Financial Independence, Retire Early is one of the best goals one can hope to accomplish. When you accumulate enough money to live on forever, that allows you to do whatever you want. Taking money out of the picture is one of the best things you can do. Here we go over what financial independence is, and how to achieve it.
- 1 What Is Financial Independence, Retire Early (FIRE)?
- 2 Why Has FIRE Only Recently Come To Popularity?
- 3 So, How Much Is Needed To Reach Financial Independence?
- 4 What Is The Safe Withdrawal Rate?
- 5 What Types Of FIRE Are There?
- 6 Use The Financial Independence, Retire Early Blueprints
- 7 How Many Years Does It Take To FIRE?
- 8 Reduce Expenses + Make More Money To Reach FIRE Sooner
- 9 No Taxes For The Majority + Withdrawing Early Without Penalty
- 10 But What About Your Health(Care)?
- 11 Your Estimated FIRE Number Is Usually Too High
- 12 The Early Retirement Police
What Is Financial Independence, Retire Early (FIRE)?
Since the dawn of time, there existed a class of people who were able to do anything they wanted because they had enough money to do so.
Nowadays, a normal person can do that as well.
Vicki Robin penned the first book on the financial independence, retire early (FIRE) topic a few decades ago. She came out with a newly revamped copy earlier this year for 2018. If you’re looking for a life-changing book, this is it. Then blogger Mr. Money Mustache brought it back to life nearly a decade ago.
Most people retire in their 60s because that’s what they’ve been told they should do their entire life. That’s what their parents have done. Instead of saving more when they get a raise or promotion, most people upgrade their lifestyle instead and spend all that money.
The average person in the US saves ~3 percent of their income. 3 percent! By our math, it’ll take you 60 years to retire. Good thing there’s social security for part of your wages, otherwise, you’d work until you were dead!
Why Has FIRE Only Recently Come To Popularity?
Prior to a few decades ago, your average person did not have access to investing — the buying and selling of stocks, bonds, and other securities. You had to get a broker and pay him a large fee or get a financial advisor and pay him a ton of money over your lifetime.
With the invention of the ETF and the popularity of passive income due to John Bogle, it’s so much easier to invest these days.
The major reason why people didn’t pursue financial independence in the past boils down to access. The ability to access the market has exploded — first came the discount brokers, allowing cheap access, then came the robo-advisors, allowing 100 percent, hands-off investing. In just a few years, robo-advisors have begun chipping away pretty heavily at money that was previously in financial advisor accounts.
Another big theme is financial apps – a group of people recognized that you could tell people about investing until the cows came home, but people wouldn’t realize they had extra money due to human psychology. If you’ve been spending your entire paycheck and living paycheck to paycheck for so long, it might seem impossible to save more money. Apps that round up each transaction you make and put that change in an investment account changed that. Other money apps ask you to chip in a few dollars per month and increase it as you go along.
Is this dangerous if the market goes down? Yes. But anything saved today is better than if you had spent it and saved $0. No?
The truth is, FIRE has always existed for the extremely wealthy because the extremely wealthy had access to grow their investments. Now, the average person has the ability to grow their wealth by investing as well, and become financially independent
So, How Much Is Needed To Reach Financial Independence?
Conventional FIRE research suggests retiring when you reach 25x your yearly expenses in net worth.
For example, if you spend $40,000 a year, you would be financially independent when you’ve saved up $1,000,000. Each year you would withdraw $40,000, with an increase of 3 percent per year due to inflation. So the second year you’d withdraw $41,200.
This is a baseline that many FIRE believers use as suggested by the Trinity Study. If you’re heavily versed in math, check out more quantitative analysis done by ERN. It’s the best advanced research I’ve seen on the topic — his 20+ safe withdrawal rate (SWR) series is my favorite in the topic.
Traditionally, you don’t count your physical residence as part of your Financial independence number. This is because we assume your 25x yearly expense of assets is generating a return and is liquid enough to be sold. Since you must live somewhere, you can’t sell off that place and generate excess returns in that way.
Reaching financial independence and retiring early definitely seems difficult at first glance, but if you’re curious to see other people who have retired early, I’ve compiled a list of 30 people who retired before 40 in this post. These are all people who retired in their 20s and 30s! Start saving and investing early, so you can do whatever you want with your life sooner!
A lot of FIRE proponents try and save 50 percent or more of their income. It seems like a giant number, but if you try to chop a few of your expenses every few weeks and work hard at getting raises or promotions, or working on your side-hustle, you’ll be there sooner than you realize. Trying to save an extra 2 or 3 percent per month until you get to a high savings rate will make it much easier instead of trying to get to 50 percent all at once. When you save 50 percent, you get to reach your financial independence number in 15 years. At 60 percent, you get to retire in under a decade.
If you’re familiar with high-level financial concepts, reaching your financial independence number is essentially similar to creating your own perpetuity — a bond instrument that generates returns forever.
In general, your investments should lean towards more stocks the farther away you are from retirement, and more bonds the closer you are to retirement.
A good way to get an easy answer to the weights of your portfolio is to take a look at the Target Date Funds Vanguard has, and then you can replicate it yourself by just buying the underlying funds if you are comfortable doing so.
What Is The Safe Withdrawal Rate?
A cornerstone of Financial Independence, Retire Early (FIRE) is the safe withdrawal rate (SWR). It tells you what percentage of your portfolio you can sell each year and not run out of money when you die. That’s how we came up with the 4 percent rule as a general baseline.
Keep in mind this is based on historical data, and historical performance is different from future performance. The market may perform much differently, so take the analysis with a grain of salt.
Also, our historical data generally only stretches back to the early 1900s. The stock market didn’t exist in the same diversified way as back then. You could also say the stock market is an entirely different creature today as more and more people invest in it. The growth of the market could be very well fueled by the increase in accessibility to the average person.
The most often quoted study, the Trinity Study, shows that a 4 percent SWR is what most people should aim for. That’s 25x your yearly expenses.
Some people take it to the extreme and go all the way to a 3.25 percent SWR, which translates into saving 31 times your yearly expenses.
A big part of what causes the SWR to fail is sequence of returns. If you look at the historical SP500 and bond market data, you can see that the SWR at 4 percent tends to fail if you retire just prior to a market recession.
What Types Of FIRE Are There?
There are three camps of FIRE, that somewhat correspond to current economic classes. They’re called lean FIRE, FIRE, and fatFIRE.
LeanFIRE devotees try to retire somewhere with a low cost of living (COL), sometimes taking it to the extreme by using geographic arbitrage and moving to really cheap international locations — we’ve compiled a list of 18 places across all continents here. If people stay in the US, they sometimes try to take advantage of social benefits. Generally, this group is particularly frugal and values not working more than extra luxuries.
Normal FIRE consists of living a middle class lifestyle.
FatFIRE is generally considered $2M+ for cities that aren’t NYC or SF. This is definitely a smaller subset of FIRE, but you should check out Physician on Fire as a source of FIRE for doctors, Big Law Investor as a source for lawyers, and Financial Samurai as a source for people in finance.
For all three, the level of FIRE is usually dependent on your spending patterns and not your net worth. If your net worth is $2M and you’re only spending $30k a year, you’re more defined as LeanFIRE. For whatever reason, a large amount of social benefits are defined as income and not net worth.
There’s also one other FI group that is pretty interesting. It’s best known as BaristaFI or CoastFI.
This group saves up a large percentage of their financial independence (FI) number. They then leaves the last bit to simply compound over a few years while working part-time. To them, working 10-20 hours a week feels much like retirement. For example, imagine you save up $750,000 of your $1,000,000 FI number. If your part-time work covers your yearly expenses, it would only take another 3 years to get to $1M. That’s the power of compound interest!
Despite the name “Barista”, you don’t have to work at a coffee shop. Most people would try to work part-time at their current job in order to keep their benefits.
Use The Financial Independence, Retire Early Blueprints
A financial advisor will probably tell you that it is incredibly hard to manage your finances and that’s why you need to pay him! Not true.
Most financial advisors charge in excess of 1 percent. That’s about $200,000 over your lifetime if you go with them. That’s a ton of money!
You basically have three choices when it comes down to investing:
- If you’re ok with DIY’ing your own investment portfolio, read our Admiral vs Investor shares breakdown to see how to replicate Target Date Funds for free.
- If you’re not comfortable with investing and want a robo-advisor to do it for you, check out Betterment and Ellevest. They both charge .25%, which is $25 per $10,000. Ellevest offers a free investment plan and has career counseling services.
- If you’re unable to set aside funds each month for investing just yet, check out Acorns ($5 bonus). They round up your change on all your transactions, so that you can see there’s extra money in your budget. Once you see this, you can start setting aside money each month for either a robo-advisor or Vanguard.
There’s definitely a time for a financial advisor and tax CPA/lawyer, but in my opinion I think you don’t need these advanced techniques unless you are dealing with wealth that will incur an inheritance tax or assets in multiple countries. That’s my personal opinion though, and you should seek out what is best for your personal solution.
In general, for the average person, there are only a few steps you need to take to automate and optimize your finances. We’ve created a specific personal finance blueprint that you can access here, with an explanation for each step.
We also have blueprints and step by step guides for eliminating specific parts of your debt:
- Step By Step Guide To Getting Rid Of Student Loans
- Guide To Getting Rid Of Credit Card Debt
- Step By Step Guide To Paying Off Your Mortgage Early
Lastly, you should create a budget for yourself, so that you can control how much money you spend.
I would recommend using Personal Capital for free to see where your spending is going, and then deciding which categories you can cut back in.
If you’re looking for budgeting software that really forces you to categorize each transaction so you can think about your spending, check out You Need A Budget.
How Many Years Does It Take To FIRE?
The good thing about FIRE is that there’s a simple equation to see how many years it will take to FIRE as a baseline. Assuming an average historical market rate applies to the future (which it doesn’t always come true!), here’s a chart breaking down the number of years to FIRE against the percentage of your income that you save.
As you can see, there’s a strong incentive to save up more than half, but once you reach that point, each incremental 5 percent you save is only a year saved until retirement. You’ll have to ask yourself if it’s worth it to save more or just live a comfortable life until then.
Until you reach 35 percent, each extra 5 percent you save of your income counts for more than a 3 year reduction in time to financial independence and early retirement. After you get to a 70 percent savings rate, you’re only becoming financially independent and retiring a year earlier.
FIRE is definitely easier with a higher-income. However, there’s no reason why you people with lower income can’t do it as well.
Grow your income through promotions and raises, or start a profitable side-hustle or find other ways to make money.
We’re a big fan of monetizing your life by doing things you’re already doing over here.
There’s no reason you can’t make more.
Why A Side Hustle Explodes Your Path To FIRE
Sure, a side hustle gets you more money, but it also comes with some other benefits to get you closer to financial independence.
The recent tax law changes regarding passthrough entities give a pretty advantageous tax cut to people who start their own companies — a 20 percent discount.
Also, people who have their own businesses are able to sock away up to $55,000 in 2018 in their i401ks. If you’re extra enterprising, you’re able to sock away $110,000 if you have corporate 401k and SEP 401k.
If your corporation does not give enough of a match for you to reach the 401k limit, you can always ask them if you can contribute after-tax contributions. This is commonly known in the tax world as a mega backdoor Roth. HR generally understands the phrase “after-tax contributions” more often.
Reduce Expenses + Make More Money To Reach FIRE Sooner
We’ve written a ton on how to slash costs on this blog and did the exact math!
- Refinance your student loans and mortgages to save thousands in interest
- Cook your meals instead of buying them out to save thousands a year
- Consider a bikeshare or bike instead of public transportation
- A car is a depreciating asset! Consider a used one or public transportation
- Lower your cell-phone bill to $10-$40 per month
- Use credit card rewards (points and miles) to fund your travels for free
- Eat nice meals for free by becoming Yelp Elite
- Use cashback sites to get hundreds to thousands of dollars back per year
Ways To Make More Money
- Get a raise. A 50 cent hourly raise is an extra $1,000 a year.
- Get a promotion. These usually come with a salary bump.
- Switch jobs. Usually you’re more likely to get a large salary bump simply by moving jobs.
- Find a side hustle or extra ways to make money. Decide if you want to go low-risk, lower pay, or high risk, but higher reward.
No Taxes For The Majority + Withdrawing Early Without Penalty
No Taxes For The Majority — Unless You’re Super FatFIRE
If you spend less than six-figures per year as a family (you’re married with kids), odds are you’re paying $0 in long-term capital gains tax when you’ve reached financial independence. This is because if your AGI is lower than $77k as a couple, you don’t have to pay tax on long-term capital gains. Note that your AGI is not your profits exactly — it’s that minus a deduction (standard or itemized). Principle is not counted in your AGI.
As you see in the chart below, it takes about 11 years for the amount you put into the portfolio to equal the growth. This means you can take out well over 6 figures at that point and still not have to deal with taxes.
Note: If you take money out of your 401k, you will have to pay ordinary income taxes.
If your AGI is above $200,000 for individual earners, or above $250,000 for couples, you get an extra 3.8% ACA tax on top of that.
There’s also tax loss harvesting. If you’ve never heard of tax loss harvesting, it basically means that you sell ETFS to incur loss while buying a very similar ETF to replace that. Similar is usually defined as highly correlated. You can do this yourself, or put your money with a robo-advisor to do this for you.
Note that you can only report $3,000 of tax losses due to this every year.
Lastly, you should know that there are seven states that do not have state or city income taxes. If you’re looking to fatFIRE, you might want to consider one of them as state and city taxes can take a lot out of your withdrawals each year.
How Do I Get My Funds Out Before Retirement Age?
The good thing about FIRE is that there are 2 ways to get your retirement funds out before you turn 59.5. This is the age the government starts to allow you to take out tax-advantaged dollars without penalty.
One way is the Roth ladder. Note that you need 5 years of advanced planning on this, otherwise you’ll have to pay the 10 percent penalty.
The other way is the 72t rule. This requires you to take substantially equal periodic payments (SEPP) from your IRA for at least 5 years or until you reach 59.5 — whichever is longer. Bankrate has a good calculator for this.
But What About Your Health(Care)?
For those of you worried about the cost of healthcare, Root of Good writes a blog post about social subsidies for healthcare, that is, unless you’re planning to FatFIRE.
If you’re aiming for FatFIRE, you probably won’t get these benefits (unless you live in SF or NYC? Unsure). The good thing about aiming for FatFIRE though, is that your money takes much less time to compound. If your FI number is $2M (as we defined FatFIRE), and we assume healthcare insurance costs + average annualized out of pocket is $25k at most, that’s about 2-3 extra years of compounding. In the meantime, perhaps try to work part-time at your current job to practice BaristaFI.
Don’t Derail Your Personal Health
A common issue with people who first hear about Financial Independence, Retire Early (FIRE) is that they run to cut all their costs.
That’s great, but make sure you aren’t sacrificing something at the cost of your health.
If you need that gym membership to make sure you exercise, then consider keeping it. Spending extra on food to be healthy? Cool, do what you have to do.
Don’t make yourself miserable today in order to save for FIRE a few years from now.
FIRE itself won’t necessarily make you happy, so don’t start trying to become FIRE because you think it will solve all your problems.
You should be happy with life regardless. FIRE will just allow you to do what you want on a daily basis.
Be happy in your normal life. FIRE should just be the icing on top of your cake.
Your Estimated FIRE Number Is Usually Too High
Lower Expenses When You’re Financially Independent
When you’re financially independent, odds are your expenses are lower.
You don’t have transportation costs every day to your job. You don’t have to pay for extra laundry and dry cleaning.
No longer are you subject to annoyances from work, so you’re probably less likely to feel the need to consume and buy things.
You’ll have more time to spend time cooking and exercising, hopefully lowering your health bill.
Since you have more time and energy, you’ll probably be able to DIY more things instead of purchasing.
The best things in life are cheap — spending time with family and friends and finding meaning.
You’ll be able to spend more time figuring out your points and miles balances for traveling.
The Early Retirement Police
Some people view retirement as chilling by the pool, watching Youtube cat videos (they are cute though!), and generally not doing anything productive.
There’s a growing crowd of people who say you’re not retired unless you’re doing something that doesn’t involve making money or being productive.
I find that kind of weird, because human beings need meaning to live their best life.
Maybe they love being creative and being productive, but now that they have the money to be financially free, they can finally take risks to create their own startup or some kind of new product.
The important thing to take away here is how to get to financial independence. After that, you can choose to be traditionally retired or not.
So, are you thinking about FIRE or already on the way?
Olivia worked in finance and wants you to learn the secrets of financial independence. She believes there are so many ways to monetize your life and make money doing the things you're already doing because so many companies offer free money.
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