To achieve this FIRE (Financial Independence, Retire Early), 25 times annual expenses, that is 4% withdrawal rule is used in Western countries.
Would it work in India? What do we have to change to fit that to India? What are all the variables should we consider for that?
Lets dive deep in those in this episode. Hi. My name is Vijay Mohan. You are watching “Investment Insights”.
This FIRE movement has just started flaring up in western countries. I mean, it is getting its attention.
Before we see how we can change that to fit to India, lets check out how westerners are using this to calculate their needs.
The generally accepted rule for this FIRE is, to save 25 times annual expenses as networth.
If we take X as the annual expenses, 25X is the need for FIRE.
After FIRE, that is after early retirement, we withdraw 1X from this 25X every year for our annual expense needs.
What is the share of 1X in 25X? 4%. This is why it is called as “4% withdrawal Rule”.
That is, we are withdrawing 4% out of total networth every year for our annual needs.
When we withdraw like this every year, would our principal 25X sit there doing nothing? No.
That would grow every year as well. How fast does it grow? That depends on the type of asset that we have invested.
What happens when that growth is bigger than our 4% withdrawal? We would be able to withdraw money every year till our death like from a Aksaya patra (bottomless pit).
Whatever left after our life can be passed on to next generation.
Lets take a look at this using an example. That will help us to understand this better.
We are looking at a very simple calculator. This is not created to show the data accurately.
But rather to show what kind of impact each variable has on our FIRE calculation. Do not expect accuracy here.
Lets assume that our annual expense is $75,000. Its 25 times is 1.875 Million.
For now, lets leave the inflation and expected return rates as 0.
If we withdraw 4% ($75,000) every year, we will run out of money in 25 years.
That assuming that our principal 1.875 Million is not invested on anything.
But what if we have invested it to generate 8% returns? Then after 4% withdrawal, the balance would keep growing at a rate of 8%.
Or in other words, out of 8% growth, we are withdrawing only 4%, which is half of the growth.
This leads to our balance grow every year. The balance, which started as 1.875 Million would end up as 41 Millions in 50 years.
What are we missing in this calculation? Check out the annual expenses.
It is remaining the same 75,000 for 50 years. Would our expenses stay the same for 50 years?
It will definitely rise. The expenses will rise at the same rate as the inflation rate.
Now lets update our calculator to use the historical inflation rate of US, 2%.
Now we can see the annual withdrawal is rising 2% every year from 75,000 in year 1.
After taking inflation into account, our annual expenses would have risen from 75,000 to 198,000 in 50 years.
But the balance would have also risen from 1.875 million to 28 millions. This is for our assumed return rate of 8%.
Even if that return rate is 6%, there would have been 3 millions left after 50 years.
This 4% withdrawal rate would have lasted our life time, even for historical data backtesting considering the stock market return and inflation for the past 120 years.
That is why this 4% rule is widely accepted as good enough for FIRE in western countries, especially US.
Now lets go to India tab and check out the numbers for Fire in India.
Lets assume that our annual expenses is 10 Lakhs. 25 times that is 2.5 Crores is in liquid assets.
Again, for a 0 return and 0 inflation, this money would have been gone in 25 years.
India’s inflation range is between 4% and 8%. Lets use the average 6% in our calculation.
If the inflation is 6%, our money would have been gone in 16 years. This assuming that we holding all the money under our mattress without investing.
But if we have invested this money for a 8% return, the balance would have lasted for 33 years.
For a 10% return, the balance would have lasted for more than 50 years. What do we learn from here?
For the widely accepted 25X (4% withdrawal rule) rule to work in India, we need at least 10% return.
Till now, we were reviewing how to identify our needs. Now lets dive deeper into these variables.
Because all our life style and personal choices are different. If we understand the significance of these variables, we can adjust these to fit our needs.
First annual expenses. Update this number depending on the expected annual expenses in the place where you are planning on retiring.
You might retire in Chennai or in a peaceful remote place. Only you know your needs.
So use the value depending on that.
Next is Expense multiple. Update this number depending on your situation.
I have planned to live till 120 years. ;) Its just a plan. We can be generous on it. Nothing wrong with that.
At least, planning to live for 95 years would be a safer assumption.
But if you say what am I going to do after 75 like a pessimist, it is your choice.
So to live till 95 and to retire at 45, we need a retirement corpus that can last for at least 50 years.
We have used 25 as the expense multiple. This means, our balance has to grow at least 10% every year to last for 50 years.
10% is a very aggressive expectation. If you ask me, using 8% here would be safer.
But for 8%, as we already saw, this will last for only 33 years.
So for 8% growth to last for at least 50 years, we need a networth of at least 35 multiple.
35 is minimum requirement. Targeting 50 would give us enough safety net.
We can call this as normal FIRE for India.
But to FIRE with more comfort and confidence, we would need 70 to 100 multiples.
A 100X multiple would be a BIG FAT FIRE.
Next is networth. Include only liquid assets here.
Because we can withdraw our annuals needs only from a liquid asset.
If you want to include your real estate as well, then use appropriate expected return rate.
Expected return rate - its better to assume 8% or less here.
Change this % to match your comfort. Do not go over 10%. That will make the plan very aggressive.
It is difficult for it to work in long term. Also, the % of Bonds and Stocks is your personal choice as well.
Use a % allocation to your comfort. If you are targeting 35X, it is better to have less than 50% exposure in stocks.
For folks targeting 70X or more, you can have even 100% in stocks depending on your comfort.
Expected inflation - If you think 6% is too less, you can use 8% in your calculation.
Do not go less than 6%. That will be an aggressive plan.
Link for this spreadsheet is in the description below. Copy it to your account and use it.
Many have asked how to copy this to your account.
Go to File in top menu and click “Make a Copy”. That will copy the file to your account.
That will enable you to edit it.
All this plan looks good. But what are all the risks?
The biggest risk of all is the expected return rate. We have assumed a conservative 8% return here.
We all know that we cannot expect a constant return like this every year.
It will go up one year and go down another year. We cannot say anything for sure.
We can only say that it will go up in long term.
For our bad time, if the market goes down 50% just after our retirement?
If we check the stock market history, the chances of that happening is once in 50 years.
But still we need to be prepared to handle a situation like that.
If that happens, if our networth is at 35X and 100% in stocks, it would have taken a heavy hit and dropped to 17X.
That is why, for folks with 35X as target, it is dangerous to have more than 50% as stocks exposure in their portfolio after retirement.
The same incident would not have hurt 70X folks that much. Because they would have enough balance and have the luxury to be patient for the market to recover.
Again, the chance of this 50% drop is very less. But still a person who is planning for FIRE should account this in their calculation.
We cannot expect everything to be Rosy in the future.
Next risk is - this calculator is only accounting for early retirement needs and is not accounting for kids college expenses or their wedding expenses.
It is better to track kids college expenses separately. I will cover that in a separate video.
But if you are targeting the FAT FIRE 100X, then you do not have to save separately for kids education.100X will easily cover that.
Third risk is - what if an unexpected expense occurs? It is better to have extra buffer to handle that as well.
How much would be personal choice. 5X to 10X makes sense.
So in summary, we need at least 35X for FIRE in India.
For a comfort FIRE, we need to target 50X to 70X.
For a luxurious FAT FIRE, 100X needs to be targeted.
25X by itself sounds very exhaustive, but you are saying we need 100X for luxurious FIRE? you may think.
100X can handle any situation. 50X can handle 95% of the situation.
25X can handle 75% of the situation. Do not ask where this % is coming from.
All wild guesses. It helps to see the relative risk among these 3 options.
Targeting 25X does not mean that you will definitely end up in a problematic situation.
But we can say that the chances of that happening is 25%. May be even less.
All these are just rough guidance. Most of all, FIRE needs our flexibility.
We can expect optimistically. But when things do not go as per our expectations, we need to be ready to work to generate a side income.
Or be ready enough to downgrade the lifestyle.
As the saying goes, “When life gives you a lemon, make a lemonade”, as long as we are flexible, we can FIRE even at 25X.
It all depends on how self confident you are.
Another important thing to know is, when we achieve our FIRE goal, we do not have to retire immediately.
This gives an extraordinary power to you. Gives lot more confidence to speak in office.
You do not have to go along with the way of anyone in the office.
You will get the confidence and boldness to say and do the right thing.
When you have a confidence and boldness like that, bigger responsibilities will come automatically to you.
We should achieve FIRE just for that purpose. Totally worth it.
That is why this is called as FU money. If you do not know what that is, search it in google.
Good Luck with your FIRE journey.
We will take a deep dive into Index investing in the next episode. Thank You for watching.