Last week I got talking to an old friend of mine about the budget and the conversation soon turned to financial independence. Fortunately for both of us, we are financially independent though still actively earning though activities we love to do. I wanted to capture the summary of our conversation as I think it will help many readers of the blog.
In very simple terms, financial independence is a state where you do not need to work actively for generating an income. Note that this does not mean you should not be working – you may well do so and earn money out of such work. However, even if you were not working in a similar manner you would still be able to lead the life that you wanted to. So, contrary to what many people think, financial independence is not synonymous with early retirement. Of course, you better not think of early retirement unless you are financially independent but that is as far as it goes. You can be in a FI state and continue with your job and business for as long as you want. In my personal situation I am in a state of FI but I do take up consultancy assignments that are of interest to me. What I earn through this is either invested or used for charitable causes that are dear to me. However, I do not depend on this income to fund the lifestyle I have decided to have, now or in the future.
Many people ask me whether it is necessary for them to get to the FI state if their plan is to work till 60 or more. Surely you need to be FI only when you are no longer having an active income? This is unfortunately a fallacy and you need to understand this well. Let us look at some of the things that may create the need for being in an FI state as early as you can:-
- You may be in a job or career that you do not like much. Your being in an FI state will enable you to look at options in a much bolder way.
- There may be a passion you have which you want to convert into a business. Once you are in an FI state you will be able to take a plunge in a much easier manner.
- In the private sector today job losses are an unfortunate reality. Your ability to cope with such a mishap is significantly more when you are in an FI state.
- If something were to happen to you, the family is covered by insurance. It will however be a much better situation if you are in the FI state. Think of this as the ultimate insurance option that you can gift your family.
Now that we have established that being in an FI state is an imperative, let us see how we can get there. I will take an example of a person with a family of 4. Ravi is 40 years old with 2 children of 12 years. His details are as follows, to arrive at his FI figure.
- Current expenses are 10 lacs per year. When his children go to an Engineering college it will go up to 18 lacs per year.
- After they pass out the expenses will be 8 lacs per year.
- All of the above are expenses in the current terms.
- For being FI today Ravi needs 6 years @ 10 lacs, 4 years @ 18 lacs and finally 30 years @ 8 lacs. Here it is assumed that Ravi and his wife will live till they are 80.
- So for Ravi to be in the FI state today he needs 3.72 crores in current money.
- Now, Ravi may have about 2 crores totally, including his current value of PF accrued. This means he will need to accumulate an additional 1.72 crores to be in an FI state.
You can go ahead and calculate your FI number, compare it with your present portfolio and see how you are doing. Based on this you can then figure out a way to bridge the gap. If the figure appears large do not despair. The example given is a worst case scenario, assuming zero real rate of returns. If there is a 2 % real rate of return, the calculations change dramatically.
Financial independence is an imperative for all of us, irrespective of our life situation or for how long we want to work. In simple terms you will be able to enjoy a significantly richer and fuller life when you are in an FI state.