What is FIRE and how does it work? In the world of personal finance, FIRE stands for Financial Independence Retired Early, or some variation thereof.
One is considered to be FIRE, or FIRE’d, when their living expenses can be covered by their investment returns. At that point, you are financially independent (FI) and can retire early if you so choose (RE) because work is optional for you.
But FIRE is so much more than budgeting, investments, or a math equation. FIRE is a way of life and a growing movement that is spreading across the globe and being embraced; not because people suddenly love budgeting and personal finance but because FIRE provides hope.
For anyone that has ever felt trapped by the thought of a working career that could last into their late 60’s or early 70’s FIRE provides a feasible alternative to the traditional path that society peddles. And once embraced, the idea of reaching financial independence and retiring early is nearly impossible to snuff out. That’s because, at its core, FIRE is reclamation of one’s personal freedom. And people long to be free.
WHAT IS FIRE AND HOW DOES IT WORK?
FIRE stands for Financial Independence Retired Early, but the true meaning of FIRE is open to interpretation and varies depending on who you are talking to. “What’s your why?’ is a common question among those seeking FIRE; your answer being the definition of what FIRE means to you.
For some that means a life of travel. For others it means spending more time with their spouse, kids, pursuing a hobby, starting a business or just taking their current job and shoving it.
While FIRE means something different to everyone how you get there (i.e. how you FIRE) has a mostly agreed upon formula.
The FIRE elevator pitch goes something like this, “When your investments generate enough money to cover your annual expenses you’re financially independent (FI). At that point work is optional and you can retire early (RE) if you want to.”
That’s it, that’s FIRE; but spitting out that definition is like pointing to the Grand Canyon and saying, ‘There it is! That is awesome!’ Sure, you might see it, but there’s so much to explore, and it all starts with some very basic math.
HOW TO FIRE
The formula to reach financial independence and retire early is often preached as:
- Spend less money than you make.
- Invest the difference.
- Eliminate and avoid debt.
The time it takes to FIRE depends on two primary factors:
- Your annual expenses. Naturally the more money you need to get by, the more money you’ll need to save. Inversely, if you can survive on less you don’t need to save as much.
- Your savings rate. If for some reason you can’t save any money your savings rate is 0% and you’ll never reach financial independence since you’ll always require a paycheck to get by. On the other end of that example is someone who can save 100% of their paycheck. That person doesn’t need income to get by, and is financially free.
The trick is to find your healthy balance. Those seeking FIRE are always looking for ways to make more money, reduce their expenses, and increase the percentage of money they’re able to save. Just search around on this blog and you’ll find numerous posts, videos, and articles on each one of those topics.
THE EASY MATH THAT’S FUELING THE FIRE MOVEMENT
Most FIRE proponents use a combination the 4% Rule and the Rule of 25 as the mathematical foundation from which they build their early retirement portfolios.
While the term ‘4% Rule’ is often used as an all-encompassing term for both rules they are in fact different. By themselves both of these financial rules are fine, but adding the two together is what creates the spark that ignites FIRE.
THE RULE OF 25 (a.k.a. THE MULTIPLY BY 25 RULE)
The Rule of 25 (also know as the Multiply by 25 Rule) attempts to define how much money you’ll need to save for your retirement. Not surprisingly, based on the name of the rule, that amount is 25 times your annual expenses (not income).
If you spend $50,000 per year multiply that amount by 25 and you’ll come up with a figure of $1,250,000.
In this example, our person would need to save up $1.25 million dollars to build a nest egg large enough to support their spending of $50,000 per year. FIRE seekers use this math as their financial finish line, but that’s not where the numbers end. After all, you’ll need that money to outlast you so that you don’t go broke in retirement.
To make that happen your money needs to be invested so that it can grow and outpace inflation. Low cost index fund investing is the most popular investment strategy you’ll hear about in the world of FIRE. All examples you see in this article are assuming that your money is invested in the US Stock Market.
THE 4% RULE
The 4% Rule is the math early retirees use to figure out how much of their portfolio they can spend without ever running out of money. Not surprisingly, based on the name of the rule, that amount is 4%.
On average the U.S. stock market grows at 7% each year. Some years the growth rate is much higher than 7% and some years the market loses value. However, over time this averages out to 7% growth annually. The 4% Rule says that from your 7% growth you’ll be able to spend 4% and leave the remaining 3% invested in order to keep up with the average rate of inflation. In theory, you’ll never touch your principal investment, only a portion of the growth.
As you can see from the table below, if you spend only 4% of your portfolio’s growth and leave the remaining 3% invested you’ll have enough money to live on for the rest of your life, while keeping up with inflation.
This is possible because the US Stock Market always goes up over time. Always. This happens because there is a limit to how much damage one company can do to the stock market (i.e. a company can only fall to $0, at which point it goes away), but there is no ceiling on how much value one company can contribute.
Bad companies will go away (Radio Shack) while solid companies will stick around (Amazon, Microsoft, Apple). This is why over time the stock market will always go back up! Sure this upward march looks more like an EKG machine and less like an up-moving escalator, but the trend is very clear: up and to the right.
RULE OF 25 + 4% RULE = FIRE
When combined, the Rule of 25 and the 4% Rule give you clear goals and expectations that you can use to design your early retirement.
Another way to look at this is to think about your expenses on an individual level. For example, suppose you need $100 per month to cover a cell phone bill. We can use math from the 4% Rule and the Rule of 25 to calculate exactly how much of your portfolio that $100 per month will account for.
There are two formulas you can use to get that number.
- Annual expense divided by 0.04 (in the case of our $100 cell phone bill, that’s ($100 * 12)/.04 = $30,000
- Annual expense multiplied by 25 (again, using our cell phone bill, that would be ($100*12)*25 = $30,000
Or you if you don’t want to do any math you can use this calculator:
- To use the calculator start by entering the amount of your expense in question (by default this is $100).
- Next, use the drop down menu to choose whether this expense is daily, weekly, monthly or yearly.
- Finally, use the slider at the bottom of the calculator to choose your safe withdraw rate. 4% is the default, but some plan on withdrawing more or less from their portfolio. Pick the SWR that works for you.
PROBLEMS WITH THE 4% RULE AND RULE OF 25?
The math behind FIRE is simple, but some question using the 4% Rule since it wasn’t designed for early retirees.
Originally the 4% Rule was created to identify a “safe withdraw rate” that ensured a retirement portfolio could survive 30 years. The problem with applying this rule to FIRE is that many early retirees need their portfolio to last double that. Can the 4% Rule hold up over a 60 year period?
The answer is, yes. Most of the time.
But “most of the time” isn’t very comforting when you’re talking about your retirement. Flexibility might be required to increase the surviveablity rates of a portfolio and those seeking FIRE understand this.
While it’s true that the 4% Rule wasn’t designed with the early retiree in mind, it should also be pointed out that the 4% Rule also assumed that you’d NEVER spend less than 4% of your portfolio per year. It also assumed that that you’d never, ever add a single penny to your portfolio once you retire.
With a couple of adjustments most concerns that people have about the 4% Rule can be nullified. Applying some combination of the following solutions to their retirement plans should be enough for the early retiree to ride out any financial storms that come their way:
- Saving more than 25 times your expenses (many aim for 33 times)
- Spending less than 4% of your portfolio during a down market (3% – 3.5% are popular estimates)
- Earning money during retirement (via hobbies or side hustles)
TO RETIRE OR NOT TO RETIRE? THAT IS THE QUESTION!
While FIRE means something different to nearly everyone, most everyone agrees that the FI is more important than the RE.
Financial independence isn’t about money or retiring early, it’s about reclaiming your time and doing what you want with it. It’s about no longer being a wage slave dependent upon that paycheck for stability.
FINANCIAL INDEPENDENCE > EARLY RETIREMENT (OR FI > RE)
Many FIRE seekers are extremely driven to achieve that freedom from a paycheck. Yet, for many, that same drive that helps them achieve financial independence at an early age also means they may have no desire to retire early.
A financially independent person works because they want to, not because they need to. It’s not a stretch to assume that someone working because they want to brings more passion to their work and gets more enjoyment from their labors.
If you’re fulfilled by your work and don’t need to make money from it, why would you ever leave it?
A FIRE’d person doesn’t need to. That’s why not everyone seeking FIRE is seeking an early retirement.
CAMP FIRE FINANCE
While not everyone should pursue an early retirement, everyone should pursue financial independence. Freeing yourself from the burden of money is a lofty goal. But it’s a goal that leads to a better, happier life.
Better to strive for FIRE and come up short rather than do nothing and succeed.
Our goal for Camp FIRE Finance is to become a resource for you on your own journey to FIRE. We feature three blog posts, podcast episodes, articles, videos, infographics, or other FIRE-related media each day. The goal is to help guide and inspire you to live a better, happier life
BIRDS OF A FEATHER
Reading about the successes, struggles, failures and questions that others pursuing FIRE face can be motivating. We hope you’ll join our Camp and help us spread the FIRE.