Financial Independence Retire Early (FIRE) is a movement which involves saving and investing a high percentage of your income with the outlook of retiring before traditional pensions become available.
People who embrace FIRE will typically save and invest 50-80% of their income, with the aim of retiring in their 30s or 40s.
So what exactly is [FI] and [RE]?
Financial Independence is where your investment returns outweigh your liabilities and lifestyle expenses. For example, your yearly expenses might be £30,000 and your investments may return £40,000 a year. Thus, you are financially independent and you don’t need to work.
Retire Early is the premise that you enter retirement earlier than traditional retirement schemes allow. As mentioned above, some people achieve FIRE in their 30’s and 40’s. The retire early part of this is subjective; it could mean complete retirement or it could mean that you’re pursuing other passions for extra income. The point is, the extra income isn’t essential and you can live off your invested assets' returns.
What do you need to know?
Determine what retirement is
Everyone’s view of retirement is different. Either you’re sitting in a chair watching the world go by, or you’re travelling, exploring, or something in between. It’s important to have some sense of what your plans are. This will play a material role in defining the amount of money you’ll need in order to sustain your lifestyle. If you don’t know what you’re going to do in ‘retirement’ you won’t have any idea of how much you’ll need to save and invest.
Once you know what you want to do, you need to do some planning. First, let’s determine your FIRE number.
What is a FIRE Number? What is your FIRE number?
Your FIRE number represents the quantity of money you need to invest. This invested figure will provide you with an income to support your lifestyle.
But, how can I figure out this number? So how do you calculate this?
Let’s take a look at the 3 elements below, which will help you identify your FIRE number.
Budget & expected expenses
This is one of the most important elements. What is the lifestyle you want to lead in retirement? Want to fly everywhere first class? Or live in a hut in the woods? First Class is obviously more expensive than the hut.
The point is, you need to have an idea of what ‘Retire Early’ looks like for you. Here are some questions to ask yourself:
- House - will you have paid off your house or still have a mortgage or be renting when you Retire Early?
- Travel - what do you think your travel/lifestyle will be like? Do you want to travel domestically, internationally? How often do you expect to travel?
- Fun - Are you happy being in nature and not spending a great deal? Or do you wish to pursue experiences that cost money?
- Debt - Ideally you do not have any debt by this point. Debt will add an extra expense that you have to factor in and this will eat into your available funds. Debt may inflate your FIRE Number, leading to a longer journey towards FIRE.
There are many other categories you could add with expected lifestyle expenses. These are just some hints to get you started.
So for this story, let’s assume you have identified that you need £30,000 a year. Let’s move onto the next section.
This is a very important element of FIRE. The withdrawal rate is the percentage of investments that you will sell each year. This withdrawal will fund your income to sustain your lifestyle. It’s important to carefully identify this figure, your withdrawal rate should allow for continued asset growth or never-ending funds.
- You withdraw 10% of investments every year, but your investments are only returning 2% per year. So, you’re depleting your investments by 8% per year. Using this simple logic (assuming the percentages remained the same) you’d run out of money in 12.5 years.
- You withdraw 3% of your investments every year and your investments grow by 7% a year. Assuming these percentages are fixed, your investment funds will continue to grow by 4% a year. This is even with withdrawing money from it. At this rate, your money could last forever!
Note: This is using fixed percentages and assuming that these never change! That’s not realistic in the slightest.
This is very important as you do not want to get into early retirement and then run out of money or deplete your assets. This would undoubtedly force a return to the workplace or you’d be forced to live a frugal existence.
So, what can you do about this? What evidence is there to help support your decision?
Take a look into the ‘Trinity Study’, also known as ‘The 4 percent rule’. This study analysed withdrawal rates over a handful of different asset classes. This was conducted over varying time periods (10-40 years etc). The study claimed that a 3-4% withdrawal rate presents a lower risk of asset depletion over a 30 year period.
- 4% withdrawal over a 30 year period in 100% equities = 98% chance of portfolio success (i.e. you only have a 2% chance of running out of money).
- 3% withdrawal over a 30 year period in 100% equities = 100% chance of portfolio success.
Note: This study was conducted in 1998, you should conduct your own research as to whether you want to follow this study. These calculations may not be appropriate for 2021 onwards.
So, given the above information, you’ll have some options to consider:
- How early are you retiring? How long do you need your portfolio to survive?
- What’s your risk appetite? Are you comfortable with 100% stocks?
These will help inform your withdrawal rate and highlight how conservative you should be. For further detailed information and analysis, take a look at The Poor Swiss.
To continue with our story, we’ll assume that our withdrawal rate is 3%.
So - you’ve identified your annual budget requirements along with your withdrawal rate. Next up, we’re going to use all this information to calculate your FIRE number.
How do we do this? Simply divide your yearly budget by the withdrawal rate you have chosen. Note, you’ll need to convert your withdrawal % into decimal (i.e. 3% would equate to 0.03).
For example (we identified £30,000 as our income and 3% as our withdrawal rate):
- 30,000 / 0.03 = £900,000.
This £900,000 is the total amount of invested assets you need, to potentially be financially independent. So, we’ve identified in this calculation that we need to have £900,000 in invested assets (equities, bonds etc). By withdrawing at a rate of 3% you’ll ‘create’ £30,000 a year in income. Additionally, the probability of depleting your £900,000 is lower.
In the above example, we know you need almost a million pounds in savings/investments to FIRE. How do you achieve this?
Initial steps to achieve FIRE
One of the best things you can do to shorten your time-to-FIRE is to increase your income. Whether that means the next step on the career ladder, moving jobs or starting side hustles - that’s up to you. But the point is, the higher your income, the higher your savings rate is likely to be. Thus the larger amounts of cash you can invest.
Debt is something that will hamper your time-to-FIRE. By holding debt, you’re limiting the amount you can save/invest each month.
For example, If you earn £1,500 a month, but you need to spend £500 a month on debts, that’s £500 unavailable for investing. So, carrying debt will limit your saving potential.
Budgeting & expenses
Budgeting is important - you’re not likely to achieve FIRE if you don’t know your expenditure. No - this is not just using an app to tell you how much you’re spending on groceries. Budgeting is about assigning a value to how much you plan to spend in a given category and monitoring it.
|Item||Budgeted £/$||Actual Spend £/$|
|Drinking & Eating Out||150||0|
This is a large topic, expect to see a more detailed post on budgeting in the future. In the meantime, take a look at You Need A Budget (YNAB) for great budgeting software!
As I mentioned above, your savings rate is one of the most important aspects of your journey to FIRE.
In the UK, the average personal savings rate is 8.62%* per annum (pa).
For FIRE, the saving rate needs to be higher, much higher. Typically, those following FIRE are likely to save between 50%-80% of their income. Yes, 50-80%. The higher your savings rate is, the quicker FIRE will arrive.
This is why I mentioned that reducing or eliminating debts is super important. If you have lots of debt, it’s going to impact the savings rate that you can achieve.
Here’s data on how saving rate percentage makes a noticeable difference in the time to FIRE. Source: Mr Money Mustache.
|Savings Rate||Years to retirement|
Notice how ‘traditional’ retirement savings of ~10% can lead to a much longer career.
*1955 to 2020
Central banks around the world are cutting interest rates including the Bank of England, with a record low interest rate of 0.1% pa (as of January 2021). Simply storing your FIRE savings as cash is not going to cut it. Not to mention, you have inflation (at 0.3% pa as of January 2021) to contend with too! With the average easy-access savings accounts offering an interest rate between 0.22%-0.32% pa - you can expect that the value of your money may erode or barely grow at all.
To achieve FIRE, you need a sizable investment portfolio likely heavily weighted towards equities, although this is up to you, and depends on your risk tolerance.
FIRE is not about chasing a quick win. Buying bitcoin or the next EV battery provider is going to be a risky gamble. I use the word “gamble” because it truly is. You’re making an active bet that single security is going to outperform. You have no idea how it’s really going to perform.
Investing is about long term growth. For UK folks, a global index tracker with market capitalisation is potentially an option. For example, the Vanguard FTSE Global All Cap fund tracks the FTSE Global All Cap Index, which contains ~6,900 companies. This index is comprised of developed & emerging markets, large, mid and small-cap companies from around the world. You’re not betting on a particular economy/country, industry/sector, or size of company. You’re focussing on global diversification, not making active bets. You are not thinking you know something that the rest of the market doesn’t. You’re accepting the average market return.
In later posts, I’ll go into detail about active vs passive investing and the impact of fees. For now, here are a few resources:
- For UK folks: Investing Demystified by Lars Kroijer.
- For US folks: The Simple Path to Wealth by JL Collins.
What FIRE isn’t
Replacement for an unhappy career
On the surface, FIRE may seem like a good substitute for ending an unhappy career. “If I just last another X years, I can leave work for good”.
This is not a great approach to FIRE. You should be running to FIRE for the opportunity that it brings. You should not be running away from something you’re unhappy with. You might be able to fix whatever you’re unhappy with and find something more fulfilling.
Retire and do nothing
This is my opinion - I mean, you could reach FIRE and then sit around and watch the world go by. But FIRE is more about taking back time and being able to decide how you want to spend your ‘retired’ years. Some people may choose to focus on volunteering. Others may create their own business or travel.
For me, FIRE is having the ability to choose where I spend my time (incl. future income sources that I don’t depend upon) and lead a meaningful life.
What are your thoughts about FIRE? Feel free to add your comments below!
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