Gursimran Singh is Principal Founder, SEBI Registered Investment Adviser ( RIA) and fee-only financial planner at www.paramasa.com
Opinions expressed are the authors and should not be construed as investment advice from Kuvera.
FIRE (Financial Independence Retire Early) – a reality check!
FIRE is the new Buzzword and currently and it is the most trending topic in personal finance.
It is very cool to say that oh! I want to quit the Rat Race and Retire on Beach!
Or I want to work on my passion.
But the real question is how is that possible? With loans, Children Education, Inflation and your own retirement goals is it possible to forgo at least 20 years of your earnings that is also when you are at peak of your career ..assuming you retire at 40 which is as per various poll conducted is the most preferred age to take early retirement, also in the time when our lifespan and our medical bills at a later stage of our life are increasing ..sounds scary!
So is it possible? let’s find out!!!
According to my experience and learnings of over the past two decades in personal finance, there are two approaches towards retirement which we should consider.
1/ Passive Retirement approach – this basically means that in retirement your passive income from your assets will be your only source of income. Passive income includes rent, interest income, capital gains from your portfolio which has real estate, stocks, bonds, gold etc.
2/ Working Retirement approach – you will be monetizing your time. This I also call “Passion Approach”. For example in your active working life, you were working as a Chartered Account in some big firm etc. and now you want to work as a freelance photographer or on something which is your passion. So Working Retirement Approach will let you “afford” that passion. Pls focus on the word AFFORD as we all know it takes years to match your active job income from passion.
Now let’s comes to the interesting part which is the math behind the above-mentioned approaches.
Basically, we need to juggle Four things to make our FIRE a success which is a detailed analysis of our annual expenses, inflation rate, median portfolio return rate and withdrawal rate. Let’s calculate the math behind the above two approaches.
Since in this approach our only source of income is passive income, so the size of our portfolio matters a most. Your portfolio size should be minimum 34 times your annual expenses, so that we can manage maximum 3% withdrawal rate, which means if our annual expenses are 10 lakhs, then we need to save minimum 3.4 Crores because 3% annual withdrawal rate will be 10.20 Lakhs. Now as I said Inflation play a major role. In the Indian context 10% minimum returns from our portfolio, we should be targeting. The rationale behind this is that our average inflation is 7% and after the withdrawal rate, the return of our portfolio should match our inflation to make portfolio inflation-adjusted so that portfolio also grow with Inflation. So to put the example to test, our 3.4 Crores portfolio will generate 34Lakhs in year one, our Expenses is 10 lakhs so rest 24 lakhs will go back to the portfolio which is around 7% of the overall portfolio, it is a buying power your portfolio will lose if it does not generate that much return. So in 2nd year, your portfolio value will be 3.64 Crores and 3% withdrawal is 10.92 Lakhs which is also 7% more than our previous year expenses which were 10.20 lakhs, so our withdrawal rate will match our inflation rate. This way your portfolio will outlast your life span if we maintain the asset allocation matching our risk profile, maintaining a conservative withdrawal rate which means not going beyond 3% and managing portfolio returns.
My request is We should not get fixated on actual numbers, but we should try to get the essence behind this concept. Personal Finance is very personal so you need to decide your own numbers, the levers you have to achieve this is your expenses and management of your portfolio, if you don’t want to take that much risk you can reduce your expenses and can go with less withdrawal rate which means less annual returns you required but pls make sure that portfolio should at least matching the inflation rate of 7% if you are in India ..if you are in Switzerland for example. Where inflation rate is around 1% than with a 3% withdrawal rate you only need a 4% annual rate from your portfolio!!
Here the objective is to bridge the gap with our income during our retirement as saving 34 times your annual expenses takes time and money if you take the above example of 10 lakhs. So let’s say we can generate 5 lakhs after we retire from our active job than all I need is 1.70 Crores which means less time and money to generate corpus which means you can retire much earlier also
I know what you are thinking that it all looks good on paper and I also know that portfolio returns are not linear in nature, sometimes your portfolio will underperform and also FIRE is about retaining your lifestyle which you want to enjoy for rest of the life it not about “ Growing “ your lifestyle, also before going into FIRE mode you have to make sure that all your liabilities are paid off and have to make lifestyle changes. so there are no free lunches and FIRE is not for everyone. I will urge to take services of your financial advisor if you are not able to manage or understand this yourself.
Following Steps will help you to create the corpus for your Retirement.
*Calculate the Future Value of your expenses or at the age, you want to retire, I recommend 7% Annual Inflation
*When you know the FV which is your target also than start investing in financial products as per your risk profile for example Index funds for Moderate risk profile and Small Cap for aggressive clients
*Always invest in Direct plans, every rupee counts!
*The earlier you start the better it is as compounding only works when you have in your side
*Buy Health Insurance with adequate cover and Term life Insurance
*With every pay increase don’t enhance your lifestyle put that money into your investments Remember your objective!!
*Finish all your liabilities
My humble request is that don’t treat FIRE as escapism from your job as you can see FIRE is not for everyone, it requires a lot of understanding, sacrifices and you need to have a purpose and well-drafted plan with a strategy if you want to achieve FIRE. If your Job is a problem then change your career, if you are happy with your work and want to continue than plan your goals and invest with timeframe till age 60 than FIRE is not for you. You need to understand yourself first before you embark on this journey. When your objective is clear and you are sure on what will be strategy than only you go ahead.
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