This article will help you understand the basic concept of FIRE and the journey towards financial independence.
What is ‘FIRE’?
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’ – what is it?
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. More on that in later part of this blog.
‘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.
How to achieve FIRE?
<<Link to the Journey to Financial Independence Blog>>
