It is a persistent question on everyone’s mind. How much I need to save per month for a stress-free & early retirement? Am I saving enough? What should be the ideal expense to savings ratio? Follow these 4 simple steps in order to plan for your retirement savings and achieve financial independence:
- Track Current Expenses (CE)
It is a first step towards any sound financial planning and particularly so in planning for retirement. Without knowledge of your current expenses (CE), it is almost impossible to understand what sort of annual or monthly budget would be required few decades down the line. More so it is difficult to judge how much of saving is possible without understanding the outflow.
You may be able to identify extravagant expenses & make appropriate cuts in your CE to clinch that goal of early retirement. These days there are variety of apps available, such as Finart, to help you automatically track and categorize your spending.
- Determine Cost of Living (CoL)
Cost of Living is a subjective term and depends on your city & lifestyle. But it can be crudely defined as the expenses required for bare necessities such as house, groceries, transport etc.
- If you are supporting a family, it will also include their expenses such as Children’s school fees etc.
- If you have incurred any major expense such as buying a TV or a vacation, average it over a year and include it in CoL This is assuming that you will be expecting such expenses over a foreseeable period of time
Use your discretion to filter through your current expenses (CE) over last few months to come up with a final CoL number. This is a non-negotiable amount which you will require month-over-month.
- Determine Ideal Income-Savings Ratio (IISR)
This can make or break your early retirement plan. So spend some quality time to determine your Ideal Income-Savings Ratio (IISR). There is no golden IISR which can be applied to all. But you can come up with the ratio which is just right for you by making use of CE & CoL numbers obtained in previous steps. Compare your cost of living or CoL with your income & follow these rules of thumb:
- Your cost of living (CoL) consumes a significant portion of your income (e.g. between 60-100%) It becomes rather difficult to do reasonable savings. In this case, make sure you save at least 10% of income even if it requires some cuts in your current expenses and/or CoL. If you can do more savings, the better. Do not allocate budget for any luxury/discretionary spending until you are saving at least 25% of your income.
- Your cost of living is much less than income (e.g. 40% or below) It indicates you are in a higher income bracket relative to your CoL. In this case target a saving of 40% or more of your income as you can afford to do the same. This will still leave a room of about 10% for your luxury/discretionary spending to improve your quality of life.
- Right Investment Instruments
Let’s say you want to continue with your current lifestyle in your retirement period as well. An intuitive estimate is if you save as much as your expenses from today onward, you will be able to enjoy as many years of retired life as the remainder of your working years.
But this is based on assumption that the instrument of your investment is close to inflation index in your country. For example, If the inflation in your country is close to 10%, you need to target an investments which can give at least similar returns. Keep in mind that returns have to be post-tax.
Let’s say a long-term fixed deposit gives close to 6% p.a. post tax You might want to split the investments into some high-gain medium-risk mutual funds which are giving close to 15% per annum. Look for their historical performance. Bear in mind that there is always some risk involved but it will ensure that your corpus does not decrease in value day-by-day.
If you have entrepreneurial gene, here is the bonus tip to plan your retirement on your own terms.
- Own a Business Stake
You won’t get rich renting out your time. You must own a stake in a business to earn your financial freedom. But a business stake is not easier to get, you have to take accountability and take risks. Renting out your time to someone can earn you money but not wealth (leaving some thoughts to ponder). Take your 2019 plunge to create wealth for yourself and for everyone around you.