Lighting your FIRE
Have you heard of the FIRE movement? FIRE – Financial Independence Retire Early is a lifestyle and investment philosophy and movement that’s focused on aggressively saving and investing to achieve financial independence and retire much earlier than the traditional retirement age.
It’s inspired by the idea that one day, one can wake up with enough money to never have to work again.
The movement probably began with the book, Your Money or Your Life, by Vicki Robin and Joe Dominguez. That book describes the Crossover Point, the point in time at which income from investments is enough to fund expenses.
FIRE involves maximising savings rates, minimising expenses, and investing the surplus, with the goal of creating enough passive income from investments to cover living expenses without needing a traditional job. Other’s describe FIRE as a movement to have enough saved and invested that the income produced by those savings and investments is greater than your salary.
But of course, if you can live on less than your salary then your savings and investments need not be as large.
FIRE proponents typically aim to save a large percentage of their income, often 50 per cent or more, to accelerate the accumulation of wealth. They aggressively invest those savings in assets like equities, real estate, or other income-generating investments.
At the apex of the FIRE movement is the FIRE number. The FIRE number is the market value of the portfolio required to produce the income required to retire financially independent.
While the FIRE movement is arguably most popular among millennials and Gen Z, anyone can adopt its principles, particularly those who value financial freedom, flexibility, and early retirement over traditional career paths. Indeed, most articles about retirement seek to address the question of ‘how much is enough’, without ever referring to FIRE.
And the key isn’t necessarily the income; it’s the ratio between how much you earn and how much you need or want to spend. If you can enjoy a life spending less, your FIRE number can be lower. For some people, their FIRE number might be less than a million dollars, for others it could be $5 million or more.
FIRE’s factions and limitations
The FIRE movement has now been around long enough that it has produced splinter groups.
The LEAN FIRE proponents typically reject materialism, value simplicity, and are content to live off $30-$50,000 per year. The other bookend is represented by the FAT FIRE proponents, who aim to live a more extravagant life.
When it comes to some of the issues faced by those who aim for financial independence and to retire early, the brutal reality is that more is more. As Mae West once famously quipped, “too much of a good thing is…wonderful.”
Of course, obsessing over a single number – your FIRE number – can create stress and anxiety itself. It’s worth remembering that you’re not rich because you have money; you’re rich when you have others, who love and value you, to share it with.
Humans were created for relationships, and very few, if any, people discover that money solves issues of loneliness, heartbreak or self-worth. Money can provide moments of extreme happiness or ecstasy – opening the curtains to that ocean view for the first time – but these are always fleeting – you get used to the view and will often have the curtains closed – so, the goal should be contentment rather than happiness.
We were also created to work. Work provides purpose, potentially a source of connection, and income. That’s not to suggest you have to continue to work in a job or industry you detest, or with people you dislike or who don’t share your values.
One of the bigger issues faced by those who retire early, say in their thirties, having achieved financial independence, is that life circumstances can change.
Having children, experiencing divorce, or experiencing a natural or financial disaster can change the amount of money you need to remain retired and financially independent. For that reason, retiring early and then being out of the workforce for many years might mean that if you have to return to work, your qualifications may no longer be relevant, and you will be re-entering the workforce at a lower level.
That said, there are many benefits to budgeting, saving, and investing with a goal in mind. As the saying goes, failing to plan is planning to fail.
Calculating the FIRE number
The three big questions everyone on the journey to financial independence needs to ask are:
- How much do I need to retire?
- What will I do post-retirement?
- What’s Plan B?
For now, we’ll address the first question from the perspective of FIRE’s proponents: How much do I need to retire?
Here at the blog, we’ve written volumes about Portfolio Construction, the Three-Bucket Strategy, the 15 per cent Rule, and so on. All of these might affect the amount of money you need for retirement and how you manage that money post-retirement.
The simplest way FIRE proponents suggest calculating the FIRE number is to begin with the amount of money required to live the lifestyle one wants, and then, from that number, calculate the investment portfolio size required to produce that income.
By way of example, if you need $100,000 per year to fund your ideal lifestyle, FIRE proponents divide that number by four per cent, to produce the portfolio value required to produce that income. In this case they would conclude a portfolio with a market value of $2,500,000 is required.
As an aside, four per cent is typically chosen as it produces a sufficiently large portfolio to provide that minimum return. If the portfolio produces a higher return, then so much the better.
Don’t forget the tax!
Here’s the problem, though. If you are retiring early, you won’t enjoy the tax-free status enjoyed by those 65 years and over. If you retire at 45, you will be paying tax on the income you generate. And those investments will need to be outside of superannuation because you can’t access your super until later in life anyway.
An individual who wants $100,000 to spend as they please needs to generate that $100,000 after tax. Once superannuation contributions, the Medicare levy, and personal tax are taken into account, they need to earn a gross income of $148,959 pre-tax.
Of course, there are loads of nuances here depending on how the income is earned, but the point is made; you will need to earn a higher pre-tax amount to arrive at $100,000 after tax.
In any case, an annual income of $100,000 after tax may require a portfolio of $3.7 million based on a gross income of $149,000, drawing four per cent per year and assuming the portfolio’s return is higher than that four per cent on average.
And don’t forget volatility
One tax is considered, one of the bigger problems FIRE followers face is that they assume a linear return. Unfortunately, even a conventional 60/40 portfolio invested 60 per cent in treasury bonds and 40 per cent in equities is not going to produce a linear return. You won’t earn a steady seven or eight per cent per year if your FIRE portfolio is exposed to public markets, like the stock and bond markets. Some years the return could be much higher and some years the returns will be much lower.
We have previously discussed the Three Bucket Strategy to help deal with this.
But some investments seek to produce attractive linear returns, which might be very attractive to followers of the FIRE philosophy.
Those investments tend to be in private rather than public markets – investments that have reduced exposure to public markets or zero exposure to them.
The private market solution
FIRE proponents may want to consider, for example, a carefully evaluated Private Credit fund.
Private Credit may offer a more predictable income stream than traditional market-based assets, which can be attractive for those seeking consistent returns in retirement. For example, some Private Credit strategies have historically delivered relatively steady monthly performance (say for example, 9.5 per cent per annum since inception) with fewer drawdowns compared to listed equities.
Hypothetically, if someone who retired eight years ago and was targeting an annual after tax income of $100,000 a year – had invested in a Private Credit fund that delievered 9.5 per cent per annum, then they would need a much smaller capital base of $1.6 million than the example of $3.7 million calculated above (noting all of the caveats associated with personal tax, superannuation, etc.)
Investors should consider looking into private credit funds which have received high independent ratings.
While no returns are ever reliable, stable, or assured, FIRE promoters and followers should at least investigate Private Credit’s potential to deliver a satisfactory profile of returns.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
