When you are young, retirement might not seem like something to worry about. The retirement age in India varies between 60 and 65 years. So, you will work all your life, and then one day, your employer will say, “Thank you so much. Your services are no longer required.” And then you will live the rest of your life with the money you saved up. Sounds simple, until you realize that it does not leave much room for living your life. What about your aspirations—the books you wanted to read, the paintings you wanted to make, the vacations you wanted to go on?
This is from where the idea of early retirement arises.
A change in perspective
To retire early, you first need to change your perspective. You must believe that the meaning of retirement is not the end of your career but the beginning of your life. So, do not wait to retire when you are old; do it when you can afford it. If you want to retire at 40, the target should be to achieve financial freedom.
What is financial freedom?
It is a stage of life where you do not have any debts and have enough savings to lead a comfortable life. Financial freedom allows you to get a job that you love or not work at all. A popular concept to achieve that goal is Financial Independence Retire Early (FIRE).
What is FIRE?
The idea of FIRE is simple; you can retire early as long as you concentrate on extreme savings and building a substantial fund with investments. The goal is to pay off all your debts and start generating passive income before retirement. So, you might have to practice frugal living today to enjoy a comfortable life tomorrow.
Now, the big question is, “how much money should you have post-retirement?” This can be answered with the idea of a safe withdrawal rate, a formula introduced by William Bengen in 1994. It is known as the 4% rule. According to him, your retirement fund should be 25 times your annual expenses, which allows you to withdraw 4% from the fund every year. This gives an idea about how much money you would need when you retire.
Lessons from FIRE movement
The FIRE movement has a lot to teach about planning and saving for retirement. Check out the below points carefully before you start implementing the concept.
- Start financial planning for retirement early. When your target is clear, it is easier to achieve it.
- Control your expenses. The lower you spend; the higher will be your savings.
- Find additional sources of income. Part-time jobs can help you save more.
- Make saving and investing a habit. FIRE encourages you to use a large portion of your income for these purposes.
Why does FIRE not work for everyone?
Proper retirement planning is for all, but the same method cannot work for everyone equally. One of the drawbacks of the FIRE theory is that it assumes you have a large income. Without it, there is no way to build up considerable wealth before turning 40. Moreover, the 4% rule works only if you spend the same amount every year. It does not take inflation and financial emergencies into account. You also may even have to give up on some of your dreams, like traveling to foreign countries or buying expensive things. So, FIRE does not work for everyone.
How the calculations can be adjusted to the Indian context
William Bengen’s idea of a safe withdrawal rate was based on the Western culture, financial system, and lifestyle. So, it is obvious that the theory will not entirely work in a country like India, where the inflation rate is high and income tax slabs keep changing regularly.
If you want to make an early retirement plan in India based on FIRE, you need to adjust the formula slightly. A retirement fund worth 25 times your annual expenditures will not be enough. It needs to be at least 30 times your yearly expenses. But how much money will you need exactly? Let us calculate that with an example.
Assume your current age is 25 years and your monthly living cost is ₹50,000. If you want to retire by 40, you have 15 years left to accumulate the retirement fund. If the inflation rate is 6%, your monthly expenses will rise from ₹50,000 to ₹1.20 lakhs by the time you turn 40. This means you will need ₹14.40 lakhs a year to maintain your lifestyle.
By this calculation, you should have a little over ₹4.30 crores by the age of 40 to attain financial freedom. Saving alone will not help you reach that mark unless you start investing in profitable financial products today. You must put ₹12.61 lakhs a year in an instrument that offers an annual 9% compound interest to accumulate ₹4.30 crores in 15 years. And this will require you to set aside ₹1.05 lakhs per month, starting from today.
Steps to follow for early retirement
Before you start the financial planning for retirement, you must consider the factors given below:
- Define retirement: Determine how retirement looks for you. You must decide whether you want to stop working entirely or do something that you like.
- Calculate your expenses: To begin with, you must estimate your yearly expenses. Take note of every outflow carefully. Once you have a precise number on paper, planning your retirement will be an easy process.
- Lead a simple life: Aggressive savings and investments are the only ways to build a large retirement corpus. So, you must significantly lower your monthly spending and try to lead an inexpensive life.
- Make investments: You cannot save up enough for retirement without passive income sources. So, you must invest in financial products that can offer high and stable returns, like Public Provident Funds (PPFs) and mutual funds.
- Pay off loans: Make sure that all your debts are paid off before turning 40. You do not want that financial responsibility after retirement.
Achieving financial freedom is possible if you start investing early. Although it is essential, it does not mean you should compromise your lifestyle in the process. You can create a considerable retirement fund with proper planning and diversified investments. But, if you feel like going on a trip or buying a new phone, do not deny yourself that joy. You can make a financial adjustment later; remember, you only live once (YOLO)!
This is a companion discussion topic for the original entry at http://jupiter.money/resources/how-to-retire-at-40/