughts ?
Regards,
Rohan
Happy Republic day! Thanks Rohan. Actually it is when you rebalance you stick to a rigid asset allocation. I think a young person can afford to have 60% equity min until they are ready to retire. However, if you want to retire in the next couple of years, it is better to start adoping the bucket strategy. Spread your risk among assets of differing volatility but safe guard income for at least next 10Y with fixed income.
I would like to comment on this. Why not keep 50% or bit less 40% equity even one retires at normal age (60). The assumption one most likely to live for another 20 plus years. If one retires early say in 50s, I would say keep the equity to 50% or more for another 20 years. 20 plus years are very long time just to keep everything in fixed
Yes, equity exposure post-retirement is advisable but the exact amt will change from case to case.
Absolutely true Pattu sir – I firmly belong to the 2nd category as you know and all points are very very relevant
Thank you.
Absolutely true Pattu sir – I firmly belong to the 2nd category as you know and all points are very very relevant
Thank you.
While I agree that MM/ERE are not applicable for the inflation level in India – you need to do a different maths – however, IMHO the philosophy they espouse is valid and instrumental in influencing your thinking and outlook – a change in thinking I believe is the first step we need for retirement planning when most people in India are not even thinking about it!
I get your point. They inspire reads to live frugally and aspire for financial freedom, but not all readers (at least most Indian readers) are able to understand the assumptions behind their statements. I would recommend studying retirement math to a person who has understood its importance. The math is universal. The inputs depend on location.
While I agree that MM/ERE are not applicable for the inflation level in India – you need to do a different maths – however, IMHO the philosophy they espouse is valid and instrumental in influencing your thinking and outlook – a change in thinking I believe is the first step we need for retirement planning when most people in India are not even thinking about it!
I get your point. They inspire reads to live frugally and aspire for financial freedom, but not all readers (at least most Indian readers) are able to understand the assumptions behind their statements. I would recommend studying retirement math to a person who has understood its importance. The math is universal. The inputs depend on location.
hmm..interesting..the only thing i hv doubt is the assumption of 8% inflation in the long term.Recent Urjit patel committee and even earlier RBI committees have said 4% is the medium term inflation target with which they r going to work with.The current RBI governor is certainly demonstrated that containing inflation remains the top priority.
hmm..interesting..the only thing i hv doubt is the assumption of 8% inflation in the long term.Recent Urjit patel committee and even earlier RBI committees have said 4% is the medium term inflation target with which they r going to work with.The current RBI governor is certainly demonstrated that containing inflation remains the top priority.
Forget what policy makers do. At rate have your expenses grow? That is the only truly relevant question
Each individual has his/Her own inflation rate.It need not be 8% or 4%.It all depends on the life style,our responsibilty to parents,children etc.I am 85 and have no dependants.Normal style of living.My normal household expenses during the last 5-6
years has increased by about 3-5% per anum.So it is left to you to calculate your own inflation rate.
Sir, I have a doubt about the distinction between the two terms, is it correct to state that financial freedom is a higher form of financial independence? That is, one works towards achieving financial independence first, and then financial freedom comes next.
If you go by how I have defined it, it is exactly the other way around. Our country is independent. We, the citizens have freedom, but we cannot do whatever we want. Independence is forever. Freedom has to be earned until one becomes independent.
Sir, I have a doubt about the distinction between the two terms, is it correct to state that financial freedom is a higher form of financial independence? That is, one works towards achieving financial independence first, and then financial freedom comes next.
Bucket Strategey-I have read about this in one of your blogs.Can you please let me have a link to this blog where you have provided deep insight into this strategy.sorry for the trouble.
It is this one, Sir.
http://freefincal.com/the-retirement-bucket-strategy-simulator/
Bucket Strategey-I have read about this in one of your blogs.Can you please let me have a link to this blog where you have provided deep insight into this strategy.sorry for the trouble.
Sir,I have come across this blog very recently but the day I have seen the depth of the contents covering all financial aspects of an individual/family, I can’t restrain myself from appreciating your approach to various situations so relevant to make one conscious about the pros and cons of his/her survival if he/she does not have the right perception/approach.Thank you very much for this unique kind of social service to the community at large.