Towards Financial Freedom… Ahoy!

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“The arrival of winter finds us in one of two categories: Either we are prepared or we are unprepared.” – Jim Rohn.

The Covid19 pandemic has forced the world to slow down; an otherwise a fast-paced life. A life where most work hard to fund their living. In order to accomplish the ever-increasing aspiration they end up only working for the living and forgetting to live a life.

The rare lucky ones are gainfully employed in what they love to do; long working hours or work-related stress do not reside where there exists a perfect harmony of purpose, passion & profession.

While the majority harbouring the desire to move up the corporate ladder as quick as possible. Moving up the ladder quickly comes at a price; the price of distorted work – life balance and added stress. Well, there is nothing wrong with this either, it’s a personal choice and the trade-offs of the choices made.

In the movie “Zindagi Na Milengi Dobaara”, Hrithik Roshan plans to work exceptionally hard to earn enough and retire by the time he hit his 40. Many people echo similar thoughts – the thought of Financial Independence or Financial Freedom .

What does Financial Independence mean?

If the passive income from investments is either equal to or more than the money required to fund the living is Financial Independence

This financial independence allows the freedom to live the life one desires without having to worry about money. This could mean different things to different people – some pursuing their passion, some spending more time with family or some simply slowing down on the corporate rat race. Simply put, an early retirement.

How much is enough to fund the early retirement?

The first task towards achieving the financial independence is ascertaining the goal-post right. How much money will be good enough to sufficiently fund the early retirement?

Retiring early is no different from your
retirement planning . The only difference being that the retirement date gets preponed and the need to live on passive income for a longer time.

There could be two approach to arrive at the number (i.e.- goal value) and achieving them –

1. The conventional retirement planning.

Please read our earlier blog to understand
retirement planning . This will provide a good perspective on how to accumulate the retirement corpus and use them over the lifetime.

You can also use the link to ascertain the amount of money you will need to fund the retirement goal.

The challenge with the above model is fear of outliving more than what you have planned for; the risk gets slightly elevated in case of early retirement as it would also include funding few more milestones such as Children’s education, their marriages or any healthcare needs.

2. Investment Yield approach

The investment products that can yield consistent recurring returns are Rental yield , Dividend Income and
Interest Income . The income streams of these products are called passive income. These passive incomes must add up to sufficiently fund the ongoing expenses for the living.

Rental yields – is the rent received divided by the market value of the property. The rental yield of the properties varies across geographies

Some offer excellent yields while some not so good. The annual rental yield in India is very low at less than 2.5%.

Dividend Yield – is the dividend received on direct shares of the companies divided by the market capitalisation of the company.

Markets like India & US have lower dividend yield, while some markets like UK & Australia have higher dividend pay-out ratio.

The current dividend yield of Indian companies stands at 1.55%.

Interest Income – There are various fixed income products in India – small savings schemes promoted by the government of India; the bank fixed deposits and corporate fixed deposits. Each fixed income products are priced differently given the credit risk each one carries.

Please note that the above yield & interest income are pre-tax returns and one must factor the taxation before arriving at the net yield.

The post-tax returns of a Corporate Bond Fund with good credit quality will outperform the fixed deposits over a three – year period. However, the Public Provident Fund purely from asset allocation perspective yielding a tax-free return of 7.10% looks attractive as well.

Combined Yield – By combining the above
investment products it is possible to generate 4% yield on the portfolio without letting the principal erode. This approach is a very conservative approach where there will be no risk of outliving the accumulated corpus or funds. The flip side of this entire model is that it requires relatively a larger sum. This yield combination must be applied after retiring and it is not a plan to accumulate the retirement corpus .

Corpus Required = (Current Annual Expense/ Combined Investment Yield)

If the monthly expense is Rs 1 Lac adding to Rs 12 Lacs annually; then the retirement corpus must we Rs 300 Lacs (25 times annual expense).

A very simple formula to work for people who do not love numbers.

Avoid the passive income misconception

Many people run a common misconception that investment must generate passive income immediately. The passive income gives a lot of confidence and sense of security. However, the passive income generated but not re-invested fails to reap the benefit of “Power of Compounding” – the ultimate secret to wealth creation.

Passive Income is not about plucking the fruits. The entire concept of passive income rest on the fundamental of growing the Orchard, allowing it to grow without plucking the fruits prematurely. Post achieving the retirement corpus, it allows the peace of mind to safely generate a portfolio yield of 4% year on year and live happily ever after.

Wishing you all Happy “Financial” Independence Day.

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