What is F.I.R.E?
FIRE is an abbreviation for ‘Financial Independence, Retire Early’. This is a lifestyle movement with the goal of gaining financial independence by saving consistently, investing smartly, and generating a passive income to sustain expenses.
The ‘Financial Independence’ is the part that everyone should focus on as it should be a must for all (pity they don’t teach this in schools!). It provides the freedom to choose if one wants to keep working or ‘Retire Early’ to use our precious time on this planet to chase our dreams, hobbies, travel, spending time with family and friends etc.
‘Financial Independence’ – It is more than just a number!
Financial Independence in a very simplistic definition is when,
- you have enough other sources of income (your ‘passive income’) than your salary (your ‘primary income’) that you no longer rely on the salary to sustain your annual living expenses. This passive income could be a combination of real estate rentals, equity dividends, interest from cash deposits, or earnings from other side hustles.
OR,
- you have enough assets, investments, savings etc. (your ‘net worth’) that you can safely withdraw part of the net worth every year to sustain your living expenses without ever running out of money.
So, the key is to save money over time and build an investment portfolio that provides this path to financial independence. Remember, Financial Independence is a “get rich quick” scheme, it’s a journey made up of stages as explained here.
‘Retiring Early’ – busting the traditional mindset!
Gone are the days when someone:
- got out of the college,
- took up a stable job,
- worked there for next 40-45 years,
- built up a pension, and then,
- retired in their early / mid 60s,
Most likely you fall in a category where you have or are:
- taking a short break after your college,
- working at different types of companies,
- moving across different roles on the corporate ladder,
- saving a fair amount of your net income,
- building up an investment portfolio that includes diversified assets like equity, mutual funds, ETFs, and even maybe crypto,
- and don’t have the desire to work till your mid to late 60s.
If you are doing at least 3 out of the 5 steps above, that means a generic boilerplate retirement planning advice doesn’t apply to you.
However, while financial independence is a must, retiring early is an option. Some people love what they do and get energy from working. The founder of the company that I used to work for is 80 years old, a billionaire ten times over but is still passionately running the company with full energy and enthusiasm. So, to each his own. Personally, we decided to trade our time with money as money is infinite, but time is finite … and the most precious commodity that we have. Also, our mind, body, and health changes over time, especially as we enter the later part of our lives (do watch my video on ‘Type of Years’ to get a view on that).
So, there isn’t any wrong or right decision on ‘Retiring Early’. It is what you want to do with your time.
I’m sold! So, what must be my Financial Independence ‘number’ to Retire Early?
The beauty of this concept is there is no magic ‘FIRE’ number that gets you to financial independence. Someone with a net worth of 100,000$ or an annual passive income 10,000$ can be financially independent while someone with a net worth of 10 million dollars or an annual passive income of million dollars may be nowhere near their financial independence! This is because financial independence is linked to your living expenses and lifestyle. A person with a living expense of million dollars needs a very different net worth and passive income than a person with a living expense of 10,000$
Also, FIRE has no ‘currency’. The above numbers might as well as be in Euros, Rupees, Yen, Dirhams, or any other world currency for that matter.
The mathematics behind Financial Independence is not absolute numbers but relative percentages, and therefore makes it much more resilient and durable to different market conditions. It is all about
- annual passive income > annual living expenses, adjusted to inflation, OR
- percentage of annual withdrawals from the net worth and adjusted to inflation.
SAFE WITHDRAWAL RATE
The percentage of money that you can withdraw from your net worth annually, adjust to inflation and not run out of money is called the ‘safe withdrawal rate’. Lots of studies and analysis has been done on what is considered a safe percentage to withdraw without running out of money:
- Generally, 4% is considered a safe withdrawal rate by most of the studies. However, most of these studies have been conducted for the US market with a remaining life span of 30 years.
- 3% annual withdrawal typically holds the stress test across most of the world markets and for 40 years plus of remaining life span.
- Anything between 2% to 3% would not only be safe but it is likely that you would be left with more money than you started with!
A very good analysis and simulations here on the above percentages https://thepoorswiss.com/trinity-study/.
What does this mean in terms of absolute numbers? For example, if you have one million dollars, then you can annually withdraw:
- 40,000$ with 4%
- 30,000$ with 3%
- 20,000$ to 30,000$ with 2% to 3%
The safe withdrawal rate not only helps you understand how much you can safely withdraw from your net worth but also helps you calculate how much net worth you need to sustain your living expenses. This can be achieved by simply flipping the percentages:
- To achieve a 4% safe withdrawal rate, you need a net worth that is 25 times your annual living expenses. So, if your annual expenses are 10,000$, you need 250,000$ net worth.
- To achieve a 3% safe withdrawal rate, you need a net worth that is 33 times your annual living expenses. So, you need 330,000$ net worth for the 10,000$ annual expenses.
- To achieve a 2% to 3% safe withdrawal rate, you need a net worth that is anywhere between 33 to 50 times your annual living expenses. So, you need anywhere between 330,000$ to 500,000$ net worth for the 10,000$ annual expenses.
Important to note: the withdrawal rate is based on invested savings – ideally with 60-70% of the investments in equity. The logic doesn’t work for ‘cash stashed in the mattresses, as your investments can beat inflation while cash loses value over time against inflation.
CORE PRINCIPLES OF F.I.R.E
Financial independence isn’t just a goal—it’s a shift in perspective. In order to go through this journey in.a structured manner where you can not only define your targets but also monitor your progress against such targets, there are some principles that you can follow and even refine for your personalised journey.
– Accelerate your savings to Achieve Financial Independence faster
– Start building a passive income which meets and starts meeting your expenses
– Have a certain percentage that you limit yourself to withdraw from your total portfolio every year during your retirement years (what is called safe withdrawal rate as explained above)
– Have a diversified portfolio and not just in one particular asset class or asset
– Have a bucket strategy that you spread your investments in a way that you distribute the risks over time (people generally don’t know about this or don’t give much attention to but spreading your investments in different buckets – short, medium and long term – can be your masterstroke to ride the waves of market volatility)
TYPES OF F.I.R.E
Now, this is the most interesting aspect of F.I.R.E – not one size fits all – you can define your own lifestyle and type of FIRE you would like to achieve. You can choose to chase financial freedom with just the essentials, like a backpack and a simple spreadsheet or you can aim for the luxurious version—think yacht and private chefs. And then there is another version where you keep a foot in the work world, not for survival, but for joy and flexibility.
LEAN FIRE is when your passive income is sufficient enough for meeting your base expenses (like house rentals, house payments, car payments, children education, living expenses and maybe once a year travel). So it’s basic and it doesn’t include any of the discretionary expenses and no frills luxury here. Typically uh lean fire is where you’re at expenses is below the average expenses in the city that you’re living in and your safe withdrawal rate from your total portfolio is more than 4%.
This is suitable for folks who are wanting to retire early at the age of 40 or even in their age in their 30s because they are tired of the corporate life or the rat race and they want to probably enjoy some nice sun and sea and who are into a minimalistic lifestyle
FAT FIRE is the opposite of lean fire where your passive income not only meets your base expenses but also discretionary expenses, gives you enough room for luxury travel or multiple travels during the year. Typically your expenses are above the average of the city that you’re living in and your withdrawal save withdrawal rate or your withdrawal percentage every year from your portfolio is less than 3%.
It’s typically for the folks who either want to maintain their current lifestyle or even enhance their lifestyle in during their retirement year. It is also for folks who’ve already probably achieved Financial Independence with the logic of this 4% withdrawal but they are still working because they’re building that additional fund that they end up being in this fat fire territory
BARISTA FIRE is where you’re partially working – you have a part-time job or maybe your spouse is having a full-time or even a part-time job. Typically the Barista fire is for folks who have still not decided that if they want to retire and they want to test it out or for folks who probably want to continue working in some form and maybe not as a corporate job but they will probably do something as like the title says as a barista or maybe do some consulting gig.
