Who says you have to work until you’re 65?
By merely questioning that one assumption, you crack open the door to new possibilities. The question raises others, such as:
- Why did 65 become the default retirement age? Why not 75 – or 50?
- If you had enough money to retire tomorrow, what would you want to do with the rest of your life?
- What trade-offs would you accept to make your day job optional?
The FIRE movement attempts to address these questions by encouraging followers to create their own retirement timelines. Here’s what you need to know about the movement, from its pros and cons to creating a formula for reaching FIRE yourself.
What Is FIRE?
The acronym “FIRE” stands for “financial independence and retiring early.” Financial independence, sometimes referred to as financial freedom, is not the same thing as being rich. It specifically refers to the ability to cover your monthly living expenses with passive investment income alone, independent of your job – in other words, not needing a job to pay your bills.
You can be financially independent with a middle-class income and lifestyle or even a modest, frugal lifestyle. If your investments earn you $20,000 per year, and you live on no more than $20,000 per year, you would be financially independent, even if no one would accuse you of being rich.
An important distinction comes to light when you realize you get to choose any age at which to retire: You can spend most of your income on the trappings and appearance of wealth, or you can funnel your income into investments that generate actual wealth.
Too few people – even among personal finance enthusiasts – understand the inverse relationship between feeling wealthy and becoming wealthy. But once you understand that FIRE is a choice, it forces you to reevaluate your priorities.
Benefits of FIRE
Like any popular movement, FIRE has plenty of benefits and its share of critics. The most obvious benefit of pursuing FIRE is not having to work anymore. But many of the benefits are more subtle and stem from pushing adherents to think differently about money.
1. It Challenges the 40+ Year Career Assumption
Most people never question the notion that they’ll work into their 60s. They work full-time, hopefully doing something they don’t hate, and spend nights and weekends with their families and friends. They buy the best houses they can afford, the best cars they can afford, and the best entertainment they can afford.
There’s no introspection and no questioning; just “work, weekend, repeat” ad infinitum – at least until you’re old enough for Social Security and Medicare, and then you can start thinking about throwing in the towel.
Questioning this assumption forces you to think differently about your retirement. Working for four or five decades and spending 90% to 95% of your income is only one option. The FIRE movement posits another: working for one or two decades or less, spending 30% to 50% of your income and saving the rest, and then doing whatever you like.
FIRE argues that working is a choice. It may not be a choice for you today, but whether you need to work 10 years from now is optional if you take the right actions. And that realization puts the responsibility back on you to consciously choose your career and retirement schedule, rather than thoughtlessly following the crowd.
Accepting that responsibility forces you to be more intentional in your priorities. Is it more important to you to spend more money today to feel like you’re rich? Or is it more important to accumulate the assets and freedom to do as you wish tomorrow?
2. It Removes the Constraints of Time & Money
Most people live their lives shackled by two constraints: time and money. They work full-time, so their schedule and free time are dictated by their work, and their money is dictated by their earnings from that work.
But financial independence and retiring early remove those constraints. When work becomes optional, you regain complete control over your schedule and time. You can work part-time, set your own hours, or not work at all. You can earn more money by working more hours or switching to higher-paying work if you like. It’s up to you.
3. It Allows You to Pursue Dream Work
When money no longer dictates your career decisions, more possibilities open up before you. You achieve real freedom: the freedom to stay at home with your kids, pursue your dream job, or volunteer full-time, for example.
I’ve wanted to write novels ever since I was a kid. But I didn’t do it because I didn’t want to be a starving artist. As I make progress toward financial independence, that fear has started receding into the background. Even if I publish a novel that bombs and my mother is the only buyer, I still wouldn’t starve.
What would you do if you had enough money to pay your bills for the rest of your life? Unless you already have your dream job, you’d probably do something different. And that “something different” is what becomes possible when you’re financially independent.
One final thought on the subject of dream work: Many 20-somethings don’t know what their dream work is. For that matter, the same goes for many 30-somethings. So while you figure out exactly what your true calling is in this life, pursuing FIRE will help you pay for it when the time comes.
4. It Forces You to Define How Much Is “Enough”
In my 20s and early 30s, no matter how much money I earned, I always wanted more. I’d get a raise, go out and celebrate with friends, and be ecstatic for a few days. Then that higher income became my new normal, and it wasn’t exciting anymore. After the brief euphoria of moving into a bigger home or buying a better car, I’d go back to being as happy – or unhappy – as I was before.
This constantly shifting baseline is known in psychology as “hedonic adaptation” or the “hedonic treadmill.” It’s why retail therapy only provides a few hours of happiness before leaving you feeling just as empty as before you blew several hundred dollars on clothes, shoes, or gadgets.
Lifestyle inflation doesn’t mean achieving more happiness; it just means spending more money. But pursuing FIRE forces you to define exactly how much money is “enough” as your target for investment income.
And because it takes a high savings rate to reach FIRE (more on that shortly), your idea of “enough” inherently remains grounded in what you need to be happy, not the maximum you can get away with spending at any given moment.
Criticisms of FIRE
For all its proponents, the FIRE movement has its detractors. Some of the criticisms below are legitimate risks you must mitigate before you can retire. Others are merely a reflexive reaction against the new, the disruptive, and the different.
1. You May Run Out of Money
Whether you retire at 30 or 80, you risk running out of money if you didn’t save enough while you were working.
Some investments, such as rental properties and dividend-paying stocks, generate ongoing income with no need to sell off assets. Yet because most of the returns from stocks come from price growth, retirees typically sell off a certain percentage of their stock portfolio every year in retirement, causing it to dwindle over time.
What percentage can you sell off without worrying about running out of money? The unsatisfying answer is “It depends,” but the traditional answer is that at a 4% withdrawal rate, your portfolio will last at least 30 years.
Lower withdrawal rates leave your nest egg intact longer, which means that if you want to retire early, you need more money saved. It’s hardly rocket science, but what is surprising is that you don’t have to lower the withdrawal rate by much for your nest egg to last indefinitely.
According to historical stock market performance, a 3.5% withdrawal rate will allow your nest egg to grow forever; see this explanation of how safe withdrawal rates work for details.
My Take
Running out of money is a risk of retirement in general and not unique to early retirement. No one should retire without fully understanding how much money they need to have saved and invested, regardless of their age.
2. You May Retire With Too Little Income
Just because you can live on $5,000 per month today doesn’t mean that you can live on it next year or 30 years from now. This is due to two factors: the risk of inflation and the risk of unforeseen future expenses (more on the latter shortly).
In the case of inflation, you should be taking it into account with your nest egg planning. For example, when financial planners calculate safe withdrawal rates, they adjust for inflation each year, growing the annual withdrawal by 2% or so.
I particularly like rental properties for ongoing income since rents rise alongside inflation. And since fixed-rate mortgage payments remain the same, your profit margin on rentals grows faster than the overall pace of rent or inflation growth.
My Take
Again, future income growth and accounting for inflation are fundamental to retirement planning in general. Investors should learn how to protect against inflation, regardless of when they plan to retire.
But early retirees have a unique advantage over their older counterparts: They can go back to work if need be. A person who retires at 40 can change their mind two years later and start earning an income again. A person who retires at 70 has a harder time going back to work.
3. You May Not Budget Enough for Future Medical Expenses
Most 40-year-olds have relatively low medical expenses. The same can’t be said for most 80-year-olds.
Adults must expect higher medical costs as they age and their health deteriorates. It’s part of retirement planning, just like making sure your nest egg doesn’t run dry, regardless of your retirement age.
Keep in mind that you qualify for Medicare at age 65, so by the time you reach the traditional retirement age, you can still ease your health care costs with Medicare. That said, if you didn’t work enough years to qualify for Social Security, you may be required to pay for Medicare.
My Take
Between the day you retire and your 65th birthday, you’re going to need to cover your own health care costs. Even after they qualify for Medicare, many people opt to buy extended coverage, commonly referred to as Medicare Advantage. Budget accordingly and plan on higher medical expenses as you age.
One approach is to review health care options for the self-employed. You can also use an HSA through Lively to combine a high-deductible insurance policy with your own flexible health savings investments.
Some people take relaxed, fun part-time jobs that offer health insurance. And many people who reach financial independence never retire fully. They simply switch to a dream job with a lower salary – a dream job that ideally includes health coverage.
4. You Lose Decades of Compounding & Wealth Building
When you retire, you stop earning and start relying on your investments to cover your bills. That means you stop investing fresh money into them and start withdrawing money instead, which means no more compounding returns.
Compounding is incredibly powerful, but it takes time to work its magic. Consider two people who both start working at age 22 and invest $10,000 per year every year of their careers:
- One of them works a traditional 45-year career and retires at age 67. At a 10% average annual return, they retire with an impressive $7,907,953.
- The other retires at 42. With only 20 years of contributions and compounding, their nest egg is less than a tenth as large at $630,025.
My Take
First, not everyone wants to be rich. Some people would rather retire young with a modest lifestyle than work 25 years longer to have a wealthy lifestyle.
Second, the math in the two examples above assumes that each worker is investing the same amount every year. But that’s not how FIRE works; people pursuing FIRE intentionally budget for a high savings rate to maximize their investments. They effectively swap in a high savings rate for compounding.
A better comparison would be that the FIRE seeker invests $30,000 or $40,000 per year for 20 years, in contrast with the traditional worker’s $10,000. After 20 years at 10% returns compounded, the FIRE seeker would have $1,890,075 if they invested $30,000 per year and $2,520,100 if they invested $40,000 per year. That’s still less than the 45-year-career worker, but it’s nothing to scoff at.
Finally, keep in mind that most people who pursue FIRE don’t stop working and earning entirely; they merely change careers. In fact, they may well decide to work for more years than their traditional counterparts since they’re pursuing their dream work.
5. You Live for the Future, Not the Present
If you scrimp and save and sacrifice today so that you can have a brighter tomorrow, aren’t you living in the future and not the present? For that matter, what if you get hit by a bus and never see that brighter future?
We all must walk the delicate balance between planning for the future and living in the moment. But when you invest so much of your money and energy in building passive income for tomorrow, it can be easy to lose sight of the joys of today.
My Take
Frugality and a high savings rate don’t necessarily mean sacrifice, nor do they mean you don’t live in the present. Living in the present requires mindfulness, not money.
The simple fact is that if frugality makes you miserable, then FIRE is probably not for you. The entire point of FIRE is freedom, intentionality, and prioritization. If your priorities involve spending most of your income, there’s nothing wrong with that, but you probably aren’t a good fit for FIRE.
Alternatively, if you don’t mind front-loading your frugality and living a leaner life while you’re young, you can enjoy the fruits of that frugality later in the form of financial independence. Living lean doesn’t have to mean ramen noodles every night, but it does mean spending less than you could afford to so you can save and invest more money.
6. FIRE Is Only for [Insert Identifier Here]
It’s easy to dismiss FIRE as something that only other people can attain because then you don’t have to re-evaluate your own spending and financial goals. The dismissal goes something like this:
- “Only people with six-digit salaries can afford to reach FIRE.”
- “Only single people can reach FIRE.”
- “Only married people can reach FIRE.”
- “Only people without kids can reach FIRE.”
- “Only white male millennial tech workers living in Silicon Valley who wear square ties can reach FIRE.”
And so on. They all boil down to a single justification pointing to some external reason why it’s not realistic for you to reach FIRE, taking all of the responsibility off of you.
My Take
Of all the criticisms of the FIRE movement, this one contains the least truth.
Yes, the more you earn, the faster you can theoretically reach financial independence. But spending habits are hard to break, and high earners grow accustomed to high spending. In some ways, it’s easier to earn more and hold your spending steady than it is to cut your spending in half.
Whether you’re married, single, have kids or don’t have kids, each status has its advantages and disadvantages for reaching FIRE. Having two incomes can help, but only if your spouse is equally committed to financial independence. And many families live on a single income.
The same goes for race, gender, work type, and any other identifier you want to swap in. When you stop pointing to external reasons for why you can’t do something and accept that your own decisions determine your outcome, it’s both freeing and terrifying.
You’re behind the wheel, and you get to choose where you want to go and how fast you get there.
The Formula to Reach FIRE
If anyone can reach financial independence and retire early, then how can you do it?
There are many paths to FIRE and many strategies for building passive income, but they all share common denominators. Here are the key steps to take.
1. Set a Target for Spending & Passive Income
To get anywhere, you first need to know where you want to go. Set a target for passive income, starting with the minimum amount you can spend each month and still be happy. After reaching financial independence, you can always choose to keep working, earning, and building more passive income.
By way of example, let’s say you want $4,000 per month in passive income. Now that you have a target, you can start figuring out how to reach it.
2. Set a High Savings Rate
The gap between what you earn and what you spend is one of the most critical numbers for building wealth, not just for FIRE. Look for ways to spend less and save more.
In particular, three costs make up roughly 70% of the average American’s budget, according to the Bureau of Labor Statistics: housing, transportation, and food. These three expenses offer the greatest room for savings.
For example, you could take a job that provides free housing to reduce your housing costs. You can try one of these 10 ways to minimize your transportation costs. You can bring your lunch to work and save hundreds of dollars per month. There’s always a cheaper – or even free – alternative to traditional spending. Look no further than these options for traveling the world for free.
To reach FIRE in five or 10 years, aim for a savings rate of 50% to 70% of your income. It’s not easy, but if it were easy, everyone would work for five years and then retire.
3. Maximize Your Active Income
The more you earn, the more you can save. Start working on getting that promotion or raise, find a better-paying job, or even change careers to earn more.
And your income potential doesn’t end with your full-time job. Look into side gigs to generate extra money. You can even turn your hobby into a money-making business.
The trick is to avoid lifestyle inflation and not spend more just because you start earning more. All that additional income should go straight into income-producing investments.
Pro tip: If you’re looking for a way to make some extra money on the side, consider Instacart. With Instacart you’ll earn extra income going grocery shopping for others. Since you’ll be able to set your own hours, you can work as much or as little as your schedule allows.
4. Invest for Passive Income
From dividends to rental properties, private notes to art (yes, you can even invest in art through Masterworks), crowdfunding websites like Groundfloor to bonds, you have plenty of options for generating passive income.
Personally, I like rental properties for high-yield income and stocks for diversification and long-term growth. One enormous advantage of rental properties is that you can leverage other people’s money to build your portfolio of income-producing assets.
For example, say you take $25,000 and use it as the down payment to buy a fixer-upper for a rental property. You cover closing costs with a seller concession and finance the renovation costs with a hard money loan. Upon completion, you refinance the property with a cheaper long-term mortgage and pull your original $25,000 back out.
You now have a property generating monthly income with no net cash investment from you. You can repeat this process indefinitely, creating a new stream of passive income with each property. It even has a fun acronym in the world of real estate investing: BRRRR, or “Buy, Renovate, Rent, Refinance, Repeat.”
Pro tip: If you’re interested in real estate but don’t want to own physical property, look into DiversyFund. It allows you to build wealth through commercial real estate, and you can get started with just $500. Sign up for DiversyFund.
5. Know Your FIRE Ratio
As they say in business, that which gets measured gets done.
In addition to your savings rate, one crucial number to track is your FIRE ratio, otherwise known as a FI ratio. It’s the percentage of your monthly expenses that you can currently cover with your passive income.
For example, if your monthly expenses total $4,000, and you currently have $400 coming in from investments every month, you have a FIRE ratio of 10%.
When your FIRE ratio reaches 100%, pop the champagne cork because you’re financially independent. You can retire and never work another day if you like. Or you can keep working, either in your current career or a fun, low-stress second career.
I also like to track my net worth through the budgeting app YNAB, though I acknowledge that it’s largely a vanity metric. For financial independence, your net worth is only as relevant as its ability to generate ongoing income for you.
Finally, keep an eye on your asset allocation as well. At the beginning of your journey to FIRE, your investing strategy should focus on growth regardless of short-term volatility.
After all, if the stock market drops by 20% while you’re working, it’s no skin off your back – quite the opposite since you’re buying rather than selling at this point in your career. But as you get closer to retirement, income stability and reliability become more important. Without your full-time job to pay your bills, you become vulnerable to sequence of returns risk.
Look for ways to reduce risk in your stock investment portfolio as you get closer to retiring, regardless of your age.
Investment Strategies for People Pursuing FIRE
So, people who reach financial independence and possibly retire early have slightly different advantages and risks than those who retire in their 60s. But does that translate to a different investing strategy?
Yes — but only to an extent.
Stick with the Fundamentals for Stocks
Yes, you could pick individual stocks, or mimic stock picking services. And I occasionally do, with a little fun money on the side.
But most people pursuing FIRE use index funds and low-cost exchange-traded funds (ETFs) to diversify their portfolios and gain exposure to thousands of stocks, investing in the market as a whole rather than trying to pick the next Netflix.
Over the long term, the S&P 500 index has returned an average of 10% annually.
If you don’t know anything about stocks, try investing through a free robo-advisor like SoFi Invest. Alternatively, with even the slightest knowledge you can pick a few ETFs yourself.
I recommend at least one large-cap U.S. fund, one small-cap U.S. fund, one international developed countries fund, and one emerging markets fund. As you learn more, you can branch out, but just those four funds make an excellent foundation for your stock portfolio.
Stick with a robo-advisor until you reach a high net worth, and then consider switching to a human hybrid advising model. By saving yourself the hefty fees charged by traditional investment advisors, you can reach financial independence years earlier.
Include Real Estate in Some Form
As a real estate investor myself, I can assure you that not everyone should invest directly in real estate. Only consider it if you have a passion for it, and plan to invest in properties as a side business.
For the average person, you’re better off diversifying into real estate through more passive means. Try one of many indirect ways to invest in real estate, such as real estate crowdfunding investments like Fundrise, Streitwise, and Groundfloor.
While you can easily invest in publicly traded real estate investment trusts (REITs), and they do provide excellent liquidity, they come with several drawbacks. Most notably, they move with too much correlation with stock indexes to provide any real diversification benefits.
In my own investment portfolio, I use real estate as a stand-in for bonds. My real estate investments provide strong income yields with far more stability than the stock market. They don’t offer the same liquidity, but I don’t need liquidity from my real estate investments. My emergency fund and stock investments offer plenty.
And if you do decide to invest in real estate directly, you can score some excellent tax benefits to boot!
Minimize High-Risk Speculation
It seems like everyone has a grungy cousin who made $100,000 on Dogecoin speculation or the like. But that doesn’t mean you should go out and put all your savings into cryptocurrencies or other speculative investments.
I have a little money in Bitcoin, Ethereum, and other crypto assets. Emphasis on “little” — I set aside no more than 5% of my portfolio for fun money investments and speculations. It would annoy me to lose it, but it wouldn’t break me.
If you feel the need to show off how smart you are by picking stocks or speculative investments like fine art or cryptocurrencies, go for it. But only do so with a small percentage of your total assets.
Which, come to think of it, is no different than how everyone else should treat these investments.
Final Word
When you retire young, don’t expect help from Social Security or Medicare. You won’t qualify for many years, if at all.
Of course, the purchasing power of Social Security benefits has been declining for decades, losing 30% between 2000 and 2020, according to The Senior Citizens League. And the Social Security Administration admitted in 2018 that its spending deficit puts it on track for insolvency by 2034.
As for health insurance, if you retire young, you can exercise the same health insurance options as the self-employed.
A 50%, 60%, or 70% savings rate is not easy. It’s not fun to drive a 10-year-old beater while your friends drive brand-new BMWs. But it’s a lifestyle choice based on priorities: Would you rather build enough wealth to retire young, or would you rather spend most of your paycheck now?
There’s no wrong answer. But those willing to spend less today get to play tomorrow while their colleagues continue grinding away at work.
