Have you ever thought about how much you would need to achieve financial independence and retire? How about the age at which you would be able to retire? As it turns out, the FIRE movement can help you determine your retirement amount and presents a way for you to retire remarkably early.
WHAT IS THE FIRE MOVEMENT?
FIRE is an acronym that stands for Financial Independence, Retire Early. Proponents of the FIRE movement achieve financial independence and retire very early (typically as early as in their 30s and 40s). They accomplish this by embracing a frugal lifestyle, extreme savings, and smart investments. Some save and invest up to 70% – 75% of their annual income!
Does this all sound outlandish to you? It did to me too, but we’ll explore the principles further to get a better understanding of FIRE.
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HOW DID THE FIRE MOVEMENT BEGIN?
The principles behind the FIRE movement are primarily based on the 1992 best-selling book Your Money or Your Life by Vicki Robin. The book encourages readers to evaluate their values candidly. Looking at how you spend your time and money is a great way to determine your values.
Financial independence means having enough resources (from passive income, investments, etc.) to cover your living expenses without relying on formal employment. It means being able to make life choices, such as contributing to society and spending your time without the worry of money.
Within the FIRE movement, retirement takes on a new meaning. For most of its proponents, it means having the freedom to pursue things that bring them fulfillment. Many of them end up being entrepreneurs in various ventures, and some may even maintain some formal employment of their choice.
Achieving early retirement takes a lot of discipline and sacrifice. The FIRE movement demonstrates that even though early retirement may seem impossible, it is nevertheless possible.
WHAT IS FRUGALITY WITHIN THE FIRE MOVEMENT?
There is a difference between being frugal and being cheap. The latter often entails buying the most inexpensive items or services, often with little consideration on quality or value. Frugality, on the other hand, is being conscious and intentional about spending. For instance, if you have ten wristwatches you use and thoroughly enjoy, you are frugal. However, if you have ten wristwatches and only wear one of them, you will be wasteful.
THE 3 KEY STEPS TO FINANCIAL INDEPENDENCE
There are many creative ways to achieve financial independence. They can generally be summed into three key steps: increasing your income, reducing your expenses, and smart investing.
1. INCREASING YOUR INCOME
Since there is a limit to how much most people can cut expenses while maintaining a comfortable and enjoyable lifestyle, increasing income becomes a significant factor in achieving financial independence. There are many ways that you can increase your earnings if you put your mind to it. These may include:
- Work overtime hours, if this is an option that is available at your current job. Some employers often offer increased pay for working overtime or on statutory holidays.
- Find a higher paying job: this could require that you improve your skills by acquiring more education. Sometimes it may be as simple as negotiating a pay increase by demonstrating value to your employer.
- Side hustles: This is anything that generates income in addition to your full-time job. These are often passion projects, and most proponents of FIRE continue with their side hustles after achieving financial independence.
2. DECREASING YOUR SPENDING (LOW BURN RATE)
We live in a consumer culture that always encourages spending. Did you know that you are exposed to an average of more than 5,000 advertisements in a day? Phrases such as “shop till you drop” or “I need some retail therapy” are common and acceptable part of our culture. Another interesting fact that highlights the consumer culture is that an average of 50% of online shoppers will increase their orders just to reach the free shipping minimum.
The FIRE movement, in contrast, advocates for mindful spending by asking questions such as whether an item adds value to your life before making purchases. By being intentional about spending, the FIRE movement proponents can cut their expenses and speed up their financial independence journey.
WAYS TO DECREASE SPENDING MAY INCLUDE:
- Reduce housing expenses. Housing tends to be the most significant monthly expense for most people. Reducing this expense can dramatically accelerate your speed towards financial independence. It can be achieved by taking actions such as downsizing, living in a cheaper area, or house hacking. House hacking is renting out portions of your primary residence to offset your housing cost. Some FIRE proponents eliminate their housing costs through house hacking.
- 72-hour test and buying quality. As described in Carl Richards’ personal finance book The One-Page Financial Plan, this entails waiting 72 hours before making a non-essential purchase. This wait allows you to re-examine whether the acquisition would add value to your life and avoid impulsive buying.
- Travel hacking: primarily involves collecting points offered through airlines, credit cards, and hotels to earn free travel.
- Geographic arbitrage means earning money in a strong currency such as the US dollar and then spending in a weaker currency. It allows you to enjoy the same standard of living while spending a lot less. Expatriates living abroad are practicing geographic arbitrage, albeit unintentionally sometimes. Other common instances of geographic arbitragers are Westerners teaching English abroad and earning in their home currency salaries.
3. SMART INVESTING (FINANCIAL PLANNING & FORESIGHT)
Smart investing is key to achieving financial independence as it allows your savings to grow. The FIRE movement proponents spend a lot of time learning how to invest and preserve their hard-earned money.
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HOW MUCH MONEY DO YOU NEED TO RETIRE [THE 4% RULE EXPLAINED]
The 4% rule is a rule of thumb used to determine how much money you need to retire. It also determines the annual amount of funds you will need to sustainably withdrawal from your portfolio while in retirement. The rule provides the amount that you can withdrawal annually without touching your principal, i.e., living only on interest and dividends earned in your portfolio. As such, it is also known as the Safe Withdrawal Rate.
The 4% rules suggests that:
- You can spend 4% of your portfolio value, adjusting for inflation each year and never run out of money. This is because the market typically goes up by 6% to 10%, and inflation generally is about 2%. If we use the more conservative rate of 6% and adjust for 2% inflation, you can theoretically withdraw 4% each year with ever touching your principal.
- You can retire once you have saved approximately 25 times your annual expenses. The table below gives the approximate amounts you would need to achieve retirement for yearly various expense levels.
|ANNUAL EXPENSE||RETIREMENT NUMBER|
ORIGIN OF THE 4% RULE
The 4% rule came about from an exhaustive study of historical returns in the US stock market in 1994 by the financial advisor called William Bengen. The study modelled spending over 30 year periods using data for a hypothetical portfolio consisting of 50% equities and 50% bonds. The study found the safe withdrawal rate to be 4% over 30 years.
You can learn more about William Bengen’s study, Determining Withdrawal Rates Using Historical Data, here.
The 1998 study from Trinity University (popularly referred to as The Trinity Study) also arrived at a safe withdrawal rate of about 4% in retirement through different retirement portfolios. You can learn more about The Trinity Study, Retirement Savings: Choosing a Withdrawal Rate that is Sustainable, here.
CAUTION ABOUT THE 4% RULE
- It is difficult to predict the expected return rate over very long periods for portfolios that consist of a lot more higher-risk investments such as stocks.
- The life expectancy has generally been increasing worldwide. Longer life expectancy and early retirement make for a very long retirement period. The failure rate of the 4% rule increases over such long horizons.
- The 4% rule is based on US historical market data and does not include international market data. The safe withdrawal rate could be much different when global market data is included.
- The rule only works when followed closely annually. A splurge in one year during retirement could have a severe effect on your retirement nest egg.
Whether you choose to adopt FIRE in its entirety or select aspects of it, it provides many lessons that are beneficial. Lessons from the FIRE movement that are worth consideration for everyone include:
- Determining what retirement means for you and how to get there
- Becoming an intentional spender by buying only things that add value to your life
- Finding ways to boost your income, which will typically lead you to grow both personally and professionally
- Increasing your savings and investing levels to help you achieve financial independence
If you enjoyed this article or have any questions, please leave them in the comment section below! I’d love to hear from you! Also, please feel free to share this with anyone that may benefit from it.“The only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do.” ~Steve Jobs
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