Several people have routinely asked me whether I planned for this or that before deciding to retire early. Well I planned the way that works for me under my circumstances. There is no one size fits all and no one comprehensive definite solution. None the less, since so many people have this question about how to go about planning for financial independence, I thought I should write a post about it.
So what were your questions? Some have asked me if I had planned for child's education, child's marriage, travel, medical expenses, inheritance etc before deciding to retire early. I planned for none of them except for a little bit of travel after my early retirement. That is it. Nothing else. Of course not everyone can be in my situation, so I would not expect you to follow the same route. However, here are some things to look out for when you are making a plan for financial independence.
What is financial independence
Financial independence does not necessarily mean that you will not work. Neither does it mean you need to give up on all desires and live like a pauper. It just means that you have enough savings to allow you to live life as you please. Some may decide to work on their passions, some may work on their hobby projects, others could be spending time with NGOs, or time with family. It is also possible that some may still continue working, but on their own terms.
Money is just a means to realize financial independence but not an end goal. You should have other goals, some of which I have listed below, but not all of them need apply to everyone.
Be debt free
Before you can retire, you should be completely debt free. You should not have to worry about paying EMIs on car or house or anything at all. Because almost all loan interest rates are more than what your corpus can generate.
Plan your children's education expenses
You should have planned and accumulated enough corpus to see through your children's education. You can use the Funding Child’s Education Expenses calculator to figure out how much you need to save for each kid. Just add up the numbers for all your kids and you should have saved that much. Read goal based investing to understand how to change asset allocation based on how far your goal is. As your child nears a goal, you should be having more of your savings in safer funds like ultra short term debt funds or FDs.
Plan your child's marriage
If you like to save up for your kid's marriage, figure out how much it would cost today. Then, use the compound interest formula to find the corpus you will need when your child will get married. You will have to figure out some inflation rate for marriages. Save up for that.
While a medical insurance will cover some expenses, it will not be sufficient for all medical emergencies. Some procedures run into several lakhs and insurances do not have such a huge cover. Add to it, these expenses could be recurring (chemotherapy, dialysis). So figure out how big of a medical emergency you want to cover. You could set aside Rs. 1 Crore worth of savings for emergencies and it may still not be sufficient if your fate is such. Only you can come up with a number that you are comfortable with. The inflation rate for medical expenses is very high so the future value of a such a corpus will have to be large.
If you are planning on leaving something substantial for your children, plan for those goals. May be you want to leave them land, or house or a private jet. Whatever it is, make sure you have already purchased it and paid off the loan.
If you like travelling, you definitely should have this in your list. How frequently you want to travel and how much you want to spend on each trip will determine your expenses. Figure out the annual expenses of such trips and add it to your total expenses (see bottom of the page).
What I call as annual expenses include expenses that don't occur frequently. For example repainting your house or refurnishing fall under this category. Your car, electronics, computers, phones etc also need replacing at some point. All of these come under annual expenses. For a better understanding of how to plan for these kind of expenses, read my annual expenses explained post. Then figure out your annual expenses.
Your day-to-day expenses come under what I call as monthly expenses. These should cover your groceries, cell phone bills, electricity bills etc. For a better understanding of how to plan for these kind of expenses, read my monthly expenses explained post. Once you have figured out your monthly expenses, multiply it by 12 (the expense for the whole year).
Add up your travel expenses, annual expenses and monthly expenses times 12 together and you arrive at your total annual expenses. Multiply that number by 25 (for a 4% withdrawal rate) to arrive at a number. Lets call it X. Then, add the corpus you planned for children's education, children's marriage, medical emergency, and inheritance to X. That is how much you need to save up today to be financially independent.
Corpus needed = children's education corpus + children's marriage corpus + medical emergency corpus + inheritance corpus + (annual travel expenses + annual expenses + annual monthly expenses) * 25
Of course you may have other goals in addition to what I have listed above. So make sure to add all of them too. If you found the formula too difficult to comprehend then you are not a DIY (do it yourself) sort of investor. Hire a good financial planner.