Monday, 3 August 2015

Who is Wealthier? Uncle Scrooge or Donald Duck

My kids love watching cartoons. They are glued to the TV when their favorite cartoon characters are on, laughing along merrily at their silly antics. Of course the cartoon shows these days are very different from the ones I grew up watching. The favorites in my house are Chota Bheem and his gang, Kisna and friends, and Ben10 and Transformers. These cartoon characters are a lot more adventurous and get into more amazing mischief, than I could ever imagine. In our times, for one there was very little content developed purely for the Indian audience (except for Mowgli the Jungle Boy, and maybe a couple others). Also cartoon episodes would be much simpler unlike the ones today which have more elaborate and complex storylines.  So for this blog post, I figured I would use some old cartoon friends to discuss wealth as a concept. You will find other resources on the Internet, that describe wealth in this fashion, but what better way to remember a concept than through cartoons? 
So lets start by asking the question, How Rich Are You? This is a very difficult question to answer since the definition of rich would not be the same for any 2 people. Most of us would agree that the Ambanis are definitely rich. How about if you are in the top 1% of income earning people in India? Or is it 10%? Does your income level determine richness? Or is it networth? This and other similar questions make it impossible to come up with an answer that everyone would agree with.

How about wealth? Can we come up with a metric that determines How Wealthy You Are? Well this has been discussed quite a bit, and here is my version of a fairly well recognized method to measure wealth. Consider the example of my 2 favorite cartoon characters Uncle Scrooge and Donald Duck. Assume that Uncle Scrooge has a networth of Rs 1 Crore, while Donald has a smaller networth of Rs 40 Lakhs. Clearly on a relative basis, Uncle Scrooge would be considered richer than Donald Duck.

Notice here that I am making the comparison simply based on networth. I don't think income levels, cash flows, etc are material in this context. Your networth is the best metric to use in this case. However, this does not mean necessarily that Scrooge is Wealthier than Donald. Here is how I like to define wealth. Consider for a minute that all your active sources of income have stopped completely today! Your salary, your business income, or any other source of active income for which you put in work day-2-day.  If that source of income was to dry up, how many months or years would you be able to survive without any change in your current lifestyle? First you would burn through your emergency corpus. Next you would use up your funds kept aside for less critical goals, and finally you would start eating into your most critical savings. All put together how long you would be able to survive would depend on your annual expenses. So I define Wealth as the number of years you would be able to survive without changing your current lifestyle, if your active sources of income were to stop today.

Lets go back to our example and assume that Donald with his more modest lifestyle has annual expenses of Rs 4 Lakhs.  Uncle Scrooge has a more lavish lifestyle requiring Rs 12 Lakhs per year for expenses. Clearly Donald can survive 10 years based on his current annual expenses, while Scrooge can survive for 8 years and 4 months. So in my book Donald is actually wealthier than Scrooge. 

So how Wealthy are you, by this definition?  When we start our careers, our wealth levels tend to be very low since we don't have any accumulated corpus. The first thing you should focus on is building an emergency corpus, so you can pull through 6 months to 1 year without any active income. Then you slowly start building up your net corpus to 5X annual expenses, 10X annual expenses and so on. Remember to consider your expenses in the current year in which your making this calculation. Your corpus is expected to keep up with inflation to retain the multiple you are targeting. For example if your networth did not increase in a given year, you actually become less wealthy, since your annual expenses would have gone up in tune with inflation. Keep working your way along this wealth journey and by 60 years of age, if you have about 25X to 30X annual expenses socked away, you are wealthy enough to retire! The multiple goes up if you plan to retire earlier, since your corpus needs to last longer. Use the table I included in the post How much should I save before I retire, to figure out your required multiple.

Remember this concept is applicable not just for early retirees, or even related to retirement goals. At any point in time, your networth divided by current annual expenses, is a good metric to determine your wealth level. Take a stab at it, and see where you land up.

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  1. I think uncle Donald is more richer than uncle scrooge. I like this cartoon show very much.

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