Moneycontrol
Last Updated : Feb 19, 2019 12:07 PM IST | Source: Moneycontrol.com

Understanding ‘This Formula’ will accelerate your Financial Independence

Being financial independent (or financially free) means different things to different people. But the idea is not just about having ‘enough money’.

Moneycontrol Contributor @moneycontrolcom

Dev Ashish

There is something about Financial Independence (FI) that attracts a lot of working people.

Maybe its because they hate their jobs or maybe they want more flexibility in lives or maybe they just want to do something else that they really want to. Financial Independence indeed offers the exit option that many people have been waiting for years.

And the fact that you are still reading this article is proof that you too feel that being Financially Independent can do a lot of good in your personal life. Isn't it?

Being financial independent (or financially free) means different things to different people. But the idea is not just about having ‘enough money’.

It’s more about how having enough money can give people the ownership of their lives and time back again. And that feeling or thought itself is liberating.

You may now ask.

How much money is enough to become Financially Independent?

There is no perfect formulae becoming financially independent. Everyone will have a different number.

But still, there is a thumb rule good enough to start with:

You need savings of 25-30 times current annual expenses for achieving Financial Independence

Disclaimer: 25-30X is just a thumb rule. Savings worth 25-30X annual expenses might be enough for some people’s financial independence but might not be for others.

It actually depends on a wide range of factors like age, targeted age of financial independence, life expectancy, inflation, expected returns, handling sequence of returns risk, etc.

Nevertheless, targeting about 30X of current expenses is a good starting point. And if you are just beginning the journey, it’s a good enough aim to have.

As your savings begin to grow and years pass, you will have a better idea about future expenses and you can then have a more accurate financial independence calculation done for you.

So now you know you need 30X to become Financially Independent. Now comes the interesting part…

How to accelerate your Financial Freedom?

Here is an example for better understanding.

Suppose Deepak’s annual income is Rs 15 lakh. And his expenses for the year (let’s call it X) are Rs 12 lakh.

Remember the so-called thumb rule for financial independence?

30 times annual expenses, i.e. 30 X

Using the above logic, Deepak would need 30 times Rs 12 lakh - which is Rs 3.6 crore to become Financially Independent. But aren’t we missing something?

Yes. Deepak needs to save and invest too. And for that, he just has Rs 3 lakh every year (Rs 15 lakh income minus Rs 12 lakh expenses). So how can Deepak actually accelerate this?

Here’s how: If the Expense (i.e. X = Rs 12 lakh) is reduced, Deepak can save more and in turn, reach the target of 30X faster.

The annual income is the same as earlier Rs 15 lakh. But Deepak cuts down unnecessary spendings and reduces annual expenses (X) to Rs 9 lakh (from Rs 12 lakh earlier).

Let’s use the 30X thumb rule again.

Deepak now needs 30 times Rs 9 lakh - which is Rs 2.7 crore. Do note that this figure is less than the earlier calculated Rs 3.6 crore. So the first thing that happens is that the target is reduced to Rs 2.7 crore.

Now comes the magical part.

Did you realize that Deepak now also has a much higher Rs 6 lakh surplus every year (Rs 15 lakh income minus Rs 9 lakh expense) to save? This figure is double the earlier surplus of Rs 3 lakh.

So essentially, what has happened is that Deepak’s target has been reduced from Rs 3.6 crore to Rs 2.7 crore. And he can also save a much higher Rs 6 lakh (instead of Rs 3 lakh).

This is a double positive benefit of having a reduced target and higher savings capability!

Using the thumb rule of 30X, here is what happens - If the expenses (X) are lowered, a smaller corpus would be needed to become financially independent. And a smaller corpus requires a lesser number of years to achieve it. More importantly due to lower expenses, the surplus for savings is more. Hence more money can be saved. Hence the double acceleration!

If you have read till here, it is safe to say that you are interested in financial independence. But if you still aren’t convinced and feel that you will work till 60, then you need to wake up.

You can never be sure when you might be made redundant in profession due to inability to keep up, the collapse of the industry you are working in, your deteriorating health or maybe due to some other random and unknown risk.

Hence, you would be better off with some large savings base if you aim for some level of financial freedom. It’s like being prepared and having a Plan-B for the possibility of forced early retirement.

That said, you now know how you can begin your journey of financial independence with some target in mind. And more importantly, how controlling expenses can have a double positive side effect on how quickly you achieve it.
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First Published on Feb 19, 2019 12:07 pm
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