Are You Ready To Retire?
The ratio below tells you whether your passive income can support your living expenses. If it can, then you are ready to retire. Your active income streams will stop but you will have enough of passive income to see you through.
Annual Passive Income/Annual Expense = X
If X = 1
Your passive income is just enough to cover your expense. If you stop working, you will still be able to maintain maintain your current lifestyle.
If X is less than 1
You do not have enough passive income to cover your expense. You need to look for ways to increase your income or lower your current lifestyle spending.
If X is more than 1
You have more than enough of passive income to support your spending. You certainly can afford to retire.
Example: Calculate passive income ratio.
Sam has the following sources of income in a year.
1. Employment = $40,000
2. Rental income = $5,000
3. Dividends from shares = $2,000
4. Freelance jobs = $5,000
Sam has the following expenses in a year.
1. House mortgage = $6,000
2. Essentials (ie. food, utilities) = $10,000
3. Entertainment (ie. music, games) = $1,000
If Sam stops working, then his income will be $5,000 (rental) + $2,000 (dividends) = $7,000. This $7,000 is his passive income.
Sam's annual spending is $6,000 + $10,000 + $1,000 = $17,000.
Does Sam have enough of passive income to support his retirement?
Annual passive income/Annual spending = $7,000/$17,000 = 0.4
This means Sam's passive income can only cover 40% of his annual spending. He does not have enough of passive income to support his retirement.
Assume one month later, his parents passed away. Sam inherited a real estate property which is generating an annual rental income of $15,000.
His annual passive income becomes $5,000 (rental from his current property) + $2,000 (dividend) + $15,000 (rental from his parents' property) = $22,000
Does Sam have enough of passive income to support his retirement?
Annual passive income/Annual Spending = $22,000/$17,000= 1.3
Now Sam has enough of passive income to support his spending. He can choose to retire and that should not affect his lifestyle.
In summary, you should work towards achieving a ratio of at least 1 or higher.