What is Financial Freedom?
Today I plan to cover “Financial Freedom”, probably the most sought after “dream” by the investors and traders alike, almost all around world. But what actually is this? Does this really require as much complex and strenuous efforts as it seems? I plan to address a few key points, share some formulae or ratios that you can use to set targets for yourself and measure how well are you doing. This is far from perfect, but my intent is to give you some reference points that you can use for rough estimations (80/20) and also share that this really doesn’t require one to be extremely adventurous with his/her hard earned financial resources.
Essentially it means that your passive income is more than your active/passive expenses.
So what is that “One Number” sum that if you had you will retire?
Some think of a million, others couple of millions and for others it might be much more/less depending upon needs/wants. It all starts with what is the monthly income you desire to have when you retire? Talk to any financial planner, schedule an interview and he can work this out for you based on your profile/wishes/needs. For our calculation purpose, let’s assume US$5,000/month is what you may need after you are retired, your kids are educated/married/financially independent, and you have your own place to live.
What is the Risk Free Rate of Return in your country of living? Usually this is the rate government bonds offer. Well, there are times like the current “great recession” when there is nothing like risk free, but let’s assume that govt bonds are equivalent of risk free. Let’s say you live in US and it it might be 4% for 30year Bond while in an emerging market it might vary from 6 to 8%. If you are a client of “wealth manager” they may offer you say roughly 6% per annum. But for our calculations, let’s assume that you can only get 5% per annum.
Here are the two equations we need for our rough calculations-
- Desired monthly Income = Financial Independence Target Sum (Your Number) X (Annual Risk Free Return/12)
- Financial Independence (aka Retirement) Target= Start-up Capital Available for Investment X [(1+monthly return)*number of month -1]
Let’s solve the two equations using our assumptions-
Financial Independence Target= Desired monthly Income X (12/5%) = $5,000X 240
5,000X240 = 10,000 X [(1+monthly return)*number of month -1] – Assume 1) 5% per month via option trading and 2) $10,000 starting capital available for investment
Solving the equation via Logarithmic way, you will get 98.3 months as an answer.
Summary – If your starting capital is $10,000 and you can generate 5% per month, you will be financially independent in less than 100 month should you desire to have $5,000 per month income (assuming 5% per annum risk free rate). You can calculate this for different assumptions.
The target will be closer if you can add more capital along the way and/or improve your monthly returns. Of course there might be setback when market is not favorable to you but in the end, this simple power of compounding raises the question “do you really need to chase those speculative 1000s % returns? do you really need take unnecessary risk with your capital” Think again!!!
Disclosure- Above calculation are for example and simplified. Pls use appropriate numbers that fits to your profile and also verify with your financial adviser/planner before concluding any financial decisions.
Trade carefully, Trade profitable, OP