In the last post I had written about Financial independence as a concept and why is it very important for all of us to understand it and be aware of where we are situated with respect to it. Now, the difficulty with such concepts is that we have a need to put a number to it for the purpose of making it tangible and easy to grasp. At the same time the method of arriving at this number cannot be too complex, otherwise most people will lose interest in dealing with this.
So how does one arrive at a number? Many people are thinking “calculators” as they read this, but my belief in their utility, except for crunching large numbers, has never been a lot. I always believe in tackling things at a fundamental level, whether it is in running a company, writing a blog or looking at creating a framework of FI number. So, let me do this through a real life example where i was interacting with a friend to put these numbers in place for him.
Some details about my friend Raghav and his financial context will be in order here:-
- Raghav is 50 years old and his wife Meena is 47 years old. They have 2 children, both on the verge of getting to college.
- Their current annual expenditure with children’s schooling is to the tune of 10 lacs. Of this children related expenses are 3 lacs.
- They have assumed that their life span is another 30 years.
- They have their own apartment in Hyderabad but may relocate to Indore after Raghav finishes his work life.
Ok, so now for the nitty gritty stuff of arriving at an FI number for Raghav. The following information will be used in arriving at a number.
- We will take out the expenses incurred on children and take it as the base figure for their future expenses at current value. In this case it is 7 lacs but let us just call it X.
- Retirement costs will be equal to 30X for the next 30 years
- 1st child college will cost about 3X today
- 2nd child college will cost about 2X as he wants to do a different course.
- Both their Post Graduation will cost 2X each.
- Their marriages are likely to cost 2X each also.
- Post retirement asset purchases will cost 2X
So now, if you add up all this you can see that Raghav needs to have 45X today if he is to be considered as being in the FI state. As we know in his case X is 7 lacs this comes to be a figure of 3.15 crores. In other words, if Raghav had 3.15 crores of financial assets available today, he can take it that he is in the FI state. If this were so then even if he does not earn any more Active income it will still not impact him too badly. Of course, he can figure out till when he wants to work.
How should he assess his FI status readiness? Well, if he has 2.1 crores today then he can compare this to his FI number and say that he is currently at about 2/3 way to achieve his FI state. Clearly, in this situation he needs his active income and will be able to think of giving it up only when his assets exceed the FI figure of 3.15 crores. Note that this can get more if you put more goals. For example, if Raghav and Meena wanted to go on a few foreign holidays that will cost 5X in today’s terms then the FI number for them will go up to 3.5 crores.
You can use your life context, your goals and apply the method explained here to get a number. Knowing it and understanding how close or how far you are from it will help you immensely in deciding how you need to run your financial life.
I will do a post with my numbers next to explain this even better.