- An introduction to the concept of Financial Independence and Retiring Early (FIRE)
- Covers the basic background with a heavy focus upon the psychology and decision-making processes of FI.
- Intended as a stepping stone for people new to the concept as well as a reference document for others further along the path.
- Part One of a Six part series, approximate length is ~5000 words.
Disclaimer, nothing in this post can be constituted as financial advise for investment purposes. Please do your own research and make your own decisions when investing. I am not liable for any gains or losses you incur as a result.
Financial Independence (FI) is the idea that you don’t need to be a wage earner all your life to survive. It’s the idea that you can take control over your financial destiny and through a series of smart choices, patience and hard work can substantially improve your financial position. It’s an idea that’s based upon discipline, understanding investments and expenditures as well as taking control.
Financial Independence has a secondary component, Retire Early, hence the acronym (FIRE). Whilst I think early retirement is a worthwhile goal in and of itself it isn’t the focus of this series. Instead, this series is about obtaining the understanding and knowledge necessary to place ourselves in the best possible financial situation.
There is a phenomenal amount of literature on the internet about Financial Independence and Personal Finances. There are strategies for paying down debt, investing, budgeting and much more. This series is intended as a one stop shop set of articles that are intended to serve as a stepping stone and reference into the wider literature. If you’re already familiar with the concepts then these articles may not be for you, but I hope you will still find value from them. This series is broken into the following:
- Part One (This article) – The Concept
- Part Two – Basic Financials and Expenditure
* Part Three – The Financial Technicals behind FI
- Part Four – Investing and Tax
- Part Five – Designing a lifestyle to achieve FI
- Part Six – Essential Resources on the path towards FI
Financial Independence (FI from now on) is the concept that you can have control over your financial destiny. That you are not necessarily beholden to a pay check from an employer you despise in a job you hate. Financial Independence is not about having tens of millions in the bank. Nor is it about being a hermit out in the woods. It is a personal journey and destination where you gain control over your own destiny. The purpose of this article is to introduce you to the concept and to help you understand that it is possible.
In its simplest format FI can be described as:
Having sufficient income from your investments to cover your annual expenses.
Breaking this down, it means that you have enough money invested in revenue earning assets to pay all of the expenses required to live your day to day life without depleting your available investment capital. That is, you don’t need any supplementary income outside of your investments to survive.
If you’re financially independent a number of options open up to you. If you don’t like your job, quit, retire, wind down your hours or anything else you can imagine. You’re not beholden to the pay check at all so you’re free to live your own life. If you want to work on a passion project then go for it, so long as you don’t deplete your capital then your expenses are covered for life.
If any of this sounds familiar then you’ve probably come across these concepts before. There are a number of well known bloggers out there, I won’t pretend to list them all but the most famous is Mr Money Mustache who has managed to set himself up in a successful niche dispensing lucrative lifestyle advice. Other examples include Root of Good and Early Retirement Extreme. If you’re into Reddit there is a full financial independence subreddit dedicated towards the subject. I will cover further resources in Part Six once it has been published.
What brings all of these people together is a shared desire to retire as soon as possible. Each of the aforementioned authors (but not all) managed to do this by some combination of:
- Having very well paying jobs
- Investing their surplus income (into a massive bull market in US Equities)
- Taking advantage of particular USA taxable accounts
- Reorganising their lifestyles to minimise their expenditure
Their experiences will not be completely replicable for different people. You may earn your living in an industry where your only living choices are high cost of living cities. The taxation structures of your home country may not be as conducive as the United States towards early retirement. Your access to a massive bull market in equities is entirely unpredictable. Your ability to earn a massive salary with surplus income may be limited.
That’s okay. FI is not just a final destination it is a mindset as well. Someone who is striving towards FI will have a good understanding of their own finances, they must know how to invest surplus capital, they must be in control of their own expenditure and they must understand their own personal psychology. FI is not a 6 month goal, you can’t just reorganise a couple of things and have the capital flowing in. Instead, it is a multi year process, one where the little decisions do add up to become something much greater in the end.
The remainder of this post will cover what I consider the basics of FI and how to go about implementing them into your day to day life. In this particular article I’m going to cover the high level FI concepts to give you a taste. The more technical sections to come will be a deeper delve down into the world of Financial Independence
These posts are nerdy and dense. I will be trying to convey a huge quantity of information in the simplest format I can manage. None of this information is new, the sources are too many to count. If you’re interested in further literature I’ll provide a list of books and blogs that may be useful to you. I believe strongly in recognising where ideas come from but recognise that any such list will be incomplete.
Your single most important asset to achieving either control over your own finances or in the long run financial independence is your mindset. Understanding how you respond to money, how you spend money and how you feel about it is incredibly important. If your first instinct when obtaining a small windfall, for example $2,000, is to think about how you can spend it then you’ll need to work on this mentality if you want to achieve FI.
That being said, the road towards FI is not one of deprivation, it isn’t one of scrimping and saving for every single dollar and feeling hardship as you go along the path. Achieving FI is not about minimising your expenditures at all costs and becoming a miser. Instead, it is one of rational and enlightened choices. Of choosing delayed gratification over instant enjoyment. Of understanding the true cost that expenses place upon us in terms of our most precious resource, our limited time.
Let’s take that $2,000. Other potential uses for it could be building up a rainy day fund in the form of an Emergency Cash reserve. Saving towards a long term goal (such as a house deposit) or investing the money into an ETF to earn returns over the long run. Of these, spending it now will give you pleasure for the moment, a cash reserve will give you peace of mind and investing the money will allow it to grow into true wealth.
Which one you choose to do is up to you. No-one can dictate how you should spend your money. But understand that you have choices and each of those choices has a consequence.
One of the most common concepts I come across when discussing finances with people is that most people aren’t aware they could do anything else with their money. They see a few thousand dollars in their bank account and think “Holiday”, “House” or “Car”. Their financial literacy is low. These individuals have longer term goals, home ownership, retirement, travel and sabbatical but they don’t think about how their choices today will impact their ability to achieve these goals. Simply, they don’t know how to set up their finances to achieve longer term goals.
So grab a piece of paper and write down your emotionally honest and visceral reactions to the following scenarios:
- You get granted $10,000 by your deceased (beloved) Uncle in his will.
- Your two closest friends just bought houses and took on mortgages.
- Your neighbour just bought a new car.
- Your colleague at work has been showing your their holiday photos from a resort on a private island.
- The share market drops in value 10%.
- The share market jumps in value 10%.
- A colleague gives you a “hot tip” on a particular stock.
Look at your answers, do you notice any commonalities amongst them. The truth is, if you feel any strong reaction to any of the above then you’re financial emotions are volatile. What does it matter what anyone else is doing with their money? It’s their lifestyle and how they choose to spend it is up to them. A sudden windfall or loss, through a gift or a sudden surge in the share market shouldn’t change any of your fundamental decisions. It just gets you there slightly faster. Finally, a hot tip is just speculation. Do your own research before blindly throwing your money into something.
What is the Value of Money
Understanding that we have choice and control over what we do with our money is one thing. We must also understand what our money has cost us to obtain, how many hours we had to sacrifice at a job to earn them, how much stress we had to take on dealing with office politics and how many hours we had to spend away from what we truly enjoy. These are all the costs associated with obtaining money.
When we spend $4 on a coffee to wake us up in the morning or pick up a round of drinks to blow off steam after work we’re paying a financial cost. But as we typically increase our financial resources through our labour we’re paying these costs through our time, effort and energy. We’re paying in increased stress. FI is about recognising the impact these small costs have on us and understanding that we could be building towards an alternative.
A different way to look at this is to use the 4% rule. The 4% rule is a rule of thumb that can be used to estimate your Safe Withdrawal Rate, a concept I’ll discuss in much greater depth later. The Safe Withdrawal Rate is based upon assumptions about stock market returns and is the estimated level at which a withdrawal from the investments will not impact the underlying principle. In practice, what this means is that if you multiply your annual expenses by 25 you’ll end up with the amount in principal you’ll need to sustain yourself indefinitely.
The Safe Withdrawal Rate can also be used to estimate the amount of capital required to support any habit or expenditure we have. Multiplying any annual expenditure by 25 gives us the principal required to sustain that annual expenditure indefinitely.
For a $5/week habit this equates to ~$250/year (rounding for simplicity). Under the 4% rule this habit would need additional capital of $6,250 to maintain indefinitely. Now let’s say you have a $1,000/year habit. You’ll need $25,000 of additional capital to maintain it. If you think about how quickly you’re able to accumulate capital, for example, let’s say you’re able to save $1,000/month then that $5/week habit is adding 6 months of additional working time on to your life. Whether it’s worth it or not is up to you.
It’s Not All About Money
When thinking about finances it can be very easy to become caught up in the whole process. This is called missing the forest for the trees or paralysis of analysis. Money is a tool which enables you to get what you want, it gives you security, food, material possessions and experiences when traded with others. By itself, it’s worthless, bits in a database or pieces of paper that with modern manufacturing techniques don’t even burn that well.
The entire concept of FI is to enable your life. To remove the requirement for working a salaried role or wage to meet your life’s goals and dreams. It’s not a race to see how much you have in the bank account. It’s not a competition between you and anyone else as to “how far along the FI journey they are in comparison.” It’s simply a mechanism you can use to maximise your life through taking control of your finances.
As such, you need to go out and create that life for yourself. You need to understand what is important. If you desperately want 3-4 children, they will be expensive, so plan your life and investments around them. Appreciate that they will delay things. If you want to be able to go to nice restaurants or cultural shows every week. Plan accordingly, make the adjustments in other areas such that you can build your capital base. If you hate work so much that you’ll do anything to avoid it then slash your expenditure and accelerate the journey.
Working towards FI is not about being a miser. It’s not about trying to always get the lowest price for everything or to be cheap. FI is about understanding you only have one life and you want to get the most from it. It’s an enabling tool that will decrease the amount of paid employment you need in order to free up your time for other purposes.
So Why FI?
FI is not a cure-all, nor is it something you should define yourself by. It’s an enabling factor that will allow you to live and enjoy the life you want. A common message in the FI community. So important it’s stickied to the front page of the FI subreddit is to build the life you want, then save for it.
Breaking this down. FI is not worthwhile if:
- You have to become a hermit to achieve it (unless this is what you truly want).
- You’re unable to enjoy the pleasures of friends and family due to financial constraints.
- You spend all of your time in a depressive haze.
Instead. FI introduces the concept of choices. Knowing what you truly want out of life enables you to set goals, to accept trade off’s and to understand the opportunity cost as to what you’re doing.
It’s not necessarily about sending a fuck you to the world and riding off into the sunset with middle fingers raised. It’s about giving yourself the freedom to do so. You don’t need to quit your job, but you’ll have the financial peace of mind knowing that you could. It’s not about shutting yourself away from the world, or never having any financial dealing ever again. Many people who have reached FI are still active in their communities and actively working to better their surroundings.
The journey towards FI is long. It takes years, if not decades. Some people will have a goal to achieve it as fast as possible. These are the bloggers who post articles about their retirement in their 30s. Others are more measured, taking an extra decade or coming to the party later on in life. Retiring at 45 still gives you an additional 20 years of retirement to enjoy without work. It can also give you a more mature outlook on life.
I’ve chosen to work towards FI slowly. I really enjoy my job, it gives me great opportunities and there are many elements I like about it. That being said, I may not always be this way. By introducing FI concepts such as expenditure control, delayed gratification and smart investment choices I’ll place myself into a much stronger financial position.
Since learning about FI and beginning the journey I have been able to accelerate my savings rate substantially without any decrease in my life satisfaction. I’m learning more and more about what makes me happy and learning how to solve problems without attempting to throw money at them.
I can then leverage this position, whether that is in taking more personal risks, reducing my working hours or shifting towards a non-profit sort of role or outright retiring early. Without FI I wouldn’t have the choice, I’d be locked into a job to match my journey on the hedonistic staircase.
How long will it take to reach FI?
For many of us when we first learn the basics of Financial Independence we get really excited. We see a clear pathway towards freedom from the corporate grind towards a life where we will have the time and ability to achieve our goals. We crunch all of the numbers and get… disappointed.
Financial Independence takes a substantial period of time to achieve. To accumulate sufficient capital to cover 25-30x your expenses is no mean feat. In fact, doing so will place you within the upper echelons of the wealthy in the vast majority of societies on earth. This cannot be done overnight.
FI is one of those goals which requires patience and discipline to achieve. Patience, because the payoff is years away, if not a decade or more at the beginning. Discipline because that timeline is entirely dependent upon your actions in the here and now. Taking on unwise financial commitments now dramatically impacts your ability to reach independence in the future. It really is that simple.
We are playing a game where the micro decisions are important but the long run payoff is so far into the future that financial models would imply we heavily discount it.
The reasonable time frame for achieving FI will vary by individuals. Your income potential, location, family situation, housing situation, hobbies, interests and the broader market will all impact your ability to reach FI.
Investing into a major bull market will help to quickly grow your capital as investment returns will speed you on the journey. Investing at the end of a bull market, when asset values are high will delay it. Earning more money is a simple way to increase your savings rate, but for some this may not be achievable. Likewise, being able to dramatically reduce your expenses through locations, family and housing situations can help you on the journey.
The point being. Every individuals journey on their path towards Financial Independence will be unique. You cannot look at someone else and say, “Hey! This guy achieved FI in 5 years, I’m at the 7 year point and I’m only 50% there, I’m a failure!” This is stupid. You don’t know the details that went in to reaching that goal. They may have started from a strong capital base already, or they live in a very low-cost of living area. They may have lived with their parents for many years to keep their lifestyle costs down. They may have been willing to make sacrifices that you are not.
By far the biggest impact upon your ability to retire is your expenses. So much so that the community has termed three different options for FI.
- LeanFIRE – The goal is to achieve Financial Independence as soon as possible by drastically cutting living expenses. This is the approach taken by Early Retirement Extreme and will require assets of at least $500,000 to support an income of $20,000 per year. In a LeanFIRE household expenses are kept to an absolute minimum in order to minimise the amount of capital required.
- RegularFIRE – The goal is to achieve a regular income of ~$40,000-60,000 from the assets. Will require at least $1-1.5 million in assets to achieve at the trigger date. A RegularFIRE household is largely indistinguishable from a middle class household, except, they don’t need to commute into a job every morning to sustain it.
- FatFIRE – The goal is to accumulate a surplus of assets to live an upper class lifestyle. A relative number is >$100,000 per year on expenses which will require at least $2.5 million in capital. Individuals with high income potential will naturally gravitate towards this outcome.
Given the relative differences in the asset base requirements and the different incomes it’s easy to see that LeanFIRE can be achieved faster than regular FIRE. FatFIRE will take longer still. Whatever your goal is you will need to spend years striving towards it. At the lower end, an extremely aggressive profile with a 70-80% savings rate may lead to FI in as little as 5 years. At the top end if you’re saving 30-40% of your income it may take as many as 20.
Retiring after twenty years of work (in your forties) is still a massive accomplishment. In doing this you’ll cut twenty years off your working life compared to the average individual. In the blogging sphere there are numerous examples of people who seek to achieve FI in their early 30s. These people are the ones who are writing blogs and supplying information. Why? Because they are the people who are most passionate about the concept and are therefore most likely to write about. Selection bias in action.
You don’t start-up a financial independence blog, write post after post on bringing down expenditures and tracking every dollar without being massively interested in the goal of FIRE. Of course these individuals will reach the goal faster, you’d be surprised if someone who dedicates hours and hours of their life towards something doesn’t achieve it.
But this isn’t the only way. It’s perfectly acceptable to take a slower journey towards FI. To start later in your life and to have different priorities. None of this negates the journey. It just takes a little bit longer.
The most exciting stage of the journey towards Financial Independence is the Setup Phase. In this phase you’ll be making decision around investments, looking at creative ways to reduce your expenditure and creating lots of nifty tools to plot your life out into the future. The setup phase is the (second) most exciting part of the FI journey as everything is novel and stimulating. Learning about the benefits of compound interest for the first time, discovering tax-advantaged accounts for the first time.
The setup phase is characterised by the limited number of resources you have available relative to your ambitions. FI still seems a very long way away at this point. The things you should be looking at here:
- Am I saving a solid proportion of my income in the most advantageous way possible?
- Do I have control over any liabilities I may have including student loans, mortgages or consumer credit?
- Am I controlling my expenditure to purchase only the things that are worthwhile to me?
Once you’ve mastered these basic questions you’re ready to move on to the accumulation phase. The key risk in this phase is you will be overwhelmed. It will all seem like too much to do and you may get frustrated that it’s not happening sooner. This is okay and natural. Just relax and go through the basics.
The accumulation phase is the most boring part of the FI journey. What doesn’t seem apparent to you during the setup phase is that achieving FI requires many years of investment and solid discipline. You will need to maintain, year after year, an investment strategy that works for you. You’ll need to diligently control your spending and in particular master the hedonistic treadmill and not letting lifestyle creep sink in.
At this stage your peers will also be accumulating financial resources in their lives. They may be going on expensive holidays, buying new cars or spending extravagant amounts on housing. You may look at social media and get inundated with conspicuous consumption. During the accumulation phase comparison with others will be the hardest thing to overcome.
The accumulation stage is a multi-year slog. In this phase it’s important to have outlets to control your temptations. Splurging every now and then will not derail your journey towards FI. Splurging every day will.
Understand that it is your own perceptions and expectations that are driving the comparisons. Understand that you don’t know 100% of the financial picture of others and that their life journey is different to your own. Understand that it’s okay to be a little bit different.
At this point it’s worthwhile to look at your peer and social groups. As humans we are a social creature. We like to talk to people, to discuss what’s going on in our lives and to make friends. This drive can either be used for you or against you. If you hang around a group of FI minded or frugally minded folks then it becomes much easier. Likewise, if you’re hanging around with people who get a new iPhone every six months then the challenge will be harder.
The one thing that must be mentioned here is the role a life partner plays. Financial stress is one of the major reasons why couples break up and has been cited as a leading cause of divorce. Needless to say, if you’re working towards FI but your partner wants to experience expensive holidays every six months and drive brand new cars then this will cause internal strife.
The only way to “solve” this dilemma is to find a partner who shares similar life goals to your own. They may not be as aggressive about FI as you, they may enjoy their work more or like the social elements. That’s okay. They don’t have to be 100% aligned with all of the concepts. But they cannot be diametrically opposed. They cannot be directly or indirectly sabotaging your FI goals if you want this to work.
Over time your financial resources will expand until you reach the dithering stage.
In the dithering stage your financial resources are almost sufficient for you to retire early and declare FI. At this point you’ll not be 100% sure if you have enough saved up but it will be close. Questions such as, should I work an extra year, will come to the foreground at this point. Change can be very scary and many businesses invest heavily in change management to help them.
In this stage you should have a good understanding as to how you’re going to access your money. That may be through asset draw downs. Bond or dividend payments or other similar financial mechanisms. At this stage you likely have a large pool of semi-liquid assets floating around, potentially in various retirement accounts.
Tax planning should be a major part of your planning at this point as you’re likely to be whacked with some big tax bills when you start liquidating investments. Look into how you can best mitigate these as every additional dollar you pay in tax is a decrease in the lifestyle you can enjoy when retired.
Financial Independence and Retirement Stage
Congratulations, you’ve made it. Go fuck yourself.
You’ve finally bitten the bullet and retired from working life. This doesn’t mean that you’ll have to quit all employed work ever again in the future. But it does mean you have complete financial freedom over whether you choose to work or not.
The first thing that is recommended is to take a few months. Let it all set in. Catch up on all of those projects you’ve been letting lie idle around the house for too long now. Enjoy not having to wake up and commute to a job for the first time in a decade. Just relax.
Don’t try to do too much at this stage.
Once you’ve retired from full-time work a common phenomenon is depression. For many of us we wrap not just our identities but our social lives and circumstances into our careers. When we meet people, one of the first things we do is ask “what they do.” It will be hard not having an answer to this question in particular.
At this stage you should have a good understanding of yourself and how you respond to different situations. The challenge now is maintaining the discipline to keep your expenditure within your investment income. Look for other opportunities, either financial or non financial in nature that truly interest you and be confident that you have an excellent safety net underneath you.
This article has covered the basics of Financial Independence and why you may want to go about achieving it. It is fair to say that FI is not a common pathway, we live in a society based upon consumerism as the governing ideology and it can be intimidating to go against the mold. This article is intended to help you get over that psychology and to understand that it is possible.
The next part in this series will cover the fundamental set up of the FI lifestyle. I’ll cover controlling your expenditure, setting up emergency buffers, the basics of debts and investments and some practical tips to target the most common areas where simple improvements can be made.