Many of us sometimes think about these questions and these definitely come up in my discussions with clients. One of these questions has more to do with income and the other is more about expenses.
Everyone’s situation is unique, and financial planning is not a precise science. We tried to come up with a fairly generic answers which should assist in giving one a quick point of reference.
Couple of key assumptions here that the person is leading a financially prudent life, i.e.,
- Expenses are less than the income
- Planned expenses are in proportion to the wealth
- Savings are invested prudently
Did I save enough?
Here we are trying to see the amount one should have after working for a given number of years. Savings are going to be in proportion to one’s income – two people with different levels of income will have different savings after working for the same number of years.
A formula that gives a quick rule of thumb is
- Number of years one has worked * Current annual income/(4-0.06 * number of years one has worked)
For instance if one has worked for 15 years and current annual income is 15 lakhs then they should have 15*15/(4-0.06*15) = 225/3.1 = 72.6 lakhs in accumulated savings
This formula means that
- If a person has worked for 5 years then at the end of 5 years their savings able to support 2 years of the “current” expenses, i.e., the expenses that the person has at the end of 5 years.
- If a person has worked for 20 years then at the end of 20 years their savings able to support 10 years of “current” expenses, i.e., the expenses that the person has at the end of 20 years.
Do I have enough?
By having enough we mean that the person does not need to work for money anymore.
In this case it is only about ones wealth and expenses. It does not matter if one has saved to create the wealth, inherited it, or won it in a lottery.
The answer would be
- Current wealth/Current expenses is more than 25 – Yes you do
- Current wealth/Current expenses is less than 25 – Not yet
People who want to be a bit more conservative may want to use 30 in place of 25
We are saying that one has enough when one is able to consume 4% of their wealth on a yearly basis. Key assumptions here are:
- Wealth is invested reasonably and continues to grow
- Rate of increase in expenses is less than or equal to the rate of return on the wealth
You may want to refer to an article we had published about the strategy to invest wealth for people who were looking to retire (not work for money anymore).
We hope you find these thumb rules useful.