Financial independence #8 – Template of an investment plan

In this post I will outline a template of an investment plan that anyone will be able to use in their journey towards financial independence. For the purposes of this post I will not explain some of the logic behind the suggested actions to keep it simple. I will however, do the explanation in other future posts.

Some assumptions before we outline the plan:-

  1. Early retirement is planned at year X and normal retirement age is Y. Obviously Y > X.
  2. From age X to Y the passive income generated should be adequate for all normal expenditure.
  3. Some goals will be prior to X and there will be normal investment for these. Some will be between X and Y and the rest beyond X. For these the investment will be done till X but withdrawals will be at the years of the goals.
  4. For retirement goal, follow point 3 i.e. investment will be till year X.

Let us now get to the investment plan in general. If you are just starting out then you can make a fresh plan and if you are already having a plan you will need to look at modifying that.

  • You may be already investing in PF and PPF. Continue both of these investments till the year X. If you continue your existing job after that continue further, else contribute only to PPF ( not from passive income).
  • Apart from the above put everything into equity – have a portfolio of stocks and another portfolio of MF. You need to continue this till year X and after that if you are having any active income.
  • Make sure that the amount reached in your portfolios at year X and the growth of your portfolios between year X and year Y will be sufficient to cater to the following:-
    • Generation of passive income to cover regular expenses between year X and year Y.
    • All goals that you have planned for any of the time horizon.
    • Retirement corpus at year Y should be sufficient to last for projected lifetime.

Let us take an example of a specific goal to illustrate the point:-

  • Assume X = 50, Y=60 and current age is 30 years.
  • Child’s college education at age 55 was planned to be 1 crore, investment period was 25 years.
  • Annual investment needed at 12 % return was 75000 Rs
  • As we will now only invest till year X therefore the investment period will be 20 years instead of 25.
  • New annual investment needed will be now 1.39 lacs.
  • Assumption here is that the entire 1 crore is available at year X. Obviously we do not need this at Year X but 5 years later. Once you take this into account, the investment needed is only about 80000 Rs.

You can do the above for all the goals and increase your investment amounts. As long as the goals are a fair distance away and you are using equity the differential investment will be manageable. If these conditions are not true then the extra investment needed may not be feasible. This shows we need to plan for FI with time in hand, it will not be something that can be changed quickly in a short time horizon.

I hope with this all will be able to work out the new investment plans for the goals, in the light of FI state being reached. We also need to plan for the passive income to deal with expenses between the years X and Y. I will cover that in the next post.

Financial independence #7 – How you can do it

In the earlier posts of the series I had outlined my objectives of financial independence and the way in which I went about it. If you have read all the posts it would have given you an idea that it is definitely possible to attain FI without compromising on any important needs of today. In this post I will start on a general template that you can use for attaining your FI goals.

The first thing to consider is the age by which you want to attain FI. This will depend on your current situation as well as the amount of time available to you. For example if you are just starting out at 24 with a high paying job, it may well be possible to attain FI in the next 20 years. This will, however, depend on your family situation in the future etc. On the other hand if you are in your mid-thirties with 2 young children and not too much of financial assets, you may still need another 20 years to get to your state of FI. You must therefore be both ambitious and realistic at the same time. There is very little point in having an ambition that you should attain FI by the time you reach retirement age – that is anyway a given, if you have not done even that much then you are really in deep trouble. At the same time, an obsessive focus on investment will mean you are unable to cater properly to your needs of today and this will be counter-productive for you and your family.

The second thing to consider is how you will spend your time once you have attained FI. There are really 3 choices here – you could just continue with your current job or profession feeling good that being FI means you could walk away any day, you could give up your current vocation and take up something new that you are passionate about but did not have a chance to do earlier or you could take an early retirement and enjoy life. In the first two of these options and sometimes even in the third you will have some active income, which is great. However, by definition FI is a state in which you do not really need this income. The cake is already there, extra active income is really only the icing on it.

I think a desirable age to achieve FI will be 45, if you can do it at 50 it is still great. Anything beyond this should really happen naturally, without your having to plan for it specifically. In order to attain FI by the age of 45 or 50, you need to look at the following strategies, and relate to them from my example that I had described in the earlier posts of the series.

  • Ideally the time at which you are planning to attain FI, should be when your regular expenses have peaked and will either decline or remain flat. This typically happens when your children complete their schooling and get admitted to college. Remember the college expenditure is out of the goal amounts accumulated, not part of regular expenses.
  • All loans should be paid off by the time you get to this stage. If they have been paid off in the normal course, well and good, otherwise you need to plan for pre-payment.
  • While you can plan for a level of passive income that lets you continue with some investments, this will necessarily delay your attaining the FI state. The ideal thing would be to wind up fresh investments by this time, unless they are strictly from your active income sources.

So with the above strategies in place, how do you plan your investments that will allow you to attain the state of FI by the time desired by you? We will be discussing more on that in the next post.

Financial independence #6 – My passive income plan

In the last 2 posts I had written about my need of an annual passive income of 8 lacs and how I had arrived at it. Just to recapitulate this figure does not have expenses for accommodation or children’s education, nor does it have any amount for fresh investment, It does have about 1 lac for various insurance expenditure.

In this post I will talk about my plan of generating this income from the current year 2015. The idea is to do this till 2024 and then get into the phase for retirement spending. Note that these two plans are different ones. In the FI phase, I will be dealing with passive income while in the retirement phase I may re-balance my assets in a different way. Also, in the next 10 years I will still be investing, though not from PI. In my retirement phase I will do very little of new investment.

I will only write here about my plans of generating passive income and not of my overall investment strategies or my portfolio, which I will cover in other posts. The following is the avenues from where I generate passive income:-

  1. The tax free bonds that were available in late 2013 and early 2014, happened exactly at the right time for me. I had invested a total amount of 24 lacs in it and would have done more if I could mobilize the amount. I get a tax-free return of 8.8 % from these which is great. Total income from these annually is about 2.15 lacs.
  2. Over the years I have invested in some Mutual funds in the Dividend option. This is mostly for funds that I bought early in my investment cycle, the latter ones and my current SIP s are all Growth options. Though the dividends are not certain, it can be estimated around 1 lac per year.
  3. I had also invested in the ICICI Value Fund Series for about 10 lacs, purely with a view to earning dividend. These funds would normally give dividend of 1.5 lacs a year which is not guaranteed but very likely.
  4. The cornerstone of my FI plan was my investment in FMP s. I have substantial investment here and had plans to earn the interest as LTCG and keep investing the principal back. Due to the change in tax rules I have been forced to roll over the FMP s that had a duration of less than 3 years. In 2015 my LTCG from the FMP maturity will be close to 3 lacs and from 2016 this should be in the range of 6 lacs or so every year.
  5. Dividends from my stock portfolio are again difficult to predict with certainty but it would be in the range of 1.5 to 2 lacs every year.
  6. Interest from POMIS and FD will be about 1.5 lacs annually but I will normally not spend this.
  7. Interest from PPF will be about 3.5 lacs in 2015 but I do not plan to withdraw it.

So for 2015 the first 5 sources should be enough to meet my need of 8 lacs and this should logically continue for the entire duration of the FI period. Note that all the sources of income are really passive and tax free. I only need to re-invest the principal when an FMP matures which hardly takes any efforts.

The above gives me complete peace of mind and I can now pick and choose the kind of assignments that I want to do, as I am not dependent on the Active income from Consultancy for funding my lifestyle.

In the next few posts, I will try to work out a generic template and some guidelines as to how one can go about planning for FI. As you can see from my example, it is entirely possible.

Financial independence #5 – my strategies

Several people have wanted to know about my investments and how I managed these to get to a state of Financial independence at my desired time. The important thing to understand is this – you will need a few good strategies first in order to ensure you are on the right track. Getting to FI is a destination but what is very important is the journey. You do not only want to arrive at a state of FI, you also want to get there in good time and in good shape.

Let me explain a little what I mean by this. Your utilization of money will broadly be in 3 areas – your regular expenditure whether mandatory or discretionary, your expenditure in creating assets and finally your investments. Now even with increasing incomes, you will not be able to invest greatly in the third component if the first is increasing rapidly and the second is at a high level. Once the first peaks off and the second goes away you are in much better shape.

For my part I had looked at my life situation in the following manner before deciding on the strategies:-

  • I had decided anytime between 48 and 50 to be the cutoff age for reaching FI. The main consideration here was my children completing school and one or both of them being in college.
  • At 50 I would have 10 years of fairly active life to pursue my professional interests, prior to the conventional age of retirement at 60.
  • Ideally, I would like to maintain the same lifestyle for the 10 years, from reaching FI till the age of 60.

Based on the above the following strategies were quite easy to arrive at :-

  1. It was important to close out any loans or other liabilities well before the desired year for FI. This was easy for me as the only loan I had was for buying my Chennai apartment in 2003, which had been closed by 2005 itself.
  2. As I have an unified portfolio and not different ones for different goals, I would need to earmark some funds for the years my children would be in college. For my daughter, this was simple as she is completing her graduation in 2016 and there are FD s for her fees till then. For my son, his graduation will be till 2019 and I have earmarked the proceeds from my 2 insurance policies for his expenses in college.
  3. Though I will get some Active income from my consultancy, I did not want to depend on the same. For real FI your passive income has to suffice adequately. I needed to arrive at a level of PI by considering these:-
    1. Rent from Chennai apartment to take care of our rent in the city of stay, probably Hyderabad or Kolkata.
    2. Regular expenses, both mandatory and discretionary would reduce when the children went off to college. For the lifestyle we want to lead we need about 8 lacs a year. This has some built in inflation for the 10 year period.
    3. There are no incremental investments in my FI state, but see the next point for details.
  4. I would still continue to invest in the following, but not from a perspective of incremental investments. The amounts needed would be funded through redemption of existing financial assets, which may be unsuitable:-
    1. PPF investment would be from redemption of debt funds over the next few years. My PPF is 20 years now and I want to continue it at least for another 5 years. My  wife’s PPF current PPF is only 3 years old and we will run it till 15 years.
    2. I have a good portfolio of MF SIP now and would like to continue the same. However, this will be done through redemption of existing Mutual funds that have inferior performance now. If I do this over the next 5 years then my MF portfolio will only have the 7 desired funds.
    3. Normal churning of my stock portfolio which I will manage actively now.
  5. Any Active income is therefore available for investing in stocks, spending on causes that are important to me and any indulgences that my passive income will not cater to.

The task therefore boiled down to my portfolio generating a Passive income of 8 lacs from the year of my FI. This has to continue for 10 years or so, when my actual retirement strategies will kick in. In the next post, I will write about how I am generating this passive income.

Look forward to your comments and observations on this and my other posts in the blog.

Financial independence #4 – a personal perspective

Financial independence is something that all of us should strive to reach, but it means different thing to different people. In this post, I wanted to share why I wanted to be financially independent, as soon as possible and what specifically it means to me.

From the time I had started work at the age of 24 after my post graduation from IIM Calcutta, I was very clear that a career of 35 plus years was not what I wanted to have. It was my belief, even at that time but more so now, there is much more to life than work. Work – life balance is unfortunately a difficult thing to achieve in India, especially if you are working in a stressful corporate Executive role, as I have had for most of my life. My philosophy therefore has always been to try and get as much of a work-life balance as possible, to spend some time on activities that I really enjoy doing and work towards a time when I am financially independent and can therefore do other things in life.

Note here, I do not look upon achievement of FI as something that has me retired early. I am running a Consultancy practice now and work with companies and in areas that I genuinely like. It gives me a sense of fulfillment and I have enough time in my hands for other things I want to do. Many of my friends have said that I could have worked till 60, like most other people, and then have reached the same state. The point is, I do not even know what will happen by that time. There are several things that I can do today ( go on a trek fror example), which will be infinitely more difficult 10 years hence. I seriously doubt my level of energy after 10 years to start a Consultancy practice for example.

So what does the state of being financially independent mean to me as an individual? It can be characterized as below:-

1. You no longer need to work in order to meet your expense or investment needs.

2. All your future goals are funded now and will be met easily when the time comes.

3. You are able to maintain, enhance or cut down on your existing lifestyle as per your choice, without being compelled in any manner for financial reasons.

4. Your passive income meets your cash flow needs comfortably and leaves room for some indulgences.

5. The ups and downs of the markets will necessarily affect you but not to the extent where your financial freedom is compromised.

I am happy to have achieved this freedom in 2014 and can now plan to do some other things in life, which always interested me but I never had the bandwidth to commit for. Feel great about the fact that I have managed to get there while my children are still in college – in fact my son has just joined college in 2014.

In the next post I will talk a little more about my plans and their implementation to get to this stage.

Financial independence #3 – Understanding cash flows

Now that we have understood the Active and Passive income categories, we need to look at our cash flows needed when we have reached a state of FI. For this purpose we will be using the Extended money equation, that I had outlined in one of my earlier posts. We will be using a variant of the same which is given below:-


  • In the FI state we are assuming that Active income is not needed, so AI = 0 in this state. In other words the Passive income ( PI ) should take care of all expenditure.
  • Regular monthly expenditure ( RME ) will be Rent / EMI, Groceries, Utilities, Schooling etc.
  • Regular annual expenditure ( RAE ) will be insurance premiums, Property taxes, Maintenance, Donations etc.
  • Discretionary monthly expenditure ( DME ) will be entertainment, eating out etc
  • Discretionary Annual Expenditure ( DAE ) will be Vacations, Clothing etc.
  • Indulgences Related expenditure ( IRE ) will depend on the family.

Now in the state of FI, it will make sense to minimize the above to the extent possible without compromising on the lifestyle one is used to. The reason is this – higher the PI needed, higher is the asset base required to generate that PI. Therefore, if we want to achieve the state of FI earlier we need to see how the above parameters can be controlled. Fortunately, a lot of this will happen naturally as you will see from the following:-

  • Achievement of FI will normally coincide with the children leaving home for college. This will normally bring down the expenses in RME, due to their schooling and other costs going away. Yes, there are college expenses, but those are normally taken as a separate goal and funded differently.
  • RAE will reduce as in the state of FI, life insurance is not really required any more.
  • DME and DAE will also reduce because of children factor and lower level of activities as we grow older. After all we will look for lesser entertainment, vacations and dining out at 50 plus years, as opposed to when we are in our 30s.
  • Same logic for IRE will have it at a lower level.

I had done an analysis of my expenditure over the years and saw that my expenses had risen from 1988 (when I started work) through 2012 ( when my daughter started her college). It then stayed at pretty much the same level for another 2 years and went down after my son joined his college in 2014. Note that I an NOT talking of the total expenditure, but only the ones related to the above terms in the equation. Their college education related expenditure was funded separately as 2 goals and that money available is now used for the same.

From a planning perspective, we can therefore look at the below conditions when working out the level of PI needed:-

  1. As investment for goals are made out of AI, which we do not want to depend on now, it will be important to ensure that all investment levels for goals are at a stage where it can grow to the required amounts naturally, i.e without any additional investments in the FI period.
  2. PI should be funding at least 70 % of your peak expenses adjusted for inflation if you have 1 child, and at least 60 % if you have 2 children. As we want to be conservative let us take 70 % as the desired level.
  3. With the above conditions let us now look at my own example:
    1. Peak RME = 50 K, Peak RAE = 2 L , Peak DAE = 2 L and Peak DME = 1 L
    2. Total expenditure was 11 lacs and at 70 % it came to nearly 8 lacs
    3. For FI I needed to generate an annual PI of at least 8 lacs.

So, if I had financial resources that could be arranged in a manner, so as to generate a PI of 8 lacs a year, I could call myself as Financially independent.

There are some other things to being a FI too, from my perspective, which I will discuss in the next post.

Financial independence #2 – Active and Passive income

In order to plan for and achieve financial independence ( FI ) we will need to understand the different ways in which we can generate income for ourselves. In broad terms we can categorize income into two categories – Active income and Passive income. Achievement of FI will depend primarily on the adequacy of passive income, so we need to understand it well.

Let us first look at Active income. It is the income that we earn from our job or profession or business. It involves spending our time to create something of value to other people, who are then willing to pay for the same. For example, you may be in a job that is giving you a regular salary. Here you are spending time at your workplace and doing something useful and productive for your employer. In exchange of that your employer pays you a regular monthly salary. This is completely dependent on your spending time at work – if you decide to stop going for work then the salary would also not be there.

Let us see some other examples of Active income in order to understand this a little better:-

  • Consultation fees earned by professionals such as Doctors, Lawyers , Tax consultants etc.
  • Training revenues earned by a consultant when he conducts private or public workshops.
  • Income earned out of trading in the stock market by a trader.
  • Profits earned by a small scale business person out of his neighborhood grocery shop.
  • Commissions earned by an LIC agent from the policy that he has sold recently.
  • Profits earned out of active management of your stock portfolio.

The key criteria is, as you can see, the income being generated out of the time that you are spending today. As a contrast to this, Passive income is something that you earn without having to spend current time. A perfect example will be rent earned from a property that you own. At some point of time you had acquired the property and made efforts to get a tenant. However, now the rent comes every month without having to do much about it. Some other examples of Passive income are :-

  • Dividends earned out of your investments in Stocks and Mutual Funds.
  • Interest earned out of Tax-free bonds and other similar instruments.
  • Trailing commissions earned out of LIC policies and Mutual funds sold in the past.
  • Any kind of pension or other annuities earned on a regular basis.
  • An author or singer earning royalties out of past work.
  • Unexpected windfall from an inheritance !!

In order to achieve FI a primary condition is that our Passive income must be adequate and sustainable for all our financial needs. In a state of Financial independence, there is absolutely no bar on earning Active income by either continuing your existing activity or by doing something new altogether. However, if your financial requirements need access to the Active income then you are not Financially independent.

It is therefore easy to see that all of us should strive to be financially independent as soon as possible. People confuse it with early retirement but this is completely two different things, except that you cannot go for an early retirement unless you have achieved FI.

In the next post we will see the different uses of money that we have in a normal state and how the spending dynamics should logically need a change in our state of FI.

Financial independence #1 – the rationale

Financial independence is probably the most commonly used jargon in the financial world today. Most investors say that they want to be financially independent and all financial planners tell their clientele that they can help in constructing a financial plan that will lead to this desired state. Based on the amount of interest the term generates, I wanted to do a series of posts in my blog to deal with the different aspects of financial independence ( FI ).

Let us start by seeing why FI may be of interest to an investor. As we know, the traditional model of financial planning is that you work and accumulate investment till you retire. Hopefully at that point of time your accumulated investments will generate enough income to take care of your expenses for the rest of your life. The plan, therefore, for most people would have been to work till 60 years or more and you kind of achieved FI by default at that age.

Well, a lot of things have changed in our country over the last 15 years or so. Some of the factors that have been responsible for FI gaining a lot of currency are as follows:-

  1. There has been significant increase in income levels in almost all jobs and professions. It is therefore possible today to accumulate a reasonable amount of wealth much before the traditional retirement age.
  2. Despite the intention of doing other things in life, due to family and other pressures, most persons were unable to try other things. In the present context people with a reasonable amount of financial resources can now look at possible second careers or even take up a hobby seriously, that has some earning potential.
  3. Consultancy and other opportunities have received a huge boost in this internet age and people quitting their jobs for getting into such areas are becoming increasingly common nowadays.
  4. In some professions and industry segments, a normal career span of 35 years is becoming difficult and therefore it makes sense to look at FI in a much shorter time period than before.

So, whether you look at it from a positive or a negative angle, achieving FI needs to be seen as an important goal for every individual. This is not to be confused with Early retirement, as you can continue to work if you wish. Achievement of FI simply means that you can maintain your current lifestyle and future responsibilities without having to worry about earning income from any of your current activities.

In other words, achieving FI is tantamount to reaching Financial nirvana. You can lead your life and choose the work you want to do, without impacting the needs and goals of yourself or your family members.In the next post I will try to put a context to Financial independence in terms of what your financial status should be catering to.

Sample Financial plan #10 – the final investment plan

This is the last post on the sample financial plan for Ravi and Madhuri. We need to try and rejig the investment plan that required 13 lacs investment in equity every year. Even though, most financial planners and available calculators follow this method, the obvious flaws in this approach are not difficult to see. An uniform level of investment over a period of 20 years or more, when your income is going to increase significantly over the years makes little sense.

By now all the readers would have got the basic logic of how equity investments work well in the long term. I will therefore, only write about the suggested investment plan, rather than explain how I arrived at it. Note that I have chosen the most obvious method even though more complicated ones are possible.

  • Start with an investment of 5.4 lacs in equity in the year 2015. This is the amount available today.
  • Increase the investment amount by 10 % every year. This should not be difficult as we have already front-loaded some expenses like schooling and Ravi’s compensation will increase by 10 % every year. Madhuri’s income will probably increase too, but we have not taken that into consideration.
  • After 11 years the EMI for Housing loan will stop and that amount will get diverted to equity investment. So from 2026 to 2040 ( year of last goal) an additional 5 lacs will go into equity investment.
  • All the goal amounts in the different years will be mobilized by redemption of the equity portfolio. If for some reason, the markets are doing exceptionally bad then the money would be taken from debt ( PPF ) and paid back at a later date.
  • With the above plan and 12 % CAGR on equity all the goals of the family that we had identified will be realized.
  • Note that we have not said anything about the existing apartment in Hyderabad. Ravi can probably sell it when he moves to Kerala. Madhuri’s earning has also been taken at the existing level of 30000 Rs per month only. This will obviously increase as time goes by and can cater for some of the other indulgences the family may have.
  • Finally, though the couple have achieved financial independence by 2035, Ravi will be having a venture of his own and the earning from there can be used for other purposes if any.

The point of this series has been to show people that with a little thought and planning, it is possible to create a financial plan that will support all the important life goals of a family. It can be done without being excessively frugal or feeling constrained about all indulgences like a vacation etc. Ravi and Madhuri are not rich by any means, though they belong to upper middle-class and are reasonably well off.

The success of the plan will be in the correct formulation and regular reviews of it. With the posts available to you, I am sure you will now be able to make a financial plan on your own.

Keep reading the future posts where I will discuss about constructing a portfolio and other aspects of personal finance.

Sample Financial plan #9 – feasibility of the investment plan

We have now reached an important crossroad in the financial journey for Ravi and Madhuri. The investments needed annually to support all their dreams is now known. It is very likely that if they make these investments per year, they will have the financial support needed to actualize all their goals. The key question however is – given their current financial situation, is such an investment possible?

The short answer to the question is unfortunately NO. As we saw earlier, Ravi and Madhuri earn about 20 lacs a year currently and there expenses are more than 10 lacs today. In addition to this they may need to spend some more money on insurance etc, that we have not looked at so far. However, before we look at what can possibly be done, it will be important to understand their spending and amount of surplus available.

We will be doing this through the Extended money equation that was covered in an earlier post. Go back and read the post again if you need to understand it better as I’ll not be explaining the basics here, only the application. The equation is :-

IS = AI + PI – RME – DME – RAE – DAE – IRE

As we know AI for the family is about 1.8 lacs today and has the potential to increase by 10 % every year. RME, DME, RAE and DAE together is about 80,000 Rs today. However, as their children are just going to start proper schooling and those expenses are high, they will be comfortable to budget at least 1.1 lac for the same. Indulgence related expenditure is primarily the foreign vacations that has been planned as part of their goals. Based on this, the surplus available currently is 70,000 Rs per month. Note that their EMI for the housing loan is 40,000 Rs per month and it will run for the next 11 years.

We will take up on the different strategies of tweaking the investment plan in the next post. However, for now, let us see what can be done with the extended money equation for their family.

  • One obvious way is to increase AI. Ravi’s income will increase over the years naturally and Madhuri will start earning more as she spends more time in her freelancing. As they have already budgeted for the schooling expenses of the future, the surplus available for investment will increase over the years.
  • Another way to increase AI will be for Ravi to change his current job for a higher income one or for Madhuri to start working in a regular job. This was not something that I had recommended as the family was comfortable in their current situation and disturbing the stability on job and home front did not seem worth it.
  • Reduction of expenses is an option but that involves compromises on what they are used to, so it was seen to be the least preferred way.
  • A big part of RME is the EMI of 40,000 Rs that will be available from 2026 onward.

Based on the above, I recommended that they start funding the 2 PPF accounts and invest the rest of the available money in equity. This meant that in the first year the equity investment was only 5.4 lacs as compared to the needed 13 lacs. Is this a big problem in terms of meeting their goals? Seemingly so, but not really in practice.

Follow me in the next post to understand how this can be done.