How to Retire Early (All About Financial Independence or FIRE)
What Is "Financial Independence and Retire Early"?
FIRE (financial independence and retire early) is a movement dedicated to changing how people normally think of retirement. The traditional method of retirement involves entering into the workforce at 20, working for 45 years saving 10% of your income, then retiring at a traditional retirement age at the ripe age of 65.
Well, I’m not okay with that. Am I supposed to just sit around following this schedule working all the time, happy that I get my weekends and 2 weeks of vacation a year all? Only to retire at an age where the large majority of my life has already past me by? What if I lose my job? How will I pay my mortgage? My car loan? Utility bills? With a bit of an open mind and some deliberate lifestyle changes, it’s possible to reclaim years of your life.
Let's break it down:
- FI (financial independence) means that you do not need to rely on someone else (i.e. your job) to pay for your living expenses for the rest of your life. Typically that means the money comes from investments, passive businesses, real estate, etc. Now you have the freedom to do whatever you want with your time, within reason of course. At this point, working is optional.
- RE (retire early) is exactly what it sounds like. As stated earlier, once you reach FI, working is optional. If you wanted to, you could retire. You could spend your time traveling the world, spend time with your friends and family like you always said you would, or finally exploring your hobbies.
How Do I Reach Financial Independence?
There are three main pillars to reaching FI:
- reducing expenses
- increasing income
Step 1: Reduce Your Expenses
Reducing expenses is the first step. If you take home $50k per year after taxes, but spend $45k per year, it doesn’t allow you much wiggle room to save for retirement. Expensive restaurants, upgraded cars every few years, and luxury vacations are generally FI-killers in most cases. Now if you make millions of dollars a year, don’t let me stop you from buying that yacht. For us mere mortals though, you have to make decisions. Is it worth working an extra 5-10 years in order to drive the newest cars every three years? If you can be content with lower expenses, then your chance to reach financial independence is greatly improved.
There are some simple choices regarding expenses—the big three expenses plus a miscellaneous category—that most people resolve on their path to FI.
Don’t Buy New Cars
Buy reliable used cars. A car loses around 10% its value the minute you drive off the lot. By the end of the first year, it loses around 20% of its value. Unlike a house, a car is a depreciating asset, so you shouldn't look at it like an investment. You shouldn't buy just any used car though. If you don’t know how to fix things in your car, or don’t have a friend that can fix things in your car, don’t buy a used Mercedes or BMW. They’re notorious for breaking down after a few years. I myself drive a 2010 Toyota Prius. Not a sexy car, but it’s extremely reliable (200k miles and running without any issues) and gets great gas mileage. I bought mine used for 7.5k around 3-4 years ago. Any other used Toyotas or Hondas are a pretty safe bet.
Cut Your Housing Costs
I work in a high cost of living area and so I have several options:
- Buy a house in the city I work in. The cheapest house I could find is a 2 bed, 1 bath, 100 year old house for $500,000. On top of the $500,000 mortgage, it’s an additional $6000/year in property tax payments. This could work if I’m willing to work quite a few more years in order to pay it off (I’m not). Otherwise I’d probably house hack.
- Buy a house somewhere else. The immediate vicinity is similar, if not more expensive. However if I am willing to have a 1 hr commute (each way), I could buy a house for around $150,000 with $2500/year in property tax. This is what I eventually did – I’m not particularly attached to the big city.
- Rent an apartment in the city I work in. This cost is around $1,500/month. I psychologically feel better living in my own home instead of an apartment, but this option could work for other people. I find this to be a very personal question, so I won’t espouse a particular option. However for me, I felt the best by buying a house in a lower cost of living area and choosing the long commute.
Cut Your Food Budget
Eating cheaply is very easy and possible if you cook your own food. Shop the sales. Bring your own lunches to work. Meal prep. The USDA released an estimated cost of food for a household for July 2019: approximately $386 for a family of 2 on a "thrifty" plan with on the other hand $766 for a liberal plan. Similarly, a family of 4 is estimated to cost approximately $564 on a thrifty plan and $1099 on a liberal plan. Try to aim to beat the thrifty cost. However in no circumstances should health be ignored. There’s no point in saving food cost if you’re eating unhealthy foods.
Cut Miscellaneous Expenses
Of course this is the category you hear about the most. "Don’t buy a latte every morning." "Don’t have any subscription services." "Don’t buy any avocado toast." "Cut your cable". Sure, go through these items and see where you can cut back, but don’t do it in a way that makes your life harder. For example, I don’t like paying for internet, but I wouldn’t cut my internet and try to tether data from my phone. I'm a big internet user, and that would be extremely inconvenient.
Try to cut the big things first, then see how low you can go. Cable, for example, can cost around $100 a month. If you watch a football game once a week, and the rest of the time the cable goes unused, then each of those football games cost you $25/game. Is it worth paying $25/game?
The key idea behind reducing your expenses is that you can spend money on either expenses or life energy. Is having cable worth working an extra 5 years of your life or would you rather put it in your savings in order to have your money work for you?
The key thing here would be to track your spending. Otherwise how do you really know what you’re spending on? I personally use only one or two credit cards, which makes it easy to track my spending. I look at my spending once a year then try to work on it accordingly. If you’re at the beginning of your FI journey, I would suggest looking at it on a monthly or bi-monthly basis.
Step 2: Increase Your Income
You can increase your income in several different ways.
If you believe you’re kicking ass at work, but still being underpaid, ask for a raise. Talk to your boss. Switch companies. Switch careers. You can get more education (a bachelor’s or masters; I would not suggest a PhD). Get more credentials (Journeyman, PE, CPA, PMP) or even start a side business.
There’s only so much cost that you can cut before it starts to significantly affect your happiness levels. Instead of trying very hard to cut out $1000 in a barebones budget, you could try to earn an extra $1000. I’m choosing to try to climb the corporate ladder, but many people out there have an entrepreneurial spirit and would rather choose a side hustle to earn more money.
Step 3: Invest
Do you want to know why the rich keep getting richer? Their money works for them, and your money can work for you too. As difficult as it is to believe, this is the easiest step on your FI journey. After all, where do you think your 401k money is sitting? What about state pension systems? If the stock market was the volatile gambling system everyone makes it out to be, why would the most stable forms of retirement income be invested in it? Choose low cost index fund investing and you never have to think twice about it. The market will have fluctuations, and as the numbers in your investment accounts get larger and larger, these fluctuations could swing in the tens of thousands of dollars, but don’t panic. The “set it and forget it” method isn’t what we normally associate with investing, but it works!
Fidelity, one of the largest asset management companies in the world, did a performance review of accounts between 2003-2013 to see which accounts did the best. Guess what, the best performing accounts were from people who were DEAD! That’s right, even through the 2008 financial crisis, the dead peoples’ accounts beat everyone else. Ok, so maybe they just beat out the active fund managers, right? Well no. Second place goes to investors that FORGOT that they had accounts. Now, it’s possible to time the market and make a killing by playing the game, but that is incredibly, incredibly rare. Even Warren Buffet, who has made his billions by trading individual stocks, wants his money to be invested in an S&P500 index fund when he dies.
How Will I Know When I’m Done?
You have achieved financial independence when your investments and passive income generate enough money to live off of. For many people in the FIRE community, this means 25 times your annual expenses. This translates into a 4% safe withdrawal rate. For example, if you have a $1,000,000 investment portfolio, you can withdraw 4% ($40,000) the first year and $40,000 (inflation-adjusted) every subsequent year afterwards, and you will likely not run out of money.
The study that many cite is the Trinity Study, which shows that a 4% withdrawal rate has a high likelihood of not running out of money in a 30-year retirement period. Of course that study only uses a 30-year retirement period and many people seeking FIRE are looking at a 60- or even 70-year retirement period, so your mileage may vary. Many people assume a lower withdrawal rate 3.25% or 3.5% as a safety margin. If you like, you can use a program cFIREsim or FIREcalc to see the percentage of success with your numbers.
What Does This All Mean?
There are a lot of variables here that affect the years to retirement and it it’s going to take some time. After all this is not a get-rich-quick scheme; this is math.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.