Many of you would like to retire early, given an option. You would like to renounce the corporate race, reduce work tensions, have more time to pursue what you like the most. This could be more time with your family, travel, community service or starting your own business. Retirement is all about doing what you like and when you like. This might seem to be imaginary but an early retirement is possible, if you plan methodically. Let us discuss below what are the ways and means to achieve this.
Compute how much you need
You need to calculate the amount of money you will need during your retirement. Essentially, you should compute two numbers: (a) the annual amount of income which you need to live on in retirement. (b) the size of the retirement corpus which will be needed to generate that much income.
Experts say that one should plan to retire on an income which is 80% of the pre-retirement income but depending on your future plans the actual number could vary. Once you have arrived at your income figure, then you can calculate the size of the corpus necessary to product that much income.
Arriving at the corpus size
It is assumed that if you withdraw 4% of your investment portfolio each year as income, your portfolio will never drain out. It is on the expectation that your corpus will generate a 6-9% rate of return per year. This means that your corpus will not only generate enough income to cover your withdrawal but will also keep growing.
We can take 4% as a safe withdrawal rate. You can multiply the annual income number by 25 to arrive at the corpus size. Four per cent is one upon 25 of your portfolio. Accordingly, let us assume that you need an income of `6,00,000 per year, then you need to create a portfolio of `1.50 crore which is 25 times of your annual required income. But, you also need to factor in inflation.
Enhance your income
Having arrived at the corpus size required, if you believe that you will not be able to reach your corpus amount by the time you wish to retire, then you need to increase your income. Ensure that whatever the extra income that you earn goes into the corpus. To enhance your income, there are multiple ways. You can improve your qualifications to get a better paying job, take a part-time job, set up a side business or a combination of all.
Stay away from debt
Taking loans will disrupt your early retirement plans as it reduces your cash flow as you need to service the debt. If you are comfortable with debt, there is a higher probability that you will carry some debt during your retirement period. This will increase your cost of living post retirement and you need to save more and create a larger corpus to service the debt too.
Don’t be house poor
The term ‘house poor’ describes the scenario where one is living in a big and beautiful house, but majority of his cash flow goes towards payment of mortgage instalment which leaves very little money to do anything else. If you are in such a scenario, early retirement is a distant dream as bigger and beautiful house requires more in maintenance, expensive furniture and fittings, utilities, etc.
So, your housing mortgage is not only a long-term expense but also have an impact of your cash flow.
Early retirement which is often called as financial independence is a simple concept. You need enough money to create income to support your lifestyle for the rest of your life without getting employed. It is difficult but doable task provided you apply the above strategies.
The writer is associate professor of finance & accounting, IIM Shillong