Financial freedom is the freedom to be who you are & to do what you want in life, without being limited by monetary considerations.
A plan for financial freedom projects
- Minimum Corpus that would make it possible for one to live the desired lifestyle without the compulsion of having to work for a living &
- Minimum Savings that could accumulate into the desired wealth size – subject to assumed post-tax return on investment of such savings.
Assumptions have to be made for such long-term projections
- Inflation before & after retirement
- Overall after-tax portfolio return
- Life Span
- Retirement Age (***age at which no compulsion for earned income)
Both these projections are far into future. A Danish politician once said “It is difficult to make predictions, especially about the future.” The remark may have been a tongue-in-cheek one but it does highlight the peril of making financial projections in a dynamic & complex environment, more so when assumptions have to be made for all the knowable & unknowable variables in the mix. A financial projection is only as good as the quality of data & the underlying assumptions. The challenge is even greater if time period under consideration is long as then the impact of each error gets amplified.
It is a very risky bet indeed to live one’s post-retirement life on the trust of a single figure that has emerged from financial projections. Before one draws a line in sand of time to indicate the inflection point of financial freedom, it is important to monitor progress towards this goal. One can opt for retirement only when ‘earned income’ ceases to be the primary reason to remain in employment / business.
Tracking the Progress
Focus of portfolio review has to be on the worth of corpus being accumulated. Corpus value would provide the answer to
- if retired – for how long would the funds bear lifestyle expenses (inflation adjusted)?
- if working – how soon can one retire?
Formula to calculate the years –
NPER(real return,-income,current corpus,,1)
- Real Return = (1+ return)/(1+inflation)-1
- return refers to post-tax return
- Income refers to the amount required to manage expenses in the first year i.e., current expenses that will persist. The negative sign before income is to represent withdrawals.
- This amount will be withdrawn each year from the corpus. Withdrawals each year will increase at the rate of inflation assumed in the real return calculation.
- Balance corpus (after withdrawal) will grow at the rate of return assumed in the real return calculation.
- Input between the two commas refers to targeted legacy amount. This is optional. If left empty, it is assumed the yearly withdrawals will reduce the corpus to zero. If you set some value here, the yearly withdrawals will reduce the corpus to that value.
- Current Corpus refers to the accumulated retirement fund.
- The “1” refers to the withdrawals made at the start of the year.
NPER is a simple measure to appreciate ‘where we are’ in our journey to financial freedom, given the underlying assumptions.
Market returns are non-linear.
Asset Allocation undergoes a change with a change in risk tolerance, which directly impacts return (key input in the formula). It is a long period that is under consideration – before & after ‘earned income’. Each of the assumption has to be appropriately adjusted with a change in long term trend of inputs or with change in circumstances related to lifestyle.