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Do you want to Retire Early in India? A detailed guide with Excel calculator

Read the 5-minute guide to Early Retirement before reading this longer guide


On the occasion of Dhanteras I’m re-posting my article from JagoInvestor. I’ll start writing regularly starting this Diwali month on the topics some of you wanted me to elaborate 🙂

 

  • How I discovered Early Retirement?
  • WHAT IS EARLY RETIREMENT?
  • My Alternative Early Retirement Plan for Indian conditions
  • The benefits of this alternative approach
  • FREEDOM: Free by Age 40 to do work you truly enjoy
  • SECURITY: Your retirement fund is actually a 25-year emergency fund!
  • LESS STRESS: Not having to worry about money running out
  • PRACTICE: Great Training for “full retirement”
  • 4 STRATEGIES TO INCREASE YOUR SAVINGS RATE
  • FAQ 1: If I’m saving first for my retirement what about saving for my child’s college expenses?
  • FAQ 2 : What about buying our own house?
  • FAQ 3: But we want to do extended travel frequently. That’s why we want to retire early and stop working!
  • My Personal Journey so far

A few weeks back, I had shared my comments on early retirement on the “Myth of Early Retirement” article and Manish asked me to to elaborate on my comment and also do a guest post on this topic.

In this post I will go in detail on how to plan for early retirement and also share my personal early retirement journey.

Disclaimer : This article is purely the author’s personal opinion. The author is not a certified financial planner. Seek the help of a certified financial planner for your individual situation.

How to plan for early retirement - A real life study and guide for beginners

When mid-level IT employees in their 40s are being forced into early retirement anyway through layoffs, it has become a necessity for our generation to pro-actively plan for an early retirement. As early as 2011, JagoInvestor reader Ujjwal working in IT predicted this exact scenario and recommended planning for early financial freedom.

How I discovered Early Retirement?

  • I graduated in computer science straight into a recession caused by the double whammy of the dot-com bust and the 9/11 attacks. My father had recently retired from his public sector job and I did not have any job offer on hand as campus hiring dried up completely. It felt like I was being tossed around by economic forces beyond my control.
  • When I finally entered the workforce at a Big Company, I was soon frustrated by the usual job stress and job insecurity.
  • I decided to end this “working for money” problem once and for all by joining an early-stage internet startup. Joining a startup was also my dream since college and I had plans to start my own later. The idea was when the startup will sell for millions, I would strike it rich and never have to work again. Well… 6 years later when the startup was sold, my services were no longer needed. I was out of a job without striking it rich 🙂
  • Around this time, I discovered the early retirement community online that talked about focusing on the one thing I could control  : my savings rate. All along I had focused on things outside my control and failed to solve the “working for money” problem. Out of all the options available to salaried employees to achieve early financial independence, early retirement offers the highest chance of success because its success or failure is under your control: how much you save each month.

WHAT IS EARLY RETIREMENT?

Most of the Early Retirement literature online is from the U.S which is understandable because they have a longer history of regulated stock markets & mutual funds compared to India.

In this article I’ll do my best to translate Early Retirement for Indian conditions as we have our cultural differences when it comes to money like parents paying for child’s college expenses, joint families where children take care of  parents in their old age etc and recent cultural changes mirroring the U.S  like home loan EMI, SIP, credit card spending, low savings rate etc

Let me first start with what most people think when they hear the term “Early Retirement”:

  • It is a stage by Age 40 when you are able to meet all your expenses through passive income from investments like Real Estate (rental income), Mutual Funds, Stocks (dividends) etc.
  • So you don’t have to work anymore to meet your expenses.
  • You can easily live on only investment returns post-inflation so your corpus will last forever beating inflation…theoretically.

While this is the “popular dream”, in reality Early Retirement simply means achieving financial independence early in life so you can focus on achieving your important goals in life. This is popularly abbreviated online as FIRE : financial independence/retiring early.

early retirement meaning

You can be employed at this stage, but in alignment with your life goals for example:

  • To do something you love
  • To spend more time with loved ones
  • To earn money with less stress & more work-life balance
  • To lead a healthy & active lifestyle

It is possible to retire early by age 40 but only if you aggressively save at least 50% of your income starting early in your earning life instead of doing a small monthly SIP with the goal of retiring in old age at 65.

Save 50% of my income??!! I can barely meet my expenses each month

Relax! You are already saving more than you realize. You already contribute 12%  of your basic income mandatorily to your EPF and get another 12% employer match. That is a 24% savings rate on your basic income. So calm down and I’ll discuss some strategies for increasing your savings rate later in this article.

There is a reason behind the 50% savings rate

High Saving Rate

This is the simple idea behind Early Retirement before inflation & investment returns enter the picture. 50% savings rate may not be possible immediately for people whose income is low or expenses are high but early retirement is not possible unless you increase your savings rate to at least 50%

Here are some inspiring real-life people saving close to 50% :

–  1 income, EMI, 1 kid, private sector, Bengaluru. Income: 81K, Savings:43K

– Unmarried, private sector, Mumbai. Income: 65K. Savings: 30K

–  1 income, Government job, no kids, Rajasthan. Income: 70K, Savings: 42K

–  Both working, 1 kid, private sector, Mumbai. Income: 1.05L, Savings: 45K

Here is the link to the “Family Finances” section from ET Wealth magazine. Make sure to look for households who fit your profile and are saving at least 50%. Ask yourself : If people similar to me can save so much, why shouldn’t I save more than my current rate?

Let’s step back here for a minute

First, you need to be very determined to retire early.

When you truly want something you will come up with solutions rather than excuses and you’ll get inspired instead of finding faults.  Imagine in your mind’s eye for a moment all the positive reasons why you want to retire early like Family-time, Freedom, Health, Low-Stress, Travel, Security  etc.

Now get yourself into an optimistic “can-do” frame of mind before reading further.

you can do it

(Source)

Early Retirement is an improved version of Conventional Retirement

Around 100 years back even conventional retirement at age 65 was not possible for everyone. What was once a fantasy is a reality now. Now everyone believes it is perfectly normal to retire at age 65.

Similarly, for the first time in history, due to innovations like regulated stock markets, mutual funds &  SIP, even the salaried middle-class can now retire early which was previously possible only for high-earning executives or businessmen. So if you try and understand Early Retirement you too can take advantage of it and enjoy a better quality of life.

Be ready to take some tough decisions on what is important to YOU in life rather than just going with the flow of what everybody else is doing with their life.

Can I just retire early and never have to work ever?

The typical dream of Early Retirement is to “sit and eat” from the retirement corpus without having to work for money from age 40 to age 90 which is a long span of 50 years which no one can predict.

It is a difficult feat to pull off as Life has a habit of springing surprises especially when you have kids and elderly parents. But it is possible if key variables outside your control like the stock market returns work in your favor and there are real-life success stories like Mr.MoneyMustache.

Two big problems with this  “I never want to work again” Early Retirement thinking:

  • UNCERTAINTY:
    • If a family member has a major health expense not covered by health insurance, how will you meet that expense if you are not earning any additional income?
    • If you cannot find a tenant for your rental income house for more than a year, how will you meet household expenses if you are not earning any additional income?
    • If the stock market crashes by 15% and goes into a 5-year recession, will you have the stomach to withdraw money for monthly expenses from an already depleted corpus?
    • What if all of the above happen simultaneously in your life like the expression “When it rains, it pours” ?
  • STRESS:  you’ll replace the stress of a job with the stress of obsessing over running out of money every single day of your early retirement.

My Alternative Early Retirement Plan for Indian conditions

Stop working for “money” but don’t stop working
  • By Age 40: Finish saving up for retirement by saving at least 50% of your income in retirement SIP.
  • After Age 40: Stop your retirement SIP & switch to work that you truly enjoy in order to cover monthly expenses.
  • From Age 40: Let compounding double your retirement corpus every 6 years until age 65!

The idea is to permanently secure your comfortable lifestyle by age 40 so you can follow your dreams without fear. Even in the worst case scenario you’ll always be guaranteed to enjoy the comfortable lifestyle of your 30s.

The benefits of this alternative approach

FREEDOM: Free by Age 40 to do work you truly enjoy

While saving up for retirement your monthly budget at 50% savings rate will look like this:

Income Rs.1 lakh =  Rs. 50K Expenses + Rs.50K Retirement SIP

By age 40 once you finish saving up for retirement, you don’t need the retirement SIP anymore and your budget will look like this

Income Rs.1 lakh = Rs.50K Expenses + Rs.50K Surplus

After age 40, you can work for a 50% lesser salary at jobs that are more fulfilling and less stressful but fully pays for your monthly expenses including support for kids & elderly parents:

Income Rs.50K = Rs.50K Expenses

Most people who want to retire early simply are tired of the job stress and deep down are not averse to working if there is work-life balance and they are working on something they truly enjoy.

SECURITY: Your retirement fund is actually a 25-year emergency fund!

If you ever lose your job before age 65 like the TCS/Cognizant/Infosys mid-level managers in the headlines : you can use a small portion of your  retirement fund to fund monthly expenses for even 3-4 years while you re-skill and find another job after which you can replenish the amount you took out during the jobless period.

Instead of trying to live off the retirement fund for life from age 40, you strategically use the retirement fund to build a safety net for uncertain times and take calculated risks like starting a business or a new career.

LESS STRESS: Not having to worry about money running out

It is an open secret that even the pioneers of early retirement that I hero-worship like MMM & ERE bring in active income in their “early retirement” from working on their passions like building houses by hand or working as a quant trader/researcher leaving their retirement corpus to compound meaning they are not solely living off of their early retirement corpus themselves.

So if the early retirement gurus are bringing in active income why shouldn’t you factor in the active income from your dream-job in your early retirement plans?  Why assume that working on something you enjoy won’t cover monthly expenses even after working at it for 3-4 years?

You’ll be sitting on a 25-year emergency fund in the form of your early retirement corpus for God’s sake!  If you are still unsure, you can start working on your dream-job as a side-project while you are still working at your day-job to give yourself enough runway and confidence that it will make money by the time you quit your day-job.

PRACTICE: Great Training for “full retirement”

Scaling down your work by 50% by age 40 is a great way to get a preview of what “full retirement” will look like at age 65. You will get a lot of wake-up calls mostly around the state of your health, investment returns , wasteful expenses and whether you really have any true passions in life or were you just lying to yourself about “dreams & passions” to mentally escape from job stress 😉 So while planning for Early Retirement also work on your passion on the side to prepare yourself for the post-40 life.

4 STRATEGIES TO INCREASE YOUR SAVINGS RATE

Strategy #1 – Lower your expenses: This is the only thing under your control so tackle this first.  Analyze your lifestyle using apps like Spendee to cut down wasteful spending without being “penny wise and pound foolish”.

For example: In our house we use the internet for entertainment so no T.V or cable expenses, we mainly eat home-cooked food so our eating-out expenses are low, we do yoga at home so no gym fees, we own high-quality phones & laptops that are expensive but we maintain them carefully for years so they work out cheaper in the long run.

It took us almost 3 years to systematically reduce our spending without feeling deprived.  In your household, what are the top 3 categories where you could get the same value but for way less money?

Strategy #2 – Increase your income: If you’ve cut all wasteful expenses and are still not saving enough then your only option is to increase your income. Your early retirement goal gives you the clarity and urgency to do what is necessary to  get that promotion or better-paying job. It will not happen overnight but you can work towards it purposefully now that you have a time-bound reason.

Strategy #3 – Get out of Debt:   If you’ve made the mistake of buying a house on exorbitant EMI at an early age, you need to first crush your EMI or education loan before attempting early retirement.  You need to simultaneously lower expenses and increase income. Read : Is home loan EMI jeopardising your other financial goals? Here’s what to do

Strategy #4 – Work as a team with your spouse: By age 30 you are probably married and both of you are earning. Get your spouse on board and work together as a team.  If all you want is a couple of years freedom to try your hand at a new career or business, try a mini-retirement instead.

If you are debt-free and your spouse’s income can take care of expenses, you can quit your job with the safety net of your spouse’s income. If you succeed in your venture and are able to cover expenses then your spouse too can quit their job to follow their dreams. This way both of you can make money doing what you like. Even if you fail in your venture, you can re-join the workforce & try again later.

Wow! An investment of Rs.75 lakhs in SIP over 35 years has given a retirement corpus of Rs.11.7 crores

But look closer and you’ll notice that this is a bad bargain for the number of years this person has to save. Why should you take 35 years to accumulate 75 lakhs?

Let’s see what happens if you try and accumulate the same Rs.75 lakhs within 10 years and then stop your SIPs but let the Rs.75 lakhs compound untouched for another 25 years.

saving plan for 25 yrs

WHAAAAT???!!! How did you end up with Rs.12.8 crores at age 65 even though you stopped SIPs at age 40!!! 

THE SECRET : Compounding really works its magic on large numbers

SIP does not do the compounding by itself…only when you finish saving up a large corpus does meaningful and substantial compounding gets started. That is why you should accumulate your retirement corpus as early as possible for compounding to start doing its job.

See herehere and here for others who’ve illustrated  how saving up early then stopping and letting the money compound untouched grows the money like crazy meeting or even exceeding your goals as compared to doing a small monthly SIP for decades.

ILLUSTRATION OF THE TWO APPROACHES VIA EXCEL CALCULATON

saving approach

Download Early Retirement Calculator

MATHEMATICAL PROOF

THE RULE OF 72  a.k.a What they did not teach you in school 

Question 1: How long will it take for Rs.75 lakhs to double @ 12% annual return?

You don’t need a calculator to answer this. Use The Rule of 72.

This handy thumb-rule derived from the compound interest formula says that to find the number of years required to double your money at a given return %, you just divide 72 by the return %

So 72/12 = 6 years.

Answer: Rs.75 lakhs @ 12% annual return will double in 6 years

Question 2: How many times will Rs.75 lakhs double @12% annual return over 25 years?

Answer: 25/6 = 4 times

Rs. 75 lakhs @ 12% return will double 4 times over 25 years

Question 3: What’ll be the final value of Rs.75 lakhs after doubling 4 times at the end of 25 years?

Answer: 

Doubles first after 6 years       :            Rs.75 lakhs  x 2   =  Rs.1.50 crores

Doubles again after 12 years :         Rs.1.50 crores x 2  =  Rs.3 crores

Doubles again after 18 years :               Rs.3 crores x 2  =  Rs.6 crores

Doubles again after 24 years :               Rs.6 crores x 2  =  Rs.12 crores

Total doubling : 4 times

Final corpus : Rs.12 crores

  1. Now refer back to the alternative accumulation plan’s final retirement corpus of Rs.12.8 crores to verify that the Rule of 72 produces a result remarkably accurate to the result from a lumpsum investment Calculator.
  2. Also verify using CAGR calculator  that the initial lumpsum invested and future compounded corpus works out to a 12% annual return.

A word of caution on debt: Compounding works against you when you have outstanding debt. For example: Say you have a 36% annual interest Credit Card and an outstanding balance of Rs.1 lakh on it. If  you don’t pay back the debt for 2 years then the credit card balance will double to Rs.2 lakhs.

How? Rule of 72:  72/36 =2. So your debt will double in 2 years!

compound interest quote

(Source)

FAQ 1: If I’m saving first for my retirement what about saving for my child’s college expenses? 

Use the same Early Saving strategy to save for child’s college expenses:

At the time of the child’s birth itself, invest the prevailing cost of college into mutual funds and let it compound for 18 years to beat education inflation. For example: 4-year engineering course at IIT currently costs Rs.8 lakhs. Say your kid was just born this year. If education inflation is 12% y-o-y the same course will cost Rs.60 lakhs in 18 years. To beat this education inflation: Invest prevailing cost of Rs.8 lakhs in mutual funds at the time of the child’s birth itself and let it compound over 18 years to Rs.60 lakhs @ 12% annual return by the time your child is ready to enter college. Your child can take out an education loan for any shortfall over and above your savings.

If you don’t have Rs.8 lakhs to invest in mutual funds at the time of your child’s birth:

  1. Finish saving for your retirement first by age 40 so you don’t have to worry about losing your job or sacrificing your dreams.
  2. Then start SIP for your kid’s future expenses like higher education or wedding
  3. To bridge any shortfall between your SIP savings & the education or wedding expenses, your child can take out an education loan or scholarship for college and a personal loan for their own wedding.
  4. Since you’ll be earning while your child is in college, you can help out with whatever college expenses you can afford. Your child may also earn income through internships or side-projects while still in college.

Take care of your own retirement first before you save for your child because the child has other viable options like education loans, scholarships, low-cost weddings etc.  No bank will give you any “retirement loan” if you’ve not saved enough for your retirement!!!

Plus you can be a role-model to your child by balancing your dreams & your reasonable duty towards your child. You will be giving them the inheritance of them not having to worry about your retirement also when they make their own retirement plans

Like how the air hostess tells us in the safety precautions before every flight…..

oxygen mask

Image Source

I highly recommend that you read Manish’s article on how not to stress too much about the inflation in higher education expenses.

FAQ 2 : What about buying our own house?

I recommend from personal experience: Don’t buy a house on EMI at a young age in your 20s or 30s when you don’t know where you’ll settle down permanently. We move to other cities and even countries for work these days and there is no knowing ahead of time where you will settle down in old age.

Instead save SIP in mutual funds towards buying a house until you have 100% clarity closer to retirement in your 50s or 60s and then build or buy a brand new house or flat fully in cash without EMI. The SIP returns should be able to match the real estate inflation.  Until your retirement it is cheaper to rent in India at 4% rental yield even at 10% annual rent increase instead of paying EMI at 10-12%  and also property tax, water tax, maintenance, repairs, association dues etc. only to end up with an “old flat” after 25 years!

A couple we know are doing exactly this: after traveling all over India for work & renting throughout they are now building a house in their hometown for retirement in their mid-fifties.  Subramoney also recommends the same approach: See point #9 of his article.

Recommended reading: Why large investment in property at young age could be risky

FAQ 3: But we want to do extended travel frequently. That’s why we want to retire early and stop working!

Think win-win: Once you achieve financial independence you can quit your job and travel for say a year.  After a year of travel,  you can recharge both yourself and your bank accounts by returning to the job market for a couple of years to work on something you enjoy (maybe something related to travel!).  Then travel again. Repeat the process until your 60s by which time hopefully you would have traveled everywhere you wanted to and your compounded retirement fund will be waiting for you!

My Personal Journey so far

  • Age 36. Married. No kids yet.
  • We’ve saved up 30% of our retirement target so far
  • By age 45, we’ll finish saving up 100% of our retirement target & then let it compound untouched over the next 20 years
  • Own a flat bought with savings & no EMI in a city where we don’t live 🙂  Although it gives us a modest rent that we SIP, I consider it a poor decision as we could have reached financial independence already by renting instead of owning.
  • 3 years in Big Co IT dept : paid off student loan & credit card debt so savings rate was low :  around 25%. Debt-Free so I work at Internet Startup for 6 years : Saved little over 40% of my salary!
  • 3 years back, wife and I took a calculated risk to start own business when we had a savings runway of 6-7 years. 3 years later business income now covers monthly expenses and savings rate is climbing slowly towards 50%
  • Once we reach our retirement target by age 45, I may take up a job at a non-profit working for a better India at a much lower salary but only if it fully covers our already low expenses.
  • We exercise 30 mins to 1 hour daily towards our Health SIP & maintain a healthy diet. We plan to be be fit and healthy in our 60s when no health insurance will cover us.
  • We’ll save what we can for our future child using the Rule of 72 since the child has age on their side for compounding to work until age 18. But we’ll definitely teach the child to be financially independent in their 30s itself and follow their dreams without needing money from us 🙂

This is our story in brief.  We took calculated risks and re-invented ourselves with the safety net of savings that would have lasted for only 6-7 years. Imagine how you too can work on your dreams stress-free with the safety net of savings that’ll last for 25 years.

We are a regular couple with middle-class values. If we can do it so can you. Good luck!

Special Thanks: My wife & I are forever grateful to Mr.MoneyMustache for demonstrating that you can simply save your salary to freedom 25 years ahead of schedule!

I want  to end with a well-written poem about “A Man with Savings” that makes the point much better than I ever could with all the math & personal stories.

Please share your thoughts about early retirement under comments section. I would be happy to read them and also discuss more on this topic.

My Radio Interview (7 minutes)

After our Times Of India interview, I was interviewed about Early Retirement on Radio One Mumbai by the smart and talented RJ Annie of Radio One Mumbai 94.3 on the occasion of Worker’s Day (May 1). Coincidentally I had a blog post lined up on the same topic 🙂

Crisp Q&A. You’ll understand Early Retirement more deeply just by listening to this brief 7-minute interview.

Catch Annie Akm on 94.3 Radio ONE Mumbai streaming on www.1cast.in

 

rone-logo-new.png

 

 

Photos of our current lifestyle

Photos of our home, neighbourhood, travel and lots of home-cooked food…  I don’t want to talk about money this time but let the pictures do the talking 🙂

Highlights:

  • We live in a place with good facilities for the general public which allows us to  save as well as enjoy a comfortable lifestyle which I have showcased below.
  • All the cane furniture in our house was bought used from OLX and fixed up  with varnish and repairs courtesy of my wife and her father.
  • As first-time cooks we got all our recipes online from Indian blogs like  vegrecipesofindia , kannammacooks etc and International recipes from jamieoliveritdoesnttastelikechicken, sallysbakingaddiction etc apart from our respective mothers 🙂
  • Our swimming pool membership at a nearby 5-star hotel costs an affordable Rs.6000/year courtesy of my smart wife. The pool membership also comes with complimentary perks from their spa & restaurant.
  • The vacation photos are from Indian destinations 🙂

Hover over each photo to read the description for the photo

 

LTCG Tax impact on Early Retirement

Starting with the recent budget , you have to pay 10.4%(including cess) long-term capital gains tax(LTCG) on gains when you sell mutual funds or stocks after holding them for 1 year.

taxJPGimage source

What does this mean for your Early Retirement plans?

  • Not the end of the world actually! If you are selling after holding for 25 years and your return was 12% then after paying LTCG tax your return falls to 11.54% : a negative impact of only 0.46%
  • Deepesh from personalfinanceplan.in has done a fantastic job of showing the impact of the tax on different CAGR % for corpus held over different lengths of time.  I’m using an image from his article below:Impact on your CAGR due to tax on LTCG. source - personalfinanceplan.in
  • As you can see above, the longer you hold, the lesser the impact of the tax which is perfect for the Early Retiree. For example: At 12% expected return, if you hold only for 5 years then the return falls to 10.99% due to tax but if you hold for 25 years the return only falls to 11.54%.

What Should You Do?

  • If you were expecting 12% returns from equity over 25 years then reduce your expectation to 11.54% and use the Early Retirement Excel calculator to calculate the increase in SIP required.
  •  If you want to retire early at the same age as before this tax then you’ll have to increase the SIP amount. Just increase your SIP and don’t think any more about this tax.
  • I’ve added a tab to the Early Retirement Excel Calculator so you can calculate the impact of LTCG tax on your expected returns %.

What Charlie Munger has to say about LTCG tax:

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum.

In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15%—or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.

Charlie Munger, USC Business School, 1994

 Impact on our family’s early retirement plans:

  • It will take us 1 extra year to achieve our Early Retirement target if we continue our current SIP amount. I’m actually relieved that the tax impact is only 1 extra year 🙂
  • Last month I posted that we had achieved 38% of our early retirement target. Our target is now reduced to 34% after factoring in LTCG. Remind me never to post a target achieved % before the government announces its budget 😉
  • This new tax only confirms my belief that to deal with Life’s uncertainties like this new tax you need to keep working and saving whatever you can even after reaching your target early retirement corpus. Today capital gains is set at 10%.  Who knows, it may be raised to 30% over the next 25 years.
  • The biggest positive impact is that this new tax has validated our approach of letting our early retirement corpus compound for 25 years instead of trying to live off of the returns every year which would incur a 10% tax every year!! In our approach we would only pay a one-time tax of 10% at the end of 25 years. Re-read Charlie Munger’s statement above to understand what a big difference this makes.

Special thanks:

  1. livemint : for first planting the doubt in my mind that I might be over-estimating the impact of this tax.
  2. phreakv6  : for the Charlie Munger speech that pointed me in the exact direction
  3. basuvinesh  : for calculating the tax impact with a real example.
  4. My wife : for giving me the simple idea to use Excel to calculate the exact post-tax CAGR %  when I was trying to wrap my head around its impact on our unique early retirement plans which was not getting covered in the mainstream media.
  5. deepesh raghaw : for the image I used earlier. his calculations matched my excel calculator including munger’s example so I’m confident of publishing this article and the excel 🙂 I especially agree with his quote below:

Fall from 10% p.a. to 9.49% p.a. may not look like much. However, when we talk about many years of compounding, the impact is going to be sizeable.

I have read accounts where many experts have mentioned that the impact is going to be minimal. That’s clearly not the case. Most of us shifted from regular to direct to save this extra 0.5-1% p.a. of the expense ratio. Didn’t we?

Therefore, let’s not fool ourselves. There is going to be an impact of LTCG taxation. Let’s accept it and pay the taxes happily.

Valentine’s Day Special : How to convince your significant other about Early Retirement

This Valentine’s Day I want to touch on a touchy topic with couples : how to convince your significant other to work together as a team towards Early Retirement.

So this post has a guest section written by my wife on her experience getting convinced about early retirement.

Typically one person is super-excited after having read about Early Retirement online. But then they find that their partner is not as excited… atleast not that excited to single-mindedly focus on this goal to the exclusion of other goals in their life. Well.. you can’t forcibly convince someone to do something  unless you want avoidable fights with your partner on this topic 🙂 You can however influence them positively. Influencing others requires that YOU be the change you want to see in others. So you need to lead by example.

MY WIFE’S STORY ON HOW SHE CAME ON BOARD:

While my husband was saving 50% of his monthly salary to pay instalments for his first house, I was busy spending most of my money on food, clothes, shoes and a high-flying lifestyle that I had discovered with my high-paying job. Saving money was not on the top of my mind. I was in a middle-management job at a start-up and everyone around me was  exhausting their monthly credit card limits. Thankfully I never incurred debt and even paid for my car upfront with some help from my dad. But I did not save or invest seriously before the age of 30. That is when I got married, pooled our resources and made some lifestyle changes which reflected both our views on money.

The Aha! moment

In the beginning I used to find talking about my spending habits with my husband very difficult. I appreciated finer things in life and unfortunately they are not cheap. But after dozens of conversations with my husband I began to see that I associated Money with Quality of Life in the Present rather than as an Enabler to fulfill certain Life Goals in the Future. This meant that I was working a stressful, 12 hours a day job not having autonomy over my time in the present but also not securing my future.  Being a single person I immersed myself long hours in work but I couldn’t imagine sustaining this once  I had a family of my own with my husband.

I was valuing money over my time. And after our discussions my husband made me realise that I can control my time and then my life if I control “MY MONEY”. In the end I could not deny that the true role of money in my life was to serve me so I could live a happy, fulfilling life. I had to master my savings, my spending, and the investments so that I get the freedom I crave for.

In summary, I’m glad for this lifestyle that gives us more time to spend with each other and doing things that are important to us.

MY SIDE OF THE STORY:

My wife & I had different opinions about money when we got married. I wanted to retire early so I could move on to doing more meaningful work while also enjoying more leisure time. My wife saw money as a way to ensure a good quality of life where emotional needs were also fulfilled in addition to the physical needs.

Even before we got married, I used to talk finances with my wife for the post-married life. We even drew up a spreadsheet with our “ideal” lifestyle (ex: house with swimming pool, international travel etc). Since I was narrowly focused on saving as much as I could for early retirement, I used to overrule her idea of “quality of  life” and focus only on the “bare basics” needed for sustenance like rent, food, insurance etc and strictly try to meet every month’s budget. At the same time I used to work long hours trying to maximise my earnings.

Naturally this approach caused friction & disagreements in the early days as we struggled to reconcile our two different approaches. For example: I remember once getting upset at the high prices in a gourmet store selling Thai food ingredients because my wife was planning to cook Thai that weekend. Ironically I did not realise that she was planning to cook at home towards my own goal of eating out less at restaurants.

To put it simply, I was being stingy instead of being frugal. 

Slowly over the next 3 years we achieved a compromise between our approaches that was possible only because we loved & respected each other. I realised that aspiring for a good quality of life like my wife wanted had hidden benefits that cannot be quantified in money alone. For example:

  • Hiring a cook freed up time for me to exercise in the mornings. Earlier we cooked all meals ourselves.
  • When we moved from a 2BHK to a 3BHK rental I found the extra space more conducive to my work productivity since I work from home.

My wife also figured out that enjoying a higher quality of life did not always have to cost a lot. For example:

  • Instead of a house with a swimming pool she got us a swimming pool membership at a 5-star hotel nearby costing only Rs.6000 per year.
  • Instead of an international vacation she plans luxurious vacations at domestic destinations. We drive there by car saving on flight tickets which we splurge on the stay instead.

Right now we are at a happy balance where we try to achieve both our goals by saving as much as we can and living a life of quality while still staying within budget. I have added some suggestions below based on my learning from this process of give-and-take.

SUGGESTIONS BASED ON LESSONS LEARNED:

  1. Lead by example.
    • Cut out the waste in your own life first : cigarettes, eating out, impulse purchases etc. Let them see you invest the savings. Follow this blog regularly for tips.
    • You don’t need your partner on board to get started. You go ahead first and let them follow at their own pace  by watching you.
  2. Find out what makes them tick.
    • Use that as a way in to influence them. My wife was motivated by freedom to pursue her interests as much as I was. She was not in any hurry to retire early but saw the benefits of savings which enabled her to quit her job for a few years to explore her interests. Having tasted freedom for a couple of years she indulged me in my early retirement plans so we could be free permanently.
    • In the case of MoneyMustache both him and his wife imagined being able to spend more time with their baby in the early years when the baby was growing fast.
    • This process of discovering what drives your partner is beneficial to your relationship as well because you will help your partner also achieve their dream.
  3. Be willing to change yourself 
    • As you can see above both my wife & I made changes to our attitudes to accommodate the dreams of the other person.
    • Your progress will be slow in the beginning but it will gain speed soon with two people working towards the same goal now.
    • If you are not willing to change yourself then you won’t have much success trying to convince your partner about early retirement.
  4. Be Patient.
    • Don’t expect them to make drastic changes just because you had an overnight epiphany. Same goes for you. Don’t make drastic changes that you’ve not at-least given a week to think over to ensure that you can sustain it long-term.
    • Remember that it took us 3 years to get to our current happy equilibrium
  5. Focus on Habits rather than results
    • These days I don’t micromanage & fret over my monthly expenses like I used to do in the early days.
    • We’ve incorporated many good habits like cooking at home, using the outdoors & internet for entertainment, saving up to buy only high-quality products etc that our monthly expenses stay within the budgeted range more or less.
    • So focus on the more difficult long-term behaviour change rather than the easy short-term results or exact budget numbers. It will take time but is more sustainable because neither of you will feel deprived of the good things in life.
  6. Increase your income.
    • Target that promotion or change jobs. Sock away the extra income in SIP.
    • Show your portfolio to your partner every quarter to show the money growing.
    • Just make sure not to increase your expenses with the extra income. Easier said than done! but hey it is a valid suggestion 🙂
  7. Inspire them.

RECOMMENDED READING:

How do I get my significant other on board for F.I.R.E

 

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Image Source

We’ve saved up 34% of our early retirement target as of 2017

High-level numbers below

  • My Age: 36
  • % Saved for Early Retirement : 38%  34% (target % reduced due to 10.4% LTCG tax announced in the budget after this post was originally published. I’ll write a detailed article on this new tax’s impact next month)
  • Next year we are hoping to reach 50% 46% of our target. Fingers crossed!
  • I’ll update the progress bar on the right-hand sidebar every year with our progress
  • Current Monthly Saving rate : 25%
    • single-income household as mentioned in the NRI post.
    • this savings is from my business income
  • Effective Monthly Saving rate : 50%
    •  wife is moving her low-return F.Ds to mutual funds via SIP so we are effectively saving 50% of income in mutual funds towards retirement.
  • We currently have a 60:40 split between active Mutual Funds & inactive EPF/PPF.
    • more SIP in the coming years will tilt this balance towards equity
  • Our Total Portfolio Return is approximately 14%. Our Expected return is lower at 12%. 
    • Our Large-Cap fund returned 18% as of Dec 2017. We are taking this as indicative of our equity returns even though we have some mid-caps that performed better because only our large cap fund shows the XIRR 🙂 For accurate numbers we have to calculate manually and we haven’t done that yet.
    • Our PPF interest rate was 7.6% as of Dec 2017. Using this as indicative of debt returns. I’m deliberately using the lowest PPF rate since I’m approximating here.
    • So with a equity:debt ratio of 60:40, our total portfolio return is around 14%. (60×18% + 40×7.6%)
    • I’m sharing our returns only to document the numbers so we can look back many years from now on the ups-and-downs in returns. We are not really worried about the ups-and-downs as it will get smoothed out over the years like I explain in this post.

I was an NRI

I mention that I was an NRI in the Disclosure of this blog but I wanted to address this issue head-on because of a recent comment in JagoInvestor where someone said only NRIs can save a lot in a short time which is a false statement and only serves as an excuse for the self-pity crowd.

Here’s my brief NRI story:

I worked and earned in the U.S for about 9 years. I returned to India in 2013.

But before you go “oh! that’s how you saved so much so quickly”my U.S salary was not really highI started with a really low salary and since increments are based on your previous salary … my salary grew very slowly especially when I was a startup employee for 6 years.

Note that as of this time, we’ve saved up only 30% of our early retirement target. See the progress bar on the right hand side.  This 30% includes my wife’s savings also. I’m now in India. This means that I’ll be saving the remaining 70% of our early retirement target working from India. My wife is currently on a break from work to explore her interests meaning we are a single-income household for the past 3 years. So I’ll be demonstrating how early retirement is possible in India by my personal example in the years to come!

My NRI salary was only good enough to buy a Rs.45 lakh apartment over 5 years without requiring any home loan. This works out to an average savings of Rs.75,000 per month for 5 years. (Rs.45 lakhs divided by 5 years). Given the real-estate crash in India right now, the apartment is now worth about Rs.65 lakhs after 9 years since I booked it in 2008 which is a terribly low CAGR return of only 4%! I would have invested that amount in mutual funds instead if I had educated myself.  The first 3-4 years of my NRI stint, I was paying off my education loan and large credit card debt I had gotten into due to poor financial habits.

I was always embarrassed that I did not earn the big salaries of my peers in the same age group. But as I write this disclosure I’m glad I didn’t because I learned to save instead to achieve my goals and not succumb to increased lifestyle expenses with increasing salary 😉 Moreover it is my U.S experience that helps me apply Early Retirement ideas from the U.S to Indian conditions.

I grappled with the dilemma of whether to mention that I had been an NRI at the time of writing the Early Retirement article and finally decided not to mention it so that readers were not distracted from the main message of saving at-least 50% of your salary each month. From the comments on the article I can now say that my decision was correct because no one complained it was not possible to save 50% on an Indian salary. Because people were already saving 50% of their Indian salary as EMI to repay house loan just not as mutual fund SIP like I was advocating.

Coming back to this self-pity comment : recently on JagoInvestor an NRI had written an inspirational article how they had saved Rs.1.5 crores in just 7 years by investing aggressively in equity and not buying real-estate. But this commenter dismissed the achievement by saying only NRIs can do it and people in India should keep saving till age 60. I posted a reply to their comment showing how people on an Indian salary can also save the same amount in just 7 years.

My reply to the self-pity comment saying only NRIs can save a lot in a few years:

1. You should compare this NRI author with a double-income household working in IT in bengaluru/pune where husband and wife each bring in Rs.1 lakh/month. I know Indian households where one spouse’s salary is used for house loan EMI and the other spouse’s salary for expenses. If this double-income couple saved Rs.75,000/month in mutual funds then @ 12% CAGR they would have Rs.1 crore saved in the same 7 years as this NRI. That is compounding & equity returns at work.

2. If households in India can afford to pay EMI of Rs.75,000 per month on a Rs.75 lakh house loan then they can invest the same amount each month in equity too. Most people in India are saving a lot each month but in the wrong manner as EMI which this NRI smartly avoided.

3. You say people in India don’t earn that much.
But I’ve recently hired IT people in Pune & Bengaluru with minimum take-home pay of Rs.1 lakh/month for 5-7 years experience. That’s when I realized that such high salaries are the norm in Pune, Bengaluru etc. You have to agree that the past decade or so has been lucrative for IT and MBA people working in India.

4. Quite a bit of people reading this blog are high-earners early in their careers in IT, MBA etc
It is possible for them working with their spouses as a team to emulate this NRI’s impressive achievement.

5. Lastly, you are discounting the fact that cost of living is also high for NRIs as it is denominated in their foreign currency. So unless you are consistently frugal, you won’t be able to save much. What is impressive about the author is that he has consistently saved for 7-9 years which requires determination.

I will definitely consider this as the “inspiration story of the decade” for young people entering the workforce
We need inspirational stories like this because IT & MBA jobs are no longer secure that you can hope to work till age 60.

Health is “real” Wealth

I’m recovering from a lengthy and painful throat infection this new year. So I thought it would be apt to start 2018 with this topic. All of 2017 I took pride in never taking a single pill except a painkiller for a dental issue. I finally took some Ayurvedic pills for this infection after realising that this infection might be serious.

YOU MISS HEALTH ONLY WHEN YOU DON’T HAVE IT:

I obsessively talk a lot about money but all the money in the world means nothing if you don’t have the health enjoy it. Like I mentioned in the Early Retirement article, my wife & I do Health SIP in some simple ways : yoga, nutritious food, morning walks, swims etc. I used to cycle & play badminton a few years back and I would love to get back to both activities.

DIABETES – A LIFESTYLE DISEASE:

Personally my need for Health SIP comes from the fact that both my parents are diabetics and I can see how their quality of daily life is reduced in old age, so I’m obsessed with avoiding diabetes as much as I can through healthy living.  My mother tells me they used to call diabetes “the silent killer” because people would know someone had diabetes only after they died. On the surface the person who died would look healthy but diabetes was corroding organs inside.

WORK & LIFE STRESS CAN MAKE YOU SICK…PERMANENTLY:

Diabetes is an epidemic in India even among poor people.  I was shocked to learn that apart from poor diet and zero exercise, a major contributing factor is “stress” especially for men.  In the case of women, stress is known to cause hormonal changes leading to weight gain among other ill-effects.

If you want to avoid major health expenses in your old age then you need to start paying attention to your:

  • DIET
  • EXERCISE
  • STRESS

The conventional approach to retirement is to earn the maximum  and save the maximum because you never know how much you need… coz you might get diabetes and diabetes treatment is expensive etc etc. But we forget that eating out every day because we are at work, skipping exercise because we work long hours and not dealing with work stress means that it will all catch up as you get closer to old age and will be very expensive to treat not to mention your quality of life will be so poor you can’t even climb stairs easily or travel to visit your children etc. So the solution is to lead a balanced life.

quote-man-sacrifices-his-health-in-order-to-make-money-then-he-sacrifices-money-to-recuperate-dalai-lama-80-98-11

 

We are trying a different approach inspired by moneymustache’s badass approach. We already see the oldies in our family and what kind of problems they face.

For example:

  • Elderly ladies always have knee problems from standing in the kitchen for long hours every day cooking for the family 3 meals a day
  • Elderly men have diabetes from having a “desk job” and not exercising enough
  • Liver problems from alcohol abuse
  • Antibiotic resistance : needing higher dosage of western medicine as a result of popping pills indiscriminately …Fever? take a Crocin, Headache? take Saridon etc . Would it have killed to let the fever go away on its own in 5 days? The body would have developed better immunity that way.

OUR HOLISTIC WELLNESS PLAN:

So our plan is to avoid atleast what we can see the oldies suffering from . And then prepare for some of the issues our generation is likely to get like

  • Poor eyesight from starting at phone & computer screens for too long
  • Diabetes from junk food, no exercise and work stress
  • Alcohol abuse as social drinking becomes more mainstream
  • Heart problems from working in stressful work environments or not dealing with personal life stress via meditation, exercise, better communication etc.

Here are some simple changes we’ve made to our diet, exercise and stress-management.

DIET:

  • Home-cooked food & eating out less but in high quality places.
  • Moderate Alcohol for social occasions.
    • Disclosure: we have a cook who comes home and makes us home-cooked food. The benefits far outweigh the costs.  

EXERCISE:

  • Swimming
  • Walks
  • Yoga

STRESS MANAGEMENT:

  • Meditation
  • Improving communication with spouse.
  • Not habitually checking on work after work-hours.

Starting now, I urge you to make small & simple changes to your diet, exercise and stress-levels. Trust me you’ll save a ton of money staying healthy.

Around me I see super-active and healthy 80-year olds and very-unhealthy and tired 60-year olds.  How old you “feel” is a matter of how healthy you are. Please start taking care of your health atleast now before it is too late.

How to get Richer with Early Retirement

You’ve heard the saying “The Rich Get Richer”. It is usually uttered in a negative manner to hint that only the rich get richer and the rest only get poorer. In this blog we do not pull other people down for their successes. Instead we try to learn from others who’ve done well and apply it to improve our life.

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Source

An Early Retiree is also a “Rich” person who has accumulated a lot of capital by aggressively saving their salary for 10-15 years. So let’s try to understand how “The Early Retiree Can Get Richer” by listing out the many ways in which the Rich use their accumulated capital to their advantage.

You can implement some of these strategies even now before fully accumulating your retirement corpus.

Table of Contents:

  • The Early Retiree pays no interest for loans
  • The Early Retiree pays no tax on stock market profits
  • The Early Retiree gets huge discounts on purchases
  • The Early Retiree travels for free
  • The Early Retiree earns higher interest than F.D

The Early Retiree pays no interest for loans

Lesson: Don’t EMI. Instead Save up and buy big-ticket items to save big.

I bought my apartment using my savings. I did not take a home loan. If I had taken a home loan the apartment would have cost double from paying the bank EMI interest.

As an Early Retiree if you save up and then buy an apartment using savings you enjoy the same privilege enjoyed by rich people who pay the entire cost upfront from their bank accounts instead of taking loans.

See the EMI Calculator below that shows how EMI interest is almost 50% of the total loan repayment. For a house you purchased for Rs.50 lakhs you’ll end up paying Rs.1 crore with interest over the course of the loan repayment period.

home loan EMI
I assumed the lowest interest rate of 8.2% in the above example from ICICI’s home loan page. You can calculate how much more you’ll end up paying in interest if you don’t qualify for this “lowest” rate. Also if you pay EMI  for a longer loan tenure then the interest portion will go above 50%.
range of home loan interest rates
Some people will counter this by bringing up income tax deductions for interest paid but they forget that they still paid double the cost of the house in interest. Paying more in interest increases the total cost of ownership which has a direct impact on the price at which you sell the house and make a gain.

For example:
If you bought a house at Rs.50 lakhs without loan then selling it at say Rs.60 lakhs after 2 years gives you a gain of Rs.10 lakhs. But someone who took a loan like in the above graphic to buy the same house would have paid EMI interest of Rs.10 lakhs in 2 years so when they sell it for Rs.60 lakhs after 2 years their gain is zero. Refer the year-by-year EMI payment at the bottom of this EMI Calculator page.

The Early Retiree pays no tax on stock market profits

UPDATE:  LTCG Tax for equity is 10% now as of Budget 2018. Still low compared to income tax slab rates or other assets.
Lesson: Long-term Capital gains is tax-free!!!

The Early Retiree pays ZERO TAX in India on stock market profits if they’ve held the equity shares or equity mutual fund units for more than 1 year.  Even dividend income from equity shares is exempt from tax in India.

See the chart below:
web_expense-account-kgWC--414x621@LiveMint.jpg

Assume you have accumulated a corpus of Rs.1 crore which generated a 12% annual return last year. That is Rs.12 lakhs annual profit on which you don’t have to pay any tax. You could use it towards purchasing other non-financial assets like a house, car, gold, kid’s education etc without taking any loan EMI.

A PLEASANT SIDE-EFFECT: 

By using tax-free stock market profits to buy other assets as part of your annual portfolio rebalancing you are actually diversifying your portfolio into real-estate, gold, F.D etc. thereby reducing the risk of capital loss in your portfolio if you had instead kept all your investments in only the stock market.

Successive governments in India have considered imposing a long-term capital gains tax on equity shares and equity mutual funds but for now there is no tax. Leverage it to your advantage by retiring early 🙂

The Early Retiree gets huge discounts on purchases

Lesson: Use Cash as Leverage while buying a house or health, car insurance.

Real Estate discounts of 10-30% at BANK AUCTIONS :

I personally know of a person who bought a flat in a prime residential area for a great bargain through bank auction.

Banks like SBI regularly auction off properties where the borrower has defaulted on their home loan. The bank is primarily interested in recovering the loan amount they are owed and not in ensuring they get the maximum market value for the house.

This is a great opportunity for the Early Retiree sitting on cash or easy to liquidate assets like equity & F.D.  Being liquid is important to participate in bank auctions because you need to deposit 10-15% of the bid amount upfront to prove that you are a serious bidder. If you win your bid then you have to pay the full amount within 15 days.

See :

Health & Car Insurance Discounts:

ICICI Lombard Health Insurance offers a 35% discount on the annual premium if you opt to pay a deductible of Rs. 1 lakh. The insurer is telling you: “Hey! if you pay out of your own pocket for upto Rs.1 lakh in expenses then we’ll will give you a 35% discount on the annual premium”  

For an early retiree sitting on a huge savings corpus, paying Rs.1 lakh on rare years won’t pinch them that much. On all other years they enjoy a low premium! That’s what rich people would do. Since your health insurance premiums only increase as you grow older this is a great way to keep those costs down.

Same principle applies for car insurance too. Opt to pay for minor dents & repairs yourself to lower your premium.

Don’t file a claim for minor issues so you can get a no-claim bonus the following year.

Voluntary Deductible.pngSource

The Early Retiree travels for free

 Lesson: Having a great credit score gives you great perks

The typical Early Retiree pays off their credit card bill in full every month and therefore has a great credit score.  Because they have a great credit score they are eligible for credit cards that give fantastic travel points which they can use to get at-least one FREE domestic round-trip flight for two every year more than making up for the annual fee charged by these cards. They also travel in style like rich people by getting access to airport lounges while they wait for their flight.

Simply swipe your monthly expenses on these travel credit cards and pay them off in full every month. Paying each month’s bill in full means you don’t even have to care about the interest rate charged by these cards.

Card Name Free Flight Tickets worth Rs.15,000
American Express® Platinum Travel Credit Card Spend Rs.4 lakhs/year on card
Axis Bank Miles Privilege Credit Card Spend Rs.7.5 lakhs/year on card
CITI PREMIERMILES® CREDIT CARD Spend Rs.9 lakhs/year on card

High-level Details on how the rewards work:

Card Name Annual Fees Earning Redeeming
American Express® Platinum Travel Credit Card ₹5,000 Spend Rs. 1.90 Lacs in a year and you can get Travel Vouchers worth more Rs. 7,700
Spend Rs. 4 Lacs in a year and additionally you can get Travel Vouchers worth Rs. 11,800
Axis Bank Miles Privilege Credit Card ₹1,500  Yatra Vouchers worth Rs. 5,000 every time Rs. 2,50,000 is spent on the card
CITI PREMIERMILES® CREDIT CARD ₹3,000 Earn 4 Miles for every Rs.100 spent 100 Miles = Rs.45

The Early Retiree earns higher interest than F.D

Lesson: Lend to trustworthy people at higher-than-fixed-deposit interest rate

The Early Retiree has accumulated a large retirement corpus. Some of it is in F.D. The Fixed Deposit (F.D) gives him only 6% interest today and trending lower. Say family member or friend who is trustworthy needs a loan for business or kid’s education.

  1. SBI charges a really high 13% interest for Personal Loans even for someone with the highest credit score. See personal loan interest rates table below.
  2. My bank F.D today gives only 6% interest
  3. Instead I can loan my friend the money at 9% interest if I trust them to repay or against collateral.
  4. My friend gets it for 4% less than what the bank charges him and I get an interest rate 3% higher than what my bank pays for my F.D Win-Win

SBI personal loan interest rates based on credit score

Source

Here’s a good article on the Precautions to take while lending to friends and family

If you would rather not risk your friendship or relationship over lending money then there are RBI-regulated P2P lending portals are available in India. So the Early Retiree has more options to lend her money and get higher interest.

Conclusion:

This is not an exhaustive list. But this is a starting point for you to understand how to benefit from a large savings corpus without actually spending it 🙂

Let’s “ALL” get Richer through EARLY RETIREMENT! 

12% return from stock market every year?

In my earlier post on early retirement in India, I assumed an average return of 12% from investing in equity. A lot of people new to equity investing assumed that this 12% is a guaranteed rate of return like a fixed deposit which is not correct. You can find this misleading way of talking about equity returns even in popular personal finance publications.

In this post I’ll help you visualise stock market return correctly so you can also understand the risks involved in equity investing.

Imaginary F.D returns versus Stock Market returns

See below example that compares Rs.100 invested for 5 years in a 12% F.D  versus stock market.  I have used imaginary F.D & equity return % to make a point.

FD returns versus Stock market returns.png

The F.D rate is guaranteed so your investment grows at 12% every year. But the stock market returns are not guaranteed and they go up and down but at the end of 5 years Rs.100 invested in the stock market gives you the same ending value as the F.D maturity amount in this imaginary example. So you can say that in this imaginary example the stock market gave you a 12% average return at the end of 5 years.

Real-life example

The 12% return I assumed in my early retirement blog post was based on a 20-year average of the Sensex from 1996-2016 and not the “year-over-year” return. Stock market returns go up and down sometimes wildly.

See below for the year-by-year returns of the Sensex from 1996 to 2016.

20-year Sensex Returns.png

Highlights:

  • Look at the “% Returns” column. You don’t see a straight line giving 12% year after year like a fixed deposit
  • What you see is annual returns going up and down and in some years even negative returns.

Hmmm… the market returns fluctuate every year. How to calculate returns?

Enter CAGR: Compound Annual Growth Rate. CAGR  is nothing but the annual interest rate required for lumpsum ‘X’ to grow to lumpsum ‘Y’ over a period of ‘n’ years.

Since the stock market returns are volatile, a simple way to calculate returns is to take the starting year value and calculate what “FD interest rate” would have given the ending year value.  So according to the above table Rs.1 lakh invested in 1996 would have returned Rs.8.63 lakhs in 2016 which is an average return of 11.38%

Don’t worry there are online CAGR calculators: http://www.moneychimp.com/calculator/discount_rate_calculator.htm

Will my equity corpus double every 6 years at 12% return as per Rule of 72:

The Rule of 72 is easy to apply when you get a steady 12% return every year like a F.D

But when you get non-straightline returns like the stock market, your corpus will not double exactly after 6 years @ 12% average return.

Look at the Sensex returns table above:

  • Rs.1 lakh  invested in 1996
  • Doubled to Rs.2 lakhs in 2004  after 8 years
  • Doubled to Rs.4 lakhs in 2006 after just 2 years
  • Doubled to Rs.8 lakhs in 2014 after 8 years

So Rs.1 lakh doubled 3 times after 18 years just as the Rule of 72  predicted for a 12% average return. If there are years when the markets are down then the doubling takes longer. That’s the main difference between stock market and FD returns. You have to account for years when the market is down while investing in the stock market.

P.S:

CAGR way of calculating returns % works only for lumpsum investments. For mutual fund SIP returns you’ll need to use XIRR.  If you look at your mutual fund portfolio statement, your mutual fund-house or MF aggregators like CAMS & KARVY report XIRR returns only.