Thursday, September 21, 2006

How Much is Enough?

--- continuing from the last post on Financial Freedom ---

Stage 2 is a tough nut to crack.

First, you need to know what you want out of life and how you expect to be spending your retirement. And this is a question that is really, really tough to answer for two reasons:

  1. You've never thought about it
  2. Can one really reliably predict what one will be doing 10, 15, 20 years ahead?

Yet this is important, because your entire well-being in retirement depends on it.

Your Provident Fund Alone Will Not Cut It

Till a few years back, it was OK to think that your Provident Fund would take care of your retirement. But things have changed dramatically of late and there is a pretty clear indication of how our retirement options will be a few years hence. In my opinion, the writing is on the wall:

  • interest rates on capital protected investments like PF will continue to fall, eventually aligning themselves with market rates. This may not happen now or even in a few years, but definitely soon enough to demolish your PF strategy
  • the responsibility for maintaining and managing retirement funds will move away from the government and into your hands
  • inflation will eat away into your savings
  • your kids may no longer be willing to take on responsibility for your well-being (God forbid, but one never knows)
Given this horror-story setting, it is definitely important for you to know how much money you need to set aside for a happy and fulfilling retirement.

So, How Much Is Enough?

To answer this, at least in a broad sense, try the following:

  1. Figure out when you'd like to retire (Be realistic! Chances are, if you are reading this, you ain't gonna be quitting next year!!)
  2. Write down your annual budget as determined from your Stage 1 analysis
  3. Add in any additional regular payouts you think you might be incuring when you retire and increase the overall budget by, say, 20-30% since you'll probably want to live in better style than you are accustomed to right now. This is how much you would need if you were to retire today. This needs to be adjusted for increases due to inflation till your retirement date
  4. Make a guesstimate on how inflation will remain till your retirement, it's better to aim high than low, so perhaps you could take a figure of 6%
  5. Calculate the value of your annual payout at the time of retirement by multiplying your retirement payout (from step 3) with (100+inflation)% to the power 'n', where 'n' is the number of years left to retirement
  6. This figure is the annual payout you need to keep you retired and happy and should be generated entirely out of investment income. Based on investment returns of, say, 5% you need to have saved about 20 times of your retirement annual payout (from step 5) in order to be comfortable


You want to retire 15 years from now and your current annual payout is, say, Rs. 200,000. You expect to be spending an additional Rs. 100,000 for annual vacations when you retire and you anticipate inflation to remain at a level of 6% from now till you retire.

Hence, your annual retirement payout in today's money would be about Rs. 390,000 (200,000 + 100,000 increased by 30%). Adjusting it to 15 years from now for 6% inflation would yield an anticipated annual payout of Rs. 934,657 at retirement. (390,000*1.06^15)

This needs to be generated entirely out of investment income and hence you need to save about Rs. 1.87 crores by the time you retire.


Inflation will not end just because you have retired. Hence, the expenses will continue to rise even post-retirement. To account for that, you need to know how long you expect to live (!) post retirement and save even more to accommodate the increasing costs for that period.

But let's not get into that - it's too complicated!

The point of this entire article was that, while retirement planning is an inexact science, it is something you must do so prepare now rather than being taken by surprise when it's too late.

What is Financial Freedom?

I received a very kind comment the day before suggesting that I truly get what 'financial freedom' is about and I suddenly realised that I had never really talked about what that means to me. After all the very idea of this blog is to post about my journey to financial freedom - and yet that has got missed out on the way!

Different Interpretations

I guess there would be different interpretations for different people. Some might say financial freedom is when you have enough money to live off in the style you want and never have to work again. Others would tend to go with a more approachable definition of having enough money to ensure that living and other non-discretionary expenses are taken care of so one is then free to pursue other things free from the worry of paying the next bill. And for those among us who are saddled with uncomfortable amounts of debt, perhaps financial freedom is simply the ability to pay off the loans!

My Two-Stage Approach

I'm looking at financial freedom as a two-stage approach:

  1. Lifestyle Maintenance: Save enough to ensure you can meet living expenses from the interest (if you live off the pricipal then of course you'll be back to square one in no time at all!)
  2. Retirement: Then look at saving enough to retire and live a happy and comfortable life (again on the interest otherwise your kids might be a little unhappy at inheriting nothing from you, heh heh)

The first is rather easy to calculate - add up or estimate your living expenses per month, extrapolate that into an annual budget and add in any non-monthly expenses you regularly incur in order to determine your budget.

Examples of monthly expenses would be house rent, utility bills, food / groceries, entertainment, fuel, loan repayments, education-related expenses etc. Non-monthly regular payouts would include insurance payments (not an expense but a regular payout that must be accounted for nonetheless), annual vacations etc. Also factor in an anual lumpsum for large purchases that tend to come up every so often like purchasing appliances etc.

Since this will have to be met out of the interest on your savings, you can work out what the savings should be. I'd guess the interest would be about 5-6% on any capital-protected instrument (like perhaps govt bonds) so you need to have saved 17-20 times your annual budget in order to even get to Stage 1 of financial freedom.

It might be tough, but it is definitely possible for all of us. And this calculation will also give you excellent visibility on your spending habits. If you simply cannot figure out how to get to Stage 1 with your current lifestyle, perhaps it might be worth re-evaluating the necessity of some of your expenses.

Stage 2 is another story, though... will get to that in the next post! Till then, please give me your views on the subject.

ET Article Link

Thanks to.. err... 'Anonymous' for sending me the link to the Economic Times article. Was looking for it all over!

Tuesday, September 19, 2006

Thanks to the Economic Times

Hi everyone,

I've just learnt that this blog has got a mention in the Economic Times as one of a rising number of blogs on finance, investing and the stock market. Can't find the article online but will post a link once it is put up on the net.

[I, of course, look like a chump for having been a no-show on this blog for the past ten months. Oh, well, that's the price of celebrity... the intense media glare, the paparazzi, the complete lack of privacy...]

Thanks to all you readers who've followed my writing for the past couple of years and returned every so often only to read the same old stuff because I've been too lazy to add anything new. Will try to buck up now!

To the newcomers, please feel free to browse the archives. There's some stuff you might find useful. And do drop in from time to time to catch up on new articles as well.

Thanks for coming by!