This is a plan to set you free. Free to choose that path less traveled without having to worry about taking care of those who depend on you.
Is it easy? Read on and judge for yourself.
What does it take?
Everyone knows that all you need to do is save up enough money which would generate investment income equal to your salary. The question is how does one do it?
Let's say you are a 25 year old earning Rs 40,000 per month. Here's how:
Year 1: Save Rs. 12,000 each month and invest it in a set of good diversified equity funds. Equity funds historically return a long term average return of 14-16%. We will assume 14% for this plan.
Year 2: Increase your investments by 10% to Rs. 13,200 per month. This is not too difficult because you can expect your salary to increase by 8-10% every year!
Years 3-20: Repeat the 10% increase every year in line with your salary increase and stay invested in good equity funds. During this period, you will probably encounter 3 or 4 market storms when it would seem that every thing has gone to h***. Stay the course.
The entire calculation is in an excel sheet here.
*Equity growth is illustrative. It will never grow at a steady pace as shown. Markets tend to fluctuate and you will see large ups and downs.
If every thing goes according to plan (there is a possibility that it may not, more on that later), in 20 years, you would have accumulated Rs. 3+ Crore. That sounds like a lot of money by saving only Rs. 12,000 per month!
And it is. In fact, you would have contributed only about Rs. 90 lakhs of this. The rest comes from that magical thing called compounded return. It's good to have a friend like that working for you!
Now for the regular income
By the time you get to this point, your expenses would have gone up too and you would need about Rs. 1.3 lakhs per month to meet your expenses. Here's what you would do now:
Step 1. Take 5 years worth of expenses (Rs 80 lakhs) and put that into a debt/liquid fund. Keep drawing from it every month for your expenses. (Technically it's not really “Salary”, but really?)
Step 2. Let the rest remain in equity funds so your friend – compounded return – keeps working for you.
Step 3. At the end of every 5 years, take 5 years worth of expenses from the equity funds and add to your debt funds
Step 4. You are all set for the next 50 years. Now, go change the world with that brilliant mind of yours!
By the way, what you did above is called an "income ladder" and is an awesome way to generate inflation protected income when you stop earning. Aren't you feeling really smart now!
What could go wrong with this plan?
Return from equity investing, while higher than say an FD, is not certain and it may just happen that 20 years from now the markets are down and you have less money than planned. There is no need to panic! Markets usually get back to average.
That's the thing with plans – they need you to adjust and correct course based on what happens. And, just as poor markets can delay your quitting date, good market conditions may help you quit sooner. That's just life.
I don't know if I can do this?
We never said it was easy. But we have an alternative plan for you to try – think of it as this plan with training wheels.
Are you ready for the challenge?