Lot of times I get this question and there is no one answer which fits all.
There has been lot of research done on this and as a thumb rule 25 times of Annual Expense is what you require before you can call it a day.
Where this number 25 Times of Annual Expense comes from?
It is based on the fact that first year you would withdraw 4% and next year you will withdraw 4% again, adjusted for inflation. The corpus should end you for time immortal if your returns is more than 4%+Inflation
You can look at below link for more info on 4% Withdrawal Rate
So we are working on 3 set of numbers
1. Annual Expense
2. Annual Withdrawal Rate
3. Annual Returns from Investment
If you see everything is driven by X i.e annual expense.
So basically it boils down to the most basic and simple personal finance advise:-
1. Spend Less, Save More (Earn More)
If your X is small, you will be able to save more and in turn your 25X will be reached faster.
When I tell that you need 25X of your annual expense people have that strange look on their face, how is that possible before actual retirement age ?
Most are not able to visualize in how many years they can achieve it or what they will have to do to achieve it in reasonable time frame.
Below table will help you visualize how many years it will take to achieve 25x with different savings rate, at 10% returns.
How to read the above matrix ?
Lets say your expense is 50% of your total income for the year, i.e rest of the 50% is your saving. So your savings rate is 50%
In the matrix go to row which shows 50% Saving rate highlighted in green.
Column shows how much time in years it will require to reach 5X, 10X, 15X, 20X, 25X and 30X of your annual expense.
As per the matrix 25X of your annual expense will take 13.3 years with 50% savings rate and 10% annual rate of return.
Check whats your savings rate and see how much time it would take at that rate.
To achieve the target you either have to move up in savings rate or move to left i.e. less than 25X of annual expense.
This matrix is great tool, gives you clarity on how easy it is to achieve the goal and what is required to be done.
Watch your expense like hawk, increase your savings rate by spending less and/or earning more, give your investments time to grow.
If I had such understanding a decade ago, I would have avoided lot of mistakes which I did chasing returns even though my Savings rate was good.
As I said earlier 25X is just rule of thumb, and is just to give you some kind of target or visualization on how it can be done with discipline.
You may have to work your own number as per your own circumstance and what financial independence mean to you.
See what my mentor D.Muthukrishnan thinks about Financial Independence
It is not necessary to quit work once you achieve financial independence. The liberating factor is that you would then be able to start setting terms for your work.
— D.Muthukrishnan (@dmuthuk) September 17, 2018
I would like to add to above, financial independence gives you an option to fail in things which you want to pursue, which otherwise you will not do as failing was not an option. It gives you freedom to fail.
It opens up lot of avenues for you and added assurance that even if you fail at doing something it will not impact your lifestyle or finances.
You just work on different level when you have such setup.
You no longer worry about how I will pay my bills, but are more focused on have I spent my time well and on the purpose which are close to my heart.
The whole focus will shift from earning to giving back to the cause or purpose you want to work on.
Together we can do it, Slowly … Steadily … but Surely (Inspired by @FI_InvestIndia)
Hope all achieve their goal of Financial Independence and work on their higher purpose.
This article was first Published on our Richlife Blog