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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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A thumb rule for financial independence

Posted by Muthu on August 1, 2015

Getting rich is a never ending quest and it is fine as long we enjoy the journey instead of feeling feverish about the goal, which would always be a moving target.

Rich is relative. If you have Rs.10 crores and if your neighbour has Rs.100 crores, he is richer than you. There would always be many who would be richer than us. Of course, there would be lot more who would be poorer than us well.

Rich or poor is relative to whether we have more or less to someone whom we are comparing with. So what we should first aspire for in life is financial independence. Once we achieve it, there is no harm in aspiring to be rich, as much as our life circumstances, risk profile etc. allow it.

I’ll explain the thumb rule for financial independence with an example. If you are 50 years of age and expect to live till 80, you should have not less than 30 years (expected age minus current age) of annual expenses in financial assets in addition to having a primary residence and zero debt.

So financial independence for a 50 year old = Primary residence + zero debt + 30 times annual expenses in financial assets.

If the monthly expense is Rs.50,000; then the annual expense works out to Rs.6 lakhs. 30 times the annual expenses is Rs.1.8 crores.

This thumb rule is very conservative as it assumes you would get only returns (on your corpus) on par with inflation. In reality, in India, by investing in a right mix of debt and equity, we can even aim for 4% real return above inflation. In my opinion, this would be possible for at least next 2 to 3 decades.

In the example seen above, you are financially independent, if you have a house, no debt and Rs.1.8 crores in financial assets. When you are financially independent, your passive income would be able to meet your expenses and present life style for rest of your life.

Unlike getting rich, which is relative (you are always richer or poorer than someone); financial independence is absolute and measurable. Once you achieve financial independence, it does not matter where you stand in the rich hierarchy.

Financial independence does not mean you need to retire. It only means you can freely pursue what you want in life irrespective of the income it creates.

For example, if you take my case, I’m 42 and financially independent. I’ve no intention of retiring from what I’m doing now. God willing and health permitting, I want to work for next 28 years, till I turn 70. I thoroughly enjoy what I’m doing. I’ve a great work life balance and is grateful for finding out nearly a decade ago as to what I want to do for rest of my life. In future, even if I my income drop, I would only want to do this. I choose whom I want to work with and enjoy working with them to create and manage wealth.

So once you achieve financial independence, you are free to do anything you want, which would include what you are doing right now. More than change in your activities, financial independence would change your perspective. If you are no longer dependant on your active income to meet out your expenses, it completely changes the way you work and look at things. That freedom is worth aspiring and achieving.

So aim to achieve financial independence as early as possible. By proper planning, most of us can achieve it in 20 years of our career. So if you can do it by 40 or 45 years of age, the quality of your remaining life would improve drastically.

Like any thumb rule, this is only a broad indicator. Individual circumstances may vary. Your financial advisor would be able to guide you based on your individual life and financial situation.

Today is the beginning of August, the month in which our nation attained independence. So start today to plan for your financial independence.

All the best.

16 Responses to “A thumb rule for financial independence”

  1. gamanand thakur said

    Thanks Muthu Sir for right advice in right time again a lot of thanks. Regards Gamanand Thakur Korba, Chhatisgarh.

  2. N S Kamath said

    Thanks. From the parameters mentioned above, I am near to financial independence. But I have a daughter whose marriage expenses I have to bear and son whose educational expenses for engineering. whether I have to deduct these expenses.

  3. ajjw123 said

    This is a very simple calculation which is known and explored by few people.
    great as always

  4. Akilesh said

    Nicely Said Mr.Muthukrishnan Sir !! We will follow this rule..

  5. nicegem007 said

    That equation never changes. Isn’t it? You always have a liability in the equation….where is equity?
    Probably it has to be modified like
    Financial Independence requirement is = (equity over the first 25 year life span – house at the age of 50 – family responsibilities)/ number of years expected to live, take a year or two.

  6. shankar said

    Nicely written, Muthu. Was discussing same calculation for someone who did not know how to look at financial independence.

  7. Kannan Nagarajan said

    very rightly said. simple yet profound. great wealth is not the number of crores lying in our bank account, great wealth is something which sustains your life style till your time on earth, so we can pursue our real passion.

  8. AJ said

    wow, so if I’m 40 and looking to live through say 85, then I need about Rs 75,000 x 12 (months) x 45 (years) = Rs 4,05,00,000 today? Are you looking at only liquid assets or total assets across all classes? How do you consider real estate assets since they are not very liquid and may not be generating any regular income other than increasing in capital value?

    • Muthu said

      That’s why I mentioned as financial assets.

      • Amit said

        In case any real estate generate rental income which also increases over the time. Then how rental income can be considered in financial asset. For ex I have 2nd house whose market value is 80L and I receive monthly rent of Rs 18000/-.Can u explain.

  9. Mayank said

    Hi Muthu,

    If at the age of 38, one has saved about 4.5 cr plus own house and zero debt with no kids, should he retire? Monthly expenses are around 50-70K. 4.5 cr is combination of real estate investments and debt/equity.

    The biggest issue is what should one do after retirement.

    • Muthu said

      One may be financially independent and continue to do what he is doing. Financial independence ensures that one doesn’t worry about money any longer.

      • Mayank said

        What if the person is not enjoying what he is doing currently for e.g. he is stuck in a corporate job and hates it. With the savings mentioned above, do you think he can quit?

      • Muthu said

        It is sufficient if the entire corpus is in financial assets and your life expectancy is 80 years. Since it is a combination of various asset classes, please do meet a financial advisor for consultation.

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