As the year is coming to an end, I have decided to do a series of posts on how one should be investing in 2016. There are many ways to approach this and I will choose the simplest one. We will try to look at why we are saving ( goal ), how much we need to save ( goal amount ), what should be the investment approach ( asset classes ) and finally how much we should invest in each of the asset classes ( investment plan ). Let me start by talking about the goals in this post.
I am personally a great believer in the minimalist approach and I think the fewer aspects you have to consider, the greater can be your focus. Now many of you will be thinking that you have a whole lot of financial goals, so how is it that I am recommending to deal with a single goal? Relax, I am not trying to suggest that you give up your goals. I am only suggesting a mechanism by which all of your different goals can be consolidated into a single goal. If we are able to achieve this, it will be far easier to track and manage. You will be knowing at any point of time as to how much you really need and how are you doing with respect to the need.
All of us who are working in a job or business are fundamentally trying to achieve Financial independence, which is really a state where you can live your life without depending on a regular active income. There are several posts I have written on this, if you are interested search the archives of my blog and read them up. The single goal you should be having is the FI number. While this can be expressed in absolute money terms, I prefer to view this in terms of multiples of your current annual expenses.
How do you work out your FI number? Well if your current annual expense is X and you are going to live for another 40 years according to your estimate, then the retirement component will be 40X. For all your other goals you get a value based on the current costs. For example if X is 6 lacs for you and your son needs 12 lacs for college in today’s costs then that goal will be amounting to 2X etc. Do this for all your goals and add them up to get your FI number. As I said before, you may need to read the other posts on this topic, there are a few good case studies too in the blog.
Once you have your FI number, you can compare your current value of investments to it and see how you are doing. Let me give an example of how this will work in a typical case:-
- Ravi is 40 years old and his current annual expenses amount to 6 lacs. So here we have X = 6 lacs
- His FI number is calculated to be 60X, assuming he will live till 80 and taking care of all his other goals.
- In current money terms if Ravi has 3.6 crores today, he can consider himself to be financially independent.
- At present Ravi’s current value of all investments combined is equal to 1.8 crores.
- Ravi has therefore reached 50 % of his goal and must continue to work and invest more over the next few years.
What should be your financial resolution for the new year? You must know your FI number and be able to say where have you reached in achieving the same. If you are able to do just this much, you are definitely on the road to financial freedom.