Stop and take some time now to analyze and introspect how much is enough for your family to live through a year covering across all expenses. Ever thought about it? Is it $40,000 or $80,000 that you need to run the house in a year. What ever the answer is, that’s the cash flow or amount you need to have to cover the expenses year on year. Roughly you can claim to be financially independent if you have roughly 25 times your annual expenses invested in markets. Its even better if there is no outstanding loans on the house you stay in and the cars you drive. The total gross expenses in such a case would come down by atleast 30%. So to claim yourself to be Financially Independent, you will need 20 times your annual expenses invested in markets, you should own the house you stay in with no outstanding loans.
Lets take Leo`s family as an example who works in a bank and takes home $6000 a month. Leo is the only working member in the family. This would mean a net cash of $4,200 that gets deposited in his bank account every month. Leo needs $3,000 a month to manage the family expenses. This is considerably on the lower end since Leo owns the house he stays in plus he has no other outstanding debts or loans. The means Leo needs $36,000 a year to cover the living expenses and lets say $4,000 to meet miscellaneous expenses like medical and travel. So Leo needs to have a cash flow of $40,000 a year that should flow in without depending on his current job. How can this happen? And if that happens, he can tout to be financially free. Based on the guidance I suggested, Leo will need 25 times $40,000 which is equal to $1,000,000 or $1 Million invested in Markets. How can this work? Suppose he has $1 Million invested in stocks, he can expect atleast 1% in dividends which means $10,000 coming from just dividends. He can skim off remaining $30,000 from his investment that is skimming off 3% every year from his investments.
Skimming 3% from your total investments every year is absolutely fine and will not hurt Leos future. Why? This is because Leo has invested $1 Million in 3 low cost Index funds called Russell 2000, Nasdaq-100 and MSCI Emerging Markets index. S&P 500 index. Lets see how these 3 Indexes have performed over last 15 years. In the below tables and charts, you can see on an average Leo would have make 9% CAGR over next 15 years if holds these index funds which means around 4 times in next 15 years, a tidy handsome returns on investment. So coming back to the point on skimming 3% of his investments every year, he will still make around 2.2-2.4 times at the end of 15 years if he continues to hold his investments. So 15 years from now, Leo will create a net corpus of atleast $2.3 Million in spite of skimming 3% every year. It works because of the “power of compounding” over long periods of time which itself is a completely different topic we will cover later.
Now you have a Blueprint framework to understand how much corpus to create to consider yourself Financially Free, still making money work for you over long periods of time. Its year end and now is the right time to analyze where you stand, plan to achieve the financial independence following a meticulous plan and sticking to it as close as possible with tracking every year on the progress.