A few months ago I came across the FIRE movement and I’ve been fascinated ever since. The acronym stands for Financial Independence / Retire Early. FIRE is a movement whose participants are a part of an effort to retire far earlier than the traditional retirement age.
FIRE followers hope to achieve financial independence by savings vigorously and living a life of extreme frugality. This is done by dedicating anywhere from 50% to 70% of yearly income to savings. The goal is to eventually have enough saved up to quit their jobs and live off small withdrawals from their portfolios well before the conventional retirement age of 65.
What is financial independence?
Personal finance expert Warren Ingram defines financial independence as when the income from one’s assets exceeds their expenses.
This boils down to no longer needing to work for a living because one would have enough money in savings and investments to allow them to live their current lifestyle for the rest of their life. Financial independence might seem like an ambiguous goal but the followers of FIRE have two formulas that guide their savings goals. One formula to estimate how much money they would need to save to achieve financial independence and another to conclude how many years it would take to do so.
The financial independence (FI) number
The financial independence number can be determined by multiplying annual household expenses by 25. For example, if annual expenses amount to N$300 000×25, the amount in savings needed for financial independence is N$7.5m.
After the FI number is projected, one would then calculate how many years it should take to reach it. The formula for this is; (FI number- amount already saved)/current yearly saving. In this case, the years to FI are 22.5 ((N$7.5m - N$3m)/N$200 000).
The above figures are for illustrative purposes only but one can see that a commitment to FI is a commitment to livings well below ones means and often forgoing things (possessions, activities, hobbies) that truly bring happiness or just make life more convenient.
For many, this idea of saving 70% of their income seems insane and impossible to imagine. Thousands around the world who are part of FIRE have proven that it is possible to achieve, just not easy.
Once the FI number is achieved one can stop working altogether or cut back on time spent working to pursue other passions. Within retirement, there is a balancing act that has to happen between preserving savings and withdrawing enough income to live off. The goal is to ensure you don’t outlive your savings by withdrawing too much yearly income that your savings run out. This is where the 4% rule comes into play.
The 4% rule stems from a study done at Trinity University in Texas called “Retirement Spending: Choosing a Sustainable Withdrawal Rate”. The study showed that you could withdraw 4% of your savings in the first year of retirement. Then, in each following year, you could increase your withdrawal by inflation. If this is done right and barring any huge stock market crashes, the odds of running out of money before the end of a typical 30-year retirement are low.
However, reaching financial independence and retiring early means you will need your money to last more than 30 years. For that reason, some people use a smaller initial withdrawal rate, such as 3%, to avoid outliving their savings. While others, continue to work, but less hours or start working on their passion projects.
My take away
My take away is, you don’t have to live a life of extreme sacrifice while trying to achieve financial independence. Living life is a delicate balance between enjoying the present and all it has to offer (even if it means spending money) and putting specific, measurable and ascertainable goals in place to get you to the bigger picture.
The extreme savings rates of 50%-70% of income are not realistic to many of us. Find the sweet spot that works for your lifestyle and just start.