The Financial Math of Retirement

Thank you, Nightcafe

A couple of weeks ago, the online magazine, The Ken*, published an article on retiring at 40, which sparked off hyperactive exchanges on the net, especially on Linkedin. Early retirement is a subject I know something about, and I posted my own, simplified view on Linkedin.

What follows is an expanded version of that piece:

Question: Can you retire at 40?

Answer: 20.

Multiply your annual expenditure by 20. If your net worth is over 20 times your annual expenditure, you can retire.

The math is very simple. 

For three decades, the Indian stock market - best represented by the Nifty - has returned 11% a year on average. Add just under 1% for dividends, for a return of 12% per annum.

This is ‘nominal’ return, the return in rupees. You want these rupees for what they can buy, so you need to adjust for the fact that prices are going up. I use an annual rate of inflation of 7%, though the number is now coming down. To preserve the ‘real’ value of your retirement nest egg, you can take out retirement living expenses only after allowing for inflation.

So, if your nest egg rises by 12% per year, leave 7% in there to compensate for inflation. The balance 5% is real income, while leaving your real wealth protected.

This 5% real return means 1 rupee of annual income for every 20 rupees in your retirement fund.

The answer, as I said, is 20.

My answer may raise a question, and usually does - 

“Put all my money in the share market? Isn’t that risky?” 

There definitely is a risk that the value of your equity portfolio can plummet - as most portfolios did, during the dot-com bust in 2000-01, the Global Financial Crisis of 2007-08, and the Covid-induced plunge of 2020. But, each time, equity markets recovered, and the average return of 11% a year is despite these sharp periods of panic. Such periods cause many to lose their nerve, and sell their shares when they are cheap; others buy at bargain prices. But the investor with an eye on retirement will just stay the course, waiting to reach the magic number of 20.

The other question that can come up is:

“Are there any other investments which will fund my retirement?”

The usual candidates are fixed deposits, and real estate. 

Fixed Deposits

Today, the most attractive fixed deposits will earn 8% per annum. After income tax, your return will barely compensate for inflation. So, even as the rupee value of your bank deposits grows, its purchasing power, or real value, will hardly move. When you do retire, every rupee you spend from your savings will deplete your nest egg. 

With fixed deposits, the answer is over 50: if you had 50 times your annual expenditure invested in FDs, which earned 8% a year, and you paid 20% tax, the money would last till you are 91. That would be a terrible age at which to achieve penury, and if you’re batting for a century, the number is over 60. That is really, really daunting.

Real Estate

Many fortunes have been built on real estate, and a monthly rental income from property typically moves with inflation. If your annual rental income exceeds your annual expenses, you should be good to retire - after allowing for maintenance expenses, which will increase, not just in line with inflation, but also with the age of the property.

I have made good returns on real estate, but decided early on that it’s not for me - it takes too long to buy and sell property, and I hate the paperwork of registration, the management of upkeep, and the prospect of legal hassles with tenants. I much prefer the simplicity, the elegance of investing in equities from my keyboard.

But this is me, and if you think you can create real estate returns for your retirement, go for it.

Beyond the numbers - whether 20 or 50 - there are some major details one must factor in:

• In annual expenses, include the premium on an adequate health insurance policy.

• Keep a separate kitty for major expenses anticipated, such as a child’s college fees

• Major durables - vehicle, computer, phone, and home appliances - need regular replacement. Calculate their cost, and how often you need to replace them. Add that average annual cost to your budget.

Also: you’ll probably do something after you’ve retired at 40. This will bring in income, and you’ll probably find that the nest egg has a built-in resilience.

I retired at 40, it can be done, and it is highly rewarding. And, no, that’s not me lounging on the beach - running and swimming is more my scene.

*https://the-ken.com/story/you-can-retire-at-40-and-thats-a-lie/